#DeloitteESGNow — Global Reach of the E.U. Corporate Sustainability Reporting Directive and the Impact on U.S. Companies (January 9, 2023)

#DeloitteESGNow — Global Reach of the E.U. Corporate Sustainability Reporting Directive and the Impact on U.S. Companies

Background

New sustainability reporting requirements in the European Union, which will affect U.S.-based companies with E.U. operations and are much broader than those proposed in the United States, are set to fundamentally change the reporting landscape. In November 2022, the European Council (EC) and the European Parliament approved the final text of the Corporate Sustainability Reporting Directive (CSRD), which will require sustainability reporting far beyond what most companies provide today and will apply to a substantial number of companies that previously were not subject to mandatory sustainability reporting.

The CSRD will affect not only E.U.-based companies, but all companies with significant operations in E.U. jurisdictions, including U.S.-based companies with as little as one subsidiary or branch in the European Union. Many U.S.-based companies, including certain nonlisted ones, will be subject to these European sustainability reporting requirements, whose implementation period could be more accelerated, and whose reporting and assurance provisions could be more expansive, than what the SEC’s proposed rule 1 on climate-related disclosures would require.

Scope of the CSRD

The adoption of the CSRD, coupled with the supporting European Sustainability Reporting Standards (ESRS), introduces more detailed sustainability reporting requirements for more than 50,000 companies. The scope of the CSRD is much wider than that of the existing Non-Financial Reporting Directive (NFRD) and extends to certain non-E.U. companies or subsidiaries not listed on a regulated market in the European Union, covering:

E.U. large undertakings, also referred to as “companies” or “subsidiaries” (whether listed or not), which are defined as undertakings that meet at least two of the following criteria on their balance sheet dates:2
- Greater than €20 million balance sheet total.
- Greater than €40 million net turnover.
- Greater than 250 employees.
Companies with listed securities in the European Union,3 including small4 and medium-sized5 undertakings (“small and medium-sized enterprises,” or SMEs), other than micro-undertakings.

The above scope includes large subsidiaries of non-E.U. parents (i.e., all E.U. companies are subject to these criteria regardless of the origins or domicile of their ownership).

Exemption for Subsidiaries of a Non-E.U. Parent

Subsidiaries of a non-E.U. parent are exempt from disclosing information under the CSRD if (1) the parent reports under ESRS or standards that the EC deems to be equivalent and (2) the assurance statement or conclusion on the consolidated sustainability reporting is publicly available. However, the parent’s reporting at the consolidated level must provide an adequate understanding of the risks and impacts of its subsidiaries, as well as information about the subsidiaries’ due diligence processes, when such risks, impacts, and due diligence processes differ from those of the group.

An exempted subsidiary will be required to disclose certain information about its use of the exemption.

Requirements for Non-E.U. Companies That Are Not Listed on a Regulated Market in the European Union

For financial years starting on January 1, 2028, E.U. large and listed subsidiaries (or branches, when there are no E.U. large or listed subsidiaries) of a non-E.U. ultimate parent that have more than €40 million net turnover will need to publish and make accessible a sustainability report of that parent at the consolidated level if that parent has generated a net turnover in the European Union of more than €150 million in each of the last two financial years. This means that a U.S. company with significant operations in the European Union will, in effect, be required to furnish the information to be included in a published sustainability report covering its entire operations, including its E.U. as well as non-E.U. operations.

The sustainability report communicated by an E.U. subsidiary or branch is to be prepared in accordance with the sustainability reporting standards for non-E.U. companies that the EC is expected to adopt by June 30, 2024. These standards will be different from ESRS. There will also be the option to report in accordance with ESRS or standards that are deemed to be equivalent.

Connecting the Dots

The CSRD indicates that (1) the sustainability report would need to provide consolidated information of the non-E.U. ultimate parent at the non-E.U. ultimate parent level and (2) the E.U. subsidiary or branch would be required to use its best efforts to obtain the information necessary to issue the report. This would appear to bring the whole of the non-E.U. parent and its worldwide operations within the scope of the CSRD. However, the E.U. subsidiary or branch of the non-E.U. parent will be the party responsible for publishing the sustainability report of the non-E.U. parent.

Required Disclosures

Companies within the scope of the CSRD are required to disclose:

Information on sustainability matters.
Information necessary to understand:
- The company’s impacts on sustainability matters.
- How sustainability matters affect the company’s development, performance, and position.

The CSRD requires disclosure from a “double materiality” perspective, meaning that a company must report how sustainability risks and opportunities affect its financial performance, position, and development (financial perspective) as well as how the company’s performance, position, and development affect people and the environment (impact perspective). The CSRD specifies that companies should consider each materiality perspective in its own right and disclose information that is material from the financial perspective, the impact perspective, or both.

European Sustainability Reporting Standards

To encourage companies to disclose comparable and reliable information on all material sustainability-related topics, the CSRD requires companies within its scope to use ESRS that specify the information to be reported and, when relevant, the structure in which that information should be reported. To support this requirement, the EC will adopt the following:

The EC has commissioned the European Financial Reporting Advisory Group (EFRAG) with the development of ESRS. Under this mandate, EFRAG launched a public consultation in April 2022 on the first set of draft standards developed by its Project Task Force on ESRS. The consultation period ended on August 8, 2022.

On November 15, 2022, the EFRAG Sustainability Reporting Board approved the revised ESRS drafts and submitted them to the EC for formal approval. The EC will consult E.U. bodies and member states on the 12 approved ESRS drafts before final ESRS drafts are adopted as delegated acts by June 30, 2023. Until this time, they will be referred to as “draft” ESRS.

