Third country entities, including US and UK corporates, need to take note that they may be in scope of the new EU mandatory sustainability reporting requirements under the EU Corporate Sustainability Reporting Directive (the CSRD).  The European Parliament has recently adopted the CSRD¹ and the European Council is expected to adopt the proposal shortly, after which it will enter into force.

What is the CSRD?

The CSRD was proposed by the EU Commission (EC) in April 2021² and aims to create EU corporate sustainability reporting standards, thereby improving sustainability reporting and access to publicly available information about the risks that sustainability issues present for companies. Now that the European Parliament has adopted the CSRD, the European Council is expected to adopt the proposal on 28 November 2022, after which it will be signed and published in the Official Journal of the EU and enter into force 20 days after publication³. 

The CSRD significantly widens the scope of the existing reporting requirements of the Directive 2014/95/EU (Non-Financial Reporting Directive  or NFRD)⁴ to all large companies and entities with debt or equity securities listed on an EU regulated exchange so many more companies will be required to comply with these new obligations.

In addition to entities with relevant EU listed securities, non-EU companies with substantial activity in the EU (including those with a turnover of at least EUR150 million in the EU) will also have to comply.  Many more companies are therefore expected to fall within scope of these new sustainability reporting requirements. However, there are various exemptions, in particular for third country undertakings.

When will the CSRD apply?

Once the CSRD is approved and published in the Official Journal of the EU, EU Member States will have 18 months to transpose the directive into national law. Entities will therefore need to check how particular EU Member States transpose the CSRD as there may be differences as to how the directive applies across the EU Member States.

The CSRD proposes a phased-in implementation of the rules:

• for large undertakings (with over 500 employees that are already subject to the NFRD), the CSRD is currently scheduled to apply from 1 January 2024, with reporting starting in 2025;

• for large undertakings that are not currently subject to the NFRD (with more than 250 employees and/or EUR 40 million in turnover and/or EUR 20 million in total assets), the CSRD is scheduled to apply from 1 January 2025 with reporting from 2026; and

• for listed SMEs and other undertakings, from 1 January 2026, with reports due in 2027⁵

What are the sustainability reporting obligations?

The CSRD requires comprehensive disclosure about how sustainability issues affect a company’s business as well as the impact of the business on people and the environment.

The NFRD, which has applied in all EU member States since 2017, inserted Articles 19a and 29a into Directive 2013/34/EU (the Accounting Directive)6. The NFRD requires large listed companies (with securities admitted to trading on an EU regulated market), banks and insurance companies with more than 500 employees to disclose information about their environmental and social impacts.

The CSRD amends the non-financial reporting obligation by restating Articles 19a and 29a of the Accounting Directive and by inserting Article 29b into the Accounting Directive. It significantly expands the scope of the reporting requirements to additional categories of undertakings, amends and expands the reportable information by introducing sustainability reporting standards and introduces an audit requirement.

The reporting obligations in Articles 19a and 29a are further supplemented by Article 8 of the Taxonomy Regulation which requires financial and non-financial undertakings in scope of Article 19a and 29a of the Accounting Directive as amended by CSRD to disclose certain climate-related key performance indicators (KPIs).

What is the impact on third country issuers?

Generally, the sustainability reporting obligations under CSRD apply to large EU undertakings with an average number of employees in excess of 250, total assets of EUR 20 million or more and a net turnover of EUR 40 million or more (defined as “large undertakings”) (and similarly for parent undertakings of a large group).

For third country undertakings, the sustainability reporting requirements under CSRD will apply to a company if it or any or its subsidiaries have debt or equity securities listed on an EU regulated market.

In addition, even if the parent company or any of its subsidiaries does not have securities listed on an EU regulated market, the sustainability reporting requirements under CSRD may still apply including where the net turnover of the group exceeds EUR 150 million for each of the last two consecutive financial years in the EU and it has either:

• a large subsidiary in the EU or a subsidiary listed on an EU regulated exchange; or

• a branch with revenue of more than EUR 40 million in the preceding financial year.

A non-EU parent with debt or equity securities listed on an EU regulated market and which is a large undertaking or the parent of a large group with more than 500 employees, is likely to be in scope of the reporting standards on a global consolidated basis, from 1 January 2024, with reporting from 2025. Similar entities with between 250 and 500 employees would likely be in scope of reporting on a consolidated basis from 1 January 2025, with reporting from 2026.

Where a non-EU parent company has an EU subsidiary which is a large undertaking, with debt or equity securities listed on an EU regulated market with more than 500 employees, reporting at the individual subsidiary level is likely to apply from 1 January 2024, with reporting starting from 2025.  For similar EU subsidiaries which either do not have debt or equity listed on an EU regulated market or have between 250 and 500 employees, reporting at the individual subsidiary level is likely to apply from 1 January 2025, with reporting from 2026.

