On November 28, 2022, the Council of the European Union (EU) formally adopted the Corporate Sustainability Reporting Directive (CSRD), following the European Parliament’s formal adoption of the directive earlier last month. The CSRD is a broad environmental, social, and governance (ESG) reporting framework that will impose uniform, mandatory reporting requirements on many companies with European operations, including companies not based in Europe.

The CSRD is not the first corporate ESG reporting regime in the EU; the Non-Financial Reporting Directive (NFRD) has been in effect since 2018 and has required disclosures across ESG pillars. But the CSRD, which replaces the NFRD, represents a step-change in mandatory ESG reporting nonetheless. And the CSRD is just one component of the EU’s sustainable finance framework, which also includes ESG disclosure requirements for financial market participants, with the Sustainable Finance Disclosure Regulation (SFDR), and the EU Taxonomy Regulation, a system requiring both companies and financial market participants to classify their “sustainable” economic activities under defined criteria.

The scope of entities subject to the CSRD is far greater than under the NFRD. An estimated 12,000 European companies are subject to the NFRD, representing only the largest, so-called “public interest” entities – primarily companies with securities listed on EU regulated markets, banks, and insurance companies with 500 or more employees. By contrast, the European Commission estimates that roughly 50,000 companies will fall under the CSRD’s reporting obligations. In addition to those companies currently subject to the NFRD, this will include:

• All “listed” companies offering securities on an EU index (except for “micro-enterprises”);

• All “large” companies, meaning those that meet at least two of three criteria: (i) a balance sheet of €20 million, (ii) net turnover of €40 million, and (iii) 250 employees or more on average during the year – parent undertakings of “large groups” that meet two of these criteria on a consolidated basis also qualify; and

• Non-EU companies, so-called “third-country undertakings,” with significant European operations – i.e., that generate a net turnover of €150 million or more in the EU and that have an EU subsidiary that is either listed on an EU regulated index or “large” under the above criteria, or an EU branch generating an annual net turnover of €40 million in the prior year.

The breadth of these categories means that the CSRD will have impacts on companies based in the US and elsewhere, provided they have European operations above the established thresholds. The CSRD provides for an exemption for the EU subsidiaries or branches of a non-EU parent if the EU operation was included in the parent undertaking’s consolidated management report that had sustainability disclosures deemed to be “equivalent” to those required under the CSRD. But, because the process for determining equivalence is as yet unclear, there is considerable uncertainty as to how this may apply in practice. For US companies, there is further skepticism that the far more limited scope of the US Securities and Exchange Commission’s (SEC) climate change disclosure proposal, which if finalized would address only climate-related disclosures, would be deemed equivalent to the CSRD.

Several other elements of the CSRD are also of particular note:

• Uniform Reporting Standards. The CSRD will impose uniform, comprehensive reporting standards applicable across the EU, under forthcoming European Sustainability Reporting Standards (ESRS). The ESRS will call for disclosures of numerous metrics across the ESG pillars, including things like energy and emissions data, water use, climate-related risk management strategies, circular economy, pollution, biodiversity under the “E”; working conditions, diversity, inclusion, human rights under the “S”; and business risk, strategy, and board oversight over sustainability information under the “G”. The ESRS are still under development by the European Financial Reporting Advisory Group (EFRAG).

• Double Materiality. Under the CSRD, subject companies must report according to a “double materiality” perspective, wherein they must consider not just the material impacts of ESG factors to the organization but also the organization’s own impacts on the environment and social systems. This is distinct from the US Securities and Exchange Commission’s climate reporting proposed rule, which embraces a “single materiality” perspective that would require disclosure of only climate-related impacts to the reporting entity.

• Third-Party Assurance. The CSRD will impose a third-party assurance, or audit, obligation on reporting entities, requiring reporting to be certified by an accredited independent auditor. Only “limited” assurance will be required to start. Subsequently, however, the CSRD provides for development of a more rigorous, “reasonable” assurance standard in 2028, if it is found to be feasible.

• Reporting Mechanics. The CSRD requires that companies report ESG metrics not in a separate sustainability report, but in a dedicated section of the broader company management report, thus blending the sustainability and other financial reporting into a single document. Companies also must digitally tag sustainability information to allow the EU to maintain a singular, uniform database of CSRD disclosures, furthering the goal of increasing transparency and accessibility of sustainability disclosures.

The CSRD takes a phased approach to implementation, with different categories of companies becoming subject to the reporting requirements along a staggered timeline. Large, “public interest” undertakings already subject to the NFRD and large, listed companies with 500 or more employees will be subject starting January 1, 2024, “large” undertakings not currently subject to the NFRD will be subject beginning January 1, 2025, and “small and medium-sized undertakings” with securities listed on an EU regulated market, as well as small and non-complex credit institutions and captive insurance undertakings, will become subject January 1, 2026. Non-EU companies subject to the CSRD must comply beginning January 1, 2028. For all of these groups, initial reports under the CSRD would be required to be produced the following year.

Now that it has been formally approved, the CSRD will be signed and published in the Official Journal of the EU and will enter into force 20 days later. EU Member States will then have 18 months to transpose the CSRD into their respective national laws. More details on exactly what the mandatory reporting standards will look like will become clear over the coming months, as the EU considers and adopts a delegated act setting forth ESRS by June 30, 2023, and a second, sector-specific set of ESRS by June 30, 2024.

In the meantime, European companies and non-EU companies with European operations should begin the complex evaluation process to determine whether and when they will be subject to the CSRD and its reporting obligations. Companies publicly listed in the US should take care to ensure that any future European disclosures are consistent with their SEC filings and other public disclosures made in the US. And companies with US operations should craft disclosures with due regard to the growing body of regulations and caselaw in the US concerning greenwashing.

Julia J. Casciotti also contributed to this article.