The approved ESRS drafts are as follows:

Standards Deemed to Be Equivalent

The EC still needs to decide on the equivalence of sustainability reporting standards used by non-E.U. companies, such as U.S. parent companies. If the EC decides that the sustainability reporting standards of a third country are not equivalent, it may nonetheless allow the issuers to continue using such standards during an appropriate transitional period. This exemption only applies to non-E.U. companies with securities listed on a regulated market in the European Union.

It is important to note that the disclosure requirements of the ESRS are extensive, with an estimated 84 disclosure requirements covering both quantitative and qualitative disclosures, and go beyond what the SEC’s proposed rule on climate-related disclosures would require. Therefore, it is likely that the SEC’s proposed rule, when finalized, will not be eligible for such equivalence, given its more narrow focus on climate-related disclosures and its emphasis on investor materiality rather than double materiality as required by the CSRD.

For standards to be deemed equivalent, they will most likely need to:

Take a double materiality perspective consistent with that of the CSRD so that the risks and opportunities to the company and the impacts of the company represent separate materiality perspectives.
Require disclosure of sustainability matters.
Require disclosure of information necessary to understand the company’s impacts on sustainability matters and how sustainability matters affect the company’s development, performance, and position.

Location of Disclosures

The CSRD requires disclosure of sustainability information in a clearly identifiable dedicated section of the management report within the annual report.

Digitization of Information

The CSRD requires companies to digitally tag reported sustainability information in accordance with a digital taxonomy yet to be developed. Companies will therefore be required to prepare their financial statements and their management report in eXtensible HyperText Markup Language (XHTML)6 and to mark up the sustainability reporting to make it easier for readers of the report to find the information they are seeking.

Independent Assurance

The CSRD requires all companies within its scope to seek limited assurance of sustainability reporting. The EC will perform an assessment to determine whether moving from limited to reasonable assurance is feasible for auditors and for companies. After this assessment, the EC will adopt assurance standards for reasonable assurance no later than October 1, 2028.

The assurance provider will provide an assurance report containing a conclusion on compliance with sustainability reporting standards. The report is to include (1) a description of the process used to reach this conclusion, (2) required electronic tagging, and (3) specific disclosures required under certain other E.U. legislation.

Illustrative Timeline and Impact on U.S. Companies

The impact of the CSRD’s timeline on U.S. companies and certain of their subsidiaries is illustrated below.

What may be deemed “equivalent” is yet to be determined by the EC, which may also exempt non-E.U. listed companies for a transitional period.

May also present E.U. subsidiaries with a common non-E.U. parent that are within the scope of the CSRD in one consolidated E.U. report under ESRS (until 2029).

Considerations for U.S.-Based Companies With Significant Operations in E.U. Countries

U.S.-based companies with significant operations in E.U. countries should consider the following questions:

Have you evaluated how your organization will be affected by the CSRD and supporting ESRS requirements?
Have you performed an assessment comparing your company’s currently established material sustainability topics with the CSRD’s double-materiality requirements?
Do you have data processes and controls in place to be able to report the required sustainability information? Keep in mind that while the CSRD implementation date for many U.S.-based companies may be a few years out, the CSRD will:
- Require the company to pull into the financial reporting cycle sustainability reporting that is much more comprehensive than that on climate and greenhouse gas emissions under the SEC’s proposed rule on climate-related disclosures.
- Subject this more comprehensive sustainability reporting subject matter to limited assurance upon implementation.

Where to Find Additional Information

The following Deloitte resources may help companies assess their approach to climate-related disclosures:

ESG Financial Reporting (a Web page that lists financial reporting resources for dealing with climate-related and other ESG matters).
Defining the Role of the Audit Committee in Overseeing ESG.

Contacts

For information about Deloitte’s service offerings related to ESG matters, please contact:

	Kristen Sullivan Partner Deloitte & Touche LLP +1 203 708 4593 ksullivan@deloitte.com		Lauren Pesa Partner Deloitte & Touche LLP +1 312 486 4647 lpesa@deloitte.com
	Allie Bruflodt Senior Manager Deloitte & Touche LLP +1 612 397 4172 abruflodt@deloitte.com		Michelle Risman Manager Deloitte & Touche LLP +1 312 482 2974 mrisman@deloitte.com
	Kyle Boyce Senior Deloitte & Touche LLP +1 415 783 4092 kyboyce@deloitte.com

Footnotes

SEC Proposed Rule Release No. 33-11042, The Enhancement and Standardization of Climate-Related Disclosures for Investors.

The CSRD refers to the E.U. Accounting Directive for the size criteria, which are therefore unchanged.

More specifically, undertakings with securities (may be shares or bonds) admitted to trading on a regulated market in the European Union. The same definition applies to non-E.U. undertakings (referred to as “third-country undertakings”).

Small undertakings are defined as undertakings that meet at least two of the following criteria: (1) no greater than €4 million balance sheet total, (2) no greater than €8 million net turnover, and (3) no greater than 50 employees.

Medium-sized undertakings are defined as undertakings that do not qualify as small and that meet at least two of the following criteria: (1) no greater than €20 million balance sheet total, (2) no greater than €40 million net turnover, and (3) no greater than 250 employees.

XHTML is a human-readable format that can be opened in a standard Web browser.

What may be deemed “equivalent” is yet to be determined by the EC, which may also exempt non-E.U. listed companies for a transitional period.

May also present E.U. subsidiaries with a common non-E.U. parent that are within the scope of the CSRD in one consolidated E.U. report under ESRS (until 2029).

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