Getting ready for the CSRD

The Corporate Sustainability Reporting Directive (CSRD) is a complex regulation for companies to prepare for, particularly so for groups headquartered in the US that do business in the EU.

US groups that have more than a de minimis footprint or revenues in the EU are likely to be scoped in to CSRD reporting to some extent. With compliance horizons fast approaching, it is critical for companies to begin readiness efforts. From our conversations with clients, we have repeatedly heard the following issues as priorities: scoping, reporting options, double materiality and the EU Taxonomy.

1. Scoping — assessing the “size of the problem”

For many companies, scoping exercised under the CSRD can produce unanticipated results, with the CSRD criteria scoping in a much larger proportion of their business than expected. We’ve also seen companies conduct initial assessments of their CSRD exposure and incorrectly concluding they would not be scoped in or underestimating the full scale of the CSRD scoping. Companies should complete comprehensive scoping assessments as soon as possible to not fall behind in their readiness efforts.

Common scoping issues include:

• Data availability: The scoping under CSRD is on an entity basis. This can present challenges for companies that may not have the right data where they need it.
• Interactions with group structure: A group’s structure can significantly impact the extent of the scoping. 
• Debt: Having securities listed on an EU regulated market is an element of the scoping under CSRD. Companies are looking carefully at where their securities are listed, on which exchanges and the jurisdiction of the issuer.

The EU has also pushed through an amendment to the thresholds for scoping (uprating them in line with 10 years of inflation) as part of the EU’s 25% reporting burden reduction initiative. In addition, companies should monitor their analysis in light of Member State transposition. EU Member States had until July 6, 2024, to transpose the CSRD into their national laws.

2. Reporting options — at which level and when

Third-country groups (those not headquartered in the EU) with entities scoped in to the CSRD face complex considerations for deciding how to report on the CSRD. Having conducted scoping exercises, companies are rapidly deciding their preferred reporting option and accelerating readiness work on that basis.
Common considerations to determine a reporting option include:

• Extent of scoping: For some US group companies that either have a significant portion of their revenues or entity footprint in Europe, or that have elevated EU entities in their group structure, much of their business is likely to be scoped in to reporting under the CSRD. This may drive different conversations around the reporting option.
• Scale of disclosure: The European Sustainability Reporting Standards (ESRS) and EU Taxonomy that scoped-in entities will report on are extensive and novel disclosures. As such, companies are considering whether they can handle the extent of disclosures required by the reporting option chosen— and on the applicable time horizon.
• Control of process: Given the extensiveness of the disclosures and the strategic considerations attached, many companies want to perform the preparedness for the CSRD at the enterprise level, where many companies have prepared and housed their sustainability data. This may influence the reporting option being considered and the way readiness is overseen.
• Leader or laggard: Many companies that have been leaders on environmental, social and governance (ESG) and sustainability disclosure want to maintain that position. That may influence how they choose to report on the CSRD, in addition to the capital markets implications of the disclosure choice.
• Interaction with other reporting requirements: Companies are also aware of the range of sustainability reporting initiatives underway in the regulatory and voluntary space, so they are considering how their preferred reporting option under CSRD will impact their readiness efforts in relation to other requirements.

 

3. Double materiality

Many companies have existing approaches to conduct a “materiality” assessment or a “priority issue assessment” for voluntary sustainability reporting. These often reference an existing voluntary ESG disclosure framework. However, the double materiality process prescribed by the ESRS is new, and existing approaches need to be adapted.

In a double materiality assessment, something is “material” if it bears importance from an impact or financial perspective. Assurance presents another challenge, as the process for conducting the double materiality assessment will be subject to assurance alongside the disclosures. Given that, there is a significant burden of education to explain the ESRS double materiality assessment and to build capacity around conducting assessments. 
Companies are facing a range of challenges, including:

• Guidance: Companies are engaging with the implementation guidance issued by the European Financial Reporting Advisory Group (EFRAG). That guidance has also been supplemented by a compendium of Q&As responding to practitioner questions through EFRAG’s platform
• Interaction with existing materiality approaches: For companies considering reporting at the global level, there have been discussions around the interaction of the ESRS double materiality assessment and ESRS disclosures with existing materiality assessments and disclosures made for the purposes of Securities and Exchange Commission reporting. 
• Extent of stakeholder engagement: The ESRS prescribes a list of potential stakeholders to consult for the assessment. Companies are considering how best to manage this consultation burden and the tech solutions they can leverage.

 

4. The EU Taxonomy

 
Companies that are scoped in to the CSRD are also scoped in to reporting on the EU Taxonomy on the same time horizon — and subject to the same level of assurance. Like the CSRD, the Taxonomy is a key part of the EU’s Green Deal policy framework. The Taxonomy establishes the notion of “green by law” — that an activity is not sustainable because a company says so, but rather it is sustainable by reference to science-based set of criteria developed by the European Commission’s Platform on Sustainable Finance.
 
At its core, the Taxonomy is asking companies to answer two questions:

• Are you conducting activities that can potentially contribute to a sustainable economy? (eligibility)
• Are you doing those activities in a sustainable way? (alignment)

The outcome of a Taxonomy assessment is a set of KPIs indicating the proportion of a company’s revenue, capex and opex that are “green” by reference to the Taxonomy criteria.
 
Companies face a broad range of Taxonomy challenges, including:

• Getting started with eligibility assessments: working out the size of the problem of the Taxonomy activities the company is engaged in and beginning to engage with the granularity of disclosures in relation to KPIs and activities
• Existing criteria: considering how the Taxonomy identifies an activity as qualifying as green and how a company’s existing approaches and disclosures talk about being green (whether in sustainability disclosures or green claims regarding products and services)
• Consistency: thinking through how the results of the double materiality assessment and the Taxonomy assessment will align

 
Beyond the beginning
Companies are now accelerating the pace of CSRD readiness. This is necessary as the compliance time horizons are close and the build to get ready for CSRD disclosures is extensive. This multiyear readiness effort will likely include:

• Creating a readiness roadmap: Clients are conducting gap assessments, mapping their existing reporting to the requirements of the standards they will have to report on (both mandatory and materiality-driven elements). These gaps are a mix of narrative and quantitative disclosures, and some, such as Taxonomy, are also novel; as such, they are expected to be extensive in number and require significant cross-functional collaboration and effort to fill.
• Updating ESG reporting approach: As part of CSRD readiness, many companies are thinking about whether their existing ESG reporting should be revisited.
• Revising ESG strategy: The CSRD readiness roadmap may lead companies to reconsider their ESG strategies. For example, companies may have to report on a range of sustainability topics they have never reported on before. As such, to avoid disclosing a gap, a company may want to rapidly develop and subsequently augment such strategies in these new areas.

Getting ready for the CSRD is a complex, multiyear undertaking. It is imperative that companies assess the extent to which they are scoped in to the CSRD and begin their readiness efforts.

Stay informed on sustainability reporting developments by subscribing to our monthly updates.
 
Brian Tomlinson is Managing Director, Finance Accounting Advisory Services, Ernst & Young LLP. He advises corporations across sectors at different stages of maturity on ESG practice, helping them navigate complex and evolving reporting environments and the shifting expectations of institutional investors. Brian is widely published in leading journals and publications, including Harvard Business Review, the Journal of Applied Corporate Finance, MIT Sloan Management Review and Institutional Investor.
 
_{The views of the author set out in this publication are not necessarily the views of Ernst & Young LLP or other members of the global EY organization. Moreover, they should be seen in the context of the time they were made.}