The introduction of the Corporate Sustainability Reporting Directive marks a pivotal moment in the evolution of corporate reporting in the EU, but it will bring challenges for all involved, writes Daniel O’Donovan
In an era where businesses are increasingly being scrutinised for their impact on the environment, society and their governance practices, the European Union (EU) has taken a leading role internationally by introducing the Corporate Sustainability Reporting Directive (CSRD).
The CSRD is due to be transposed into Irish law before mid-2024. Following its transposition, mandatory reporting requirements will become effective for, among others, financial years commencing on or after:
1 January 2024 for public interest entities in scope of EU non-financial reporting rules (with more than 500 employees);
1 January 2025 for other larger companies and public interest entities (with more than 250 employees); and
1 January 2026 for listed public interest SMEs, with ‘opt out’ possible until 2028.
This is a pivotal moment in the evolution of corporate reporting across the EU, bringing with it significant challenges for all involved, not least for reporting entities, their audit committees and assurance providers.
What are the key challenges?
While the CSRD is a welcome framework for enhancing transparency and accountability in corporate sustainability reporting – reflecting the EU’s commitment to fostering sustainable and responsible business practices – it introduces three significant challenges for business:
First, the breadth of information that relevant businesses will be required to report under the 12 European Sustainability Reporting Standards (ESRS) introduced by the CSRD;
Second, the need to implement the systems required to gather and record reliable sustainability data and information; and
Third, the need to provide assurance over the sustainability reports required by the CSRD.
Breadth of information to be reported
The ESRS, developed by the European Financial Reporting Advisory Group (EFRAG), aim to enhance the consistency, comparability and reliability of sustainability reporting among European reporting entities.
The scope of the ESRS is expansive, encompassing various elements that collectively contribute to a comprehensive understanding of an organisation’s environmental, social and governance (ESG) performance.
The key components driving the breadth of information required in this reporting are the:
sustainability topics;
reporting boundary;
double materiality concept; and
number of datapoints for disclosure within the ESRS.
Sustainability topics
The ESRS require disclosures about the following topics: climate change, pollution, water and marine resources, biodiversity and ecosystems, resource use and circular economy, own workforce, workers in the value chain, affected communities, consumers and end-users, and business conduct. As can be seen from this list, these are broad topic areas. The ESRS standards for each of these topics specify further subtopics in respect of which disclosures must be given. Furthermore, in respect of each of the topics and subtopics, disclosure is required about aspects of the topics as shown in the table below.
Reporting boundary
The reporting boundary required by the ESRS is in stark contrast to what reporting entities are familiar with in the context of the financial reporting boundary used to produce annual financial statements, being within the reporting entity or group. The ESRS, however, require a reporting boundary that considers the entire value chain, from suppliers to end consumers, as shown in the figure below:
This inclusive perspective ensures that the environmental and social impacts of a business are accurately captured, providing stakeholders with a complete picture of the organisation’s sustainability efforts, but it places a demanding requirement on reporting entities from a data collection standpoint.
Double materiality
Reporting entities in scope of the CSRD will be required to report on a double materiality basis. This means that they will have to report on impacts on and risks to them from a changing climate and other ESG matters (referred to as “financial materiality” as it is consistent with what entities report in the financial statements). In addition, they will report on the impact the entity itself might have on climate and other ESG matters (referred to as “impact materiality”). When compared with reporting in the financial statements, this concept doubles the challenge for reporting entities as all ESG topics must be considered from both perspectives. Gathering and assessing information and data about the reporting entity’s impact on the breadth of ESG topics is a new frontier for corporate reporting and one that the majority in the corporate reporting ecosystem have no experience of.
Datapoints for disclosure
It is clear that the scope of the information to be disclosed under the ESRS is far broader than the information to be reported in the financial statements. However, to underline this, the ESRS outline specific datapoints that reporting entities should disclose to provide transparency and facilitate comparability. As recently as October, EFRAG released a draft List of ESRS datapoints – Implementation Guidance, which includes all 1,178 disclosure requirements in the sector-agnostic ESRS published to date. The datapoints are standardised metrics that allow for consistency in reporting and enable stakeholders to assess the sustainability performance of different reporting entities. For instance, in the environmental domain, entities may report on their carbon footprint, energy consumption and waste generation. Social datapoints could include diversity and inclusion metrics, employee turnover rates, and health and safety performance. This new frontier of corporate reporting will generate tangible benefits for society at large and result in greater public interest therein but will not be without data capture challenges in the near future.