Determining whether an entity is within scope of the CSRD and, if so, the level at which it would be required to report, may be complex so companies should start any analysis well in advance.

What exemptions are available?

The CSRD proposes that a mechanism for the determination of equivalence standards should be established and that some entities may be able to satisfy the CSRD reporting requirements by using information submitted under another non-EU reporting regime where the EC determines that such information has been prepared “in a manner equivalent” to that required under the CSRD. However, there is no such equivalence mechanism yet in place, the EC has not made any decisions as to whether any non-EU regimes would be deemed equivalent and it is not clear how long any such decisions would likely take to come into force. 

What are the new sustainability reporting standards?

The precise disclosure requirements will be set out in the new European Sustainability Reporting Standards (ESRS) that the European Financial Reporting Advisory Group (EFRAG) is tasked with developing⁷. EFRAG submitted the first set of draft ESRS to the EC on 22 November 2022⁸.  The standards will now be considered by the EC and ESMA, with a view to the ESRS being adopted in 2023.

The EC has acknowledged that the ESRS will need to be consistent with other globally accepted standards currently being developed and has encouraged the EFRAG to cooperate with other international bodies including the International Sustainability Standards Board.

The EC has also noted that the CSRD will need to be aligned with other EU initiatives on sustainable finance such as the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation.

How does this compare with the proposals in the US and the UK?

The CSRD goes beyond the climate-related risk disclosure requirements that are currently being proposed by the Securities and Exchange Commission (SEC) in the US⁹.  Under the proposed SEC rules, US and foreign companies filing reports and registration statements with the SEC (i.e. companies with US publicly traded securities) would be required to include detailed climate-related information  in their registration statements and annual reports.  The new disclosure would include climate-related risks and their actual or likely material impacts on the relevant company’s business, strategy and outlook; governance of climate-related risks and relevant risk management processes; greenhouse gas emissions, specified climate-related financial metrics appearing in a note to the audited financial statements and information about climate-related targets and goals, including any transition plans . The proposed rules are modeled in part on the Task Force on Climate-Related Financial Disclosures¹⁰ and the accounting and reporting standards for greenhouse gas emissions under the Greenhouse Gas Protocol¹¹. For more information, please see our client alert: SEC proposes expansive climate-related disclosure rules - Hogan Lovells Engage

The UK has also introduced several disclosure requirements such as the Financial Conduct Authority’s climate-related disclosure rules¹² which require issuers with UK standard listed shares or global depositary receipts to include a statement in their annual report on whether they have made disclosures consistent with the UK Task Force on Climate-Related Financial Disclosures’ (TCFD) recommendations in respect of accounting periods on or after 1 January 2022 or explain why their disclosure is not consistent with the TCFD’s recommendations and set out the steps they are taking to ensure that their disclosure is consistent in the future.   The UK is looking to introduce TCFD-aligned disclosure across the economy by 2025.   The TCFD recommends that entities publish standalone transition plans at least every three years and sooner where there are significant changes to the plan.

The US and UK approaches to date therefore focus on climate-related risks, associated risk management and reporting. The key aspect that in scope third country undertakings need to appreciate about CSRD is that sustainability reporting in the EU includes environmental, social and governance reporting aspects, including employee orientated headings, human rights elements and broader social coverage than other regimes. The detail on governance including audit and review processes is also expected to be a substantial step-change from other current international regimes.

Next steps

Once the final text of the CSRD is published, undertakings with relevant activities in the EU will need to digest the new requirements and assess whether any part of their group including any subsidiaries are going to be in scope of the new obligations. If an entity determines that it will fall within scope, they will need to develop appropriate information gathering and reporting processes, together with the relevant associated governance procedures, in order to meet these new sustainability reporting requirements. 

This note is for guidance only and should not be relied on as legal advice in relation to a particular transaction or situation. Please contact your normal contact at Hogan Lovells if you require assistance or advice in connection with any of the above.

Authored by Jochen Seitz, Bryony Widdup, and Isobel Wright.

References

1. https://www.europarl.europa.eu/news/en/press-room/20221107IPR49611/sustainable-economy-parliament adopts new-reporting-rules-for-multinationals.

2. Available here: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52021PC0189&from=EN

3. See footnote 1

4. Available here: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0095&from=EN

5. See footnote 1

6. Available here: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013L0034&from=DE

7. Public consultation on the first set of Draft ESRS - EFRAG

8. News - EFRAG

9. 33-11042-fact-sheet.pdf (sec.gov)

10. Available here: https://www.fsb-tcfd.org

11. Available here:  Greenhouse Gas Protocol | (ghgprotocol.org)

12. Policy Statement of FCA dated December 2021, Enhancing climate-related disclosures by standard listed companies; available here: https://www.fca.org.uk/publication/policy/ps21-23.pdf