Division between lawmakers on directives’ scopes calls timelines into question, delaying sustainability and transition disclosures to investors.
Political disagreements are risking the creation of a robust and ambitious corporate sustainability reporting and due diligence framework, legal experts have warned EU lawmakers.
Negotiations to finalise the EU’s Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD) are ongoing, with mounting concerns that sustainability disclosure requirements under CSRD will be watered down, and both directives will be subject to further delay.
“CSRD and CSDDD are the key axis of the European sustainable framework, whether you look at sustainability in terms of responsible business or financial,” Filip Gregor, Head of Responsible Companies at law firm Frank Bold, told ESG Investor.
Finalising corporate reporting requirements is of paramount importance to financial institutions, especially investors already subject to disclosure rules under the Sustainable Finance Disclosure Regulation (SFDR), Gregor noted.
“With SFDR going first, it was kind of like putting the cart in front of the horse, with investors having to measure companies in a very abstract way due to the absence of reliable and standardised data from companies.”
The European Commission published its review consultation of SFDR last month. Gregor said it is also important that indicators outlined within CSRD and CSDDD are reviewed in line with existing disclosure requirements under SFDR to ensure they “work together”.
First published by the Commission in February 2022, CSDDD will require in scope firms to identify, prevent, and mitigate the negative impact of their activities on human rights and the environment, such as child labour and biodiversity loss. It introduces duties for corporate directors to set up and oversee the implementation of due diligence processes and ensure they are integrated into the business strategy.
Further, CSDDD will require EU companies that fall under scope to produce climate transition plans.
Late last year, the EU gave its final approval to CSRD, meaning that, from next year, nearly 50,000 large companies across EU member states will be required to disclose data on the impact of their business operations across social and environmental themes.
CSRD will be underpinned by the European Sustainability Reporting Standards (ESRS), which will specify how companies report on these social and environmental themes.
The first batch of standards, which are sector-agnostic, are currently going through a two-month scrutiny period by the EU Parliament and Council. This can be extended by a further two months.
“The latest we’ve seen is a potential within the Parliament to derail the ESRS delegated act [for sector-agnostic standards],” said James Marlow, Environment and Climate Change Managing Associate at law firm Linklaters.
“Certain factions within Parliament are attempting to vote down or veto the piece of legislation, as part of a continued trend of push back against sustainability legislation and a wider attempt to secure a 25% reduction in reporting requirements across the board, including in relation to sustainability,” he said.
It is currently unclear what this disclosure reduction would mean for the ESRS.
The ESRS delegated act, which was published in the summer, has already been watered down, moving away from the originally proposed requirement that key disclosure indicators be reported on a fully mandatory basis, instead allowing companies to only report “relevant information”, determined through a materiality assessment.
Initially targeting ten key sectors, such as oil and gas, additional sector-specific standards are “meant to make disclosure requirements clearer for companies and to specify material data points they need to be reporting according to their industry”, said Gregor from Frank Bold.
The European Financial Reporting Advisory Group (EFRAG), which has been tasked with developing the ESRS, has been “operating under the assumption there would be a delay until 2025”, Gregor added, noting that a delay until 2026 “sends a signal that sector-specific standards aren’t considered as important as they should be”.
The sector-agnostic ESRS nonetheless already require companies to identify material entity- and sector-specific disclosures on their own, which is arguably more of a burden to companies than complying with set sector-specific requirements, Gregor said.
“Without sector-specific standards and guidance, identifying such sectoral disclosures will be the most difficult piece of the puzzle. For example, a textile company should probably report on work-related issues along the supply chain, but the current practice differs greatly among companies.”
Marlow from Linklaters noted that a delay between the sector-agnostic and sector-specific ESRS requirements could provide a “welcome ‘breather’” to focus on the proper implementation of the first batch of reporting requirements.
“EFRAG is already working on guidance around how to undertake materiality assessments, guidance on defining value chains and how to approach them in reporting,” he said.
Michaela Walker, Partner and European Head of Financial Services Sector at law firm Eversheds Sutherland, noted “there are still a raft of uncertainties with CSRD”.
One such example is that the directive has several areas where member states have discretion in how they implement CSRD – for example, whether independent assurance providers will be permitted – yet “very few member states have given any indication of what this might look like”, she said.
“For multinational firms with multiple business units across Europe, this divergence could be tricky to manage and obviously needs to be tracked between now and the first reporting being required.”
Against the clock
The EU has set in place a “very ambitious timeline” to complete negotiations on the CSDDD by the end of this year, but lawyers speaking to ESG Investor have questioned whether the deadline is feasible.
“Political trilogue discussions are expected to pick up again the second half of November, where they will need to reach an agreement on the stickiest political points around scope, climate, civil liability and responsibilities,” said Julia Otten, Frank Bold’s Senior Policy Officer.
“They have to advance substantially, even if they don’t manage to get full political approval by the end of the year.”
If the CSDDD is not completed by the end of Q1 2024, it could possibly be delayed until late 2024, as EU Parliament elections are set to take place in June.
“The longer CSDDD takes to be finalised, the more chance there is of other member states developing their own national regimes,” Marlow from Linklaters warned.
France and Germany already have their own laws in place, and the Dutch, amongst others, are also considering a wider due diligence regime themselves – a prospect which risks creating a more “fractured picture”, according to Marlow.
Only once trilogue discussions are concluded will EU member states be able to implement the directive via national laws.
There are, however, several sticking points to address before CSDDD can be finalised.
One is the inclusion of the finance sector, said Otten.
The Council is generally in favour of allowing individual members states to include parts of the financial sector under the due diligence directive, which would allow countries like France – who has pushed for the exclusion of financial institutions from the regime – to exclude French firms from CSDDD requirements.
However, the European Parliament has opposed this position, deeming that the whole EU financial sector, including asset managers and institutional investors, should be covered.
Last year, the UN-convened Principles for Responsible Investment (PRI), Eurosif and Investor Alliance for Human Rights sent an open letter undersigned by 142 signatories to the European Commission, calling for a broad scope of EU financial and non-financial companies to fall under the directive, noting that investors are already subject to environmental and social disclosure rules, such as SFDR.
Otten said that the scope of CSDDD, which is expected to apply to around 17,000 companies, is more restrictive than CSRD.
“How do you justify that a company has to report on its environmental and social impacts, but then won’t really have to take any action on it?” she said.
“These [CSDDD and CSRD] directives go hand in hand. It makes a lot of sense for them to reinforce each other. It’s very important to have as much coherence between these two pieces of legislation as possible. Due diligence can enable good reporting.”