Sustainability information systems
Given the significance of the breadth of sustainability information to be reported, the transposition of the CSRD into Irish law will have a profound impact on the information systems of entities within its scope. Moreover, the scale of the endeavour for those entities that will be required to report in early 2025 on the calendar year ended 31 December 2024 is enormous in terms of what must be achieved within a timeframe that is less than 18 months away.
Such entities need to determine what sustainability matters are material using the double materiality concept and are therefore required to be included in their sustainability report and start gathering, collating, aggregating and sorting the data in relation to 2024, which will be reported in early 2025.
Reporting entities will need to establish or enhance integrated data systems that allow for the collection and management of sustainability data. This could involve integrating sustainability data within existing enterprise resource planning (ERP) systems to ensure data consistency and accuracy. Additionally, tools may be needed, such as a materiality assessment tool to help systematically evaluate the importance of various sustainability information.
As stakeholder engagement is a crucial part of a materiality assessment, systems or tools that can help track and manage interactions with stakeholders, ensuring that their perspectives and concerns are considered in the reporting process, will be necessary.
Developing or strengthening internal controls and policies related to sustainability reporting information systems will be essential. Reporting entities will need to create processes and controls to ensure the accuracy, completeness and reliability of sustainability data, which will be sourced from all areas of the organisation and well beyond the finance function.
Reporting entities that are successful in achieving this will be better positioned to facilitate an independent assurance provider’s examination of their sustainability report.
Assurance over sustainability reports
Initially, the CSRD requires an independent assurance provider to express an opinion based on a limited assurance engagement as regards the compliance of the sustainability reporting with the requirements of this Directive, including compliance with the ESRS, the process carried out by the undertaking to identify the information reported pursuant to the ESRS, and compliance with the requirement to electronically tag the sustainability report.
In later years, after an initial period, reasonable assurance over the sustainability report may be required. For reporting entities, facilitating a limited assurance engagement in the year of implementation of such a significant suite of sustainability reporting standards will require additional resources and does not come without the increased possibility of qualification given the complexity of the ESRS and the potential immaturity of reporting systems.
The challenge for independent assurance providers is that at present no assurance standard is in existence that governs the performance of such an engagement.
The International Audit and Assurance Standards Board (IAASB) is developing a standard and has released an exposure draft – International Standard on Sustainability Assurance 5000 – that seeks to address the performance of limited and reasonable assurance engagements over sustainability information.
The exposure daft is open for comment at present and a final standard is not expected until the second half of 2024.
While the development of the standard is welcome, the timeframe is extremely tight, and it is widely acknowledged that the exposure draft does not provide sufficient clarity in relation to the performance expectation of an independent assurance practitioner when performing a limited assurance engagement compared with a reasonable assurance engagement.
In the face of such unprecedented uncertainty, independent assurance providers may struggle to deliver high quality limited assurance engagements.
Challenges ahead
The rate of recent extreme weather events in Ireland and elsewhere in Europe, and their impact on supply chains, provides a clear mandate to take better care of our environment. Most people are therefore likely to welcome the intent behind the CSRD’s introduction of sustainability reporting.
Sustainability reporting by entities will be on a basis far broader than financial statements. Additional resources will be needed to address the challenges outlined in this article, but time is running out fast; the time to act on these challenges is now.
Furthermore, the successful implementation of the CSRD regime in Ireland and across the EU requires considerable pragmatism and support from policymakers, standard-setters and regulators.
The new “gold rush” in which companies will seek to lead will be a race to capture data, integrate systems and assure sustainability reports. Undoubtedly, this marks a new frontier in corporate reporting – the ESG Rush!
Daniel O’Donovan is a partner with KPMG and leads the firm’s Audit and Assurance Methodology team. He is also Chair of the Chartered Accountants Ireland Assurance and Audit Technical Committee
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