New sustainability reporting and extended duties of business managers

The EU is moving forward with its ESG activities and obliges many companies to provide comprehensive sustainability reporting. This has a direct impact on the duties of board members and managing directors. The post summarises the most important need-to-knows.

Large capital market-oriented companies, financial institutions and insurance companies with an annual average staff of more than 500 have been obliged to provide non-financial reports since 2017 (s289b(1) HGB (German Commercial Code)). This is the result of the translation of what is known as the CSR Directive (or Non-Financial Reporting Directive, NFRD for short) into German law. Companies subject to reporting requirements must, in addition to a brief description of their business model, address non-financial aspects in the non-financial statement (in particular environmental, employee and social issues, respect for human rights and the fight against corruption and bribery). For about as long, discussions have been going on about the extent to which these reporting obligations affect the due diligence obligations of the board of directors or the management of the companies subject to these reporting obligation. It therefore seems obvious that board members and managing directors must deal with the non-financial aspects in at least such a way that they can properly report on them. Some argue that the range of actions and duties of business managers is being extended beyond the actual obligation to non-financial reporting. The prevailing opinion, however, rejects this. Regardless of any reporting obligations, managers should make business decisions on an adequately informed basis, including sustainability aspects as far as they are relevant for the particular decision.

Extension and clarification of sustainability reporting

In the meantime, the EU has revised the non-financial reporting and developed it into a comprehensive sustainability reporting. The Corporate Sustainability Reporting Directive (CSRD) recently came into force at EU level and must now be transposed into national law by the EU member states. This will lead to a considerable widening of the range of companies subject to reporting requirements throughout the EU. In Germany alone, some 15,000 companies will be obliged to provide the new sustainability reports in the future, instead of about 500 companies so far. All in all, more than 50,000 companies will be affected, while the NFRD only covers some 11,700 companies across the EU.

Entities subject to mandatory reporting and commencement of reporting obligations

The duty to report on sustainability is to apply to a large number of companies as of the following dates (see Art. 5 CSRD):
Group 1: For financial years beginning on or after 1 January 2024, companies that are already required to report non-financial information under the NFRD (see above) will be subject to the reporting obligation.

Group 2: For financial years beginning on or after 1 January 2025, all large corporations and parent companies of large groups as defined in ss267, 293 HGB (German Commercial Code) will be subject to mandatory reporting, i.e. companies that exceed two of the following three criteria on two consecutive reporting dates: balance sheet total of EUR20 million , net turnover of EUR40 million, average of 250 employees during the year. Compared to the NFRD, the previous requirement of capital market orientation is dropped and the number of employees is reduced from 500 to 250.

Group 3: For financial years beginning on or after 1 January 2026, capital market-oriented small and medium-sized corporations (with the exception of micro-entities) will be subject to mandatory reporting regardless of the number of employees. Such SMEs may, however, opt out (having to state the reasons for it) in the first two years, so the reporting obligation will apply here no later than for financial years beginning on or after 1 January 2028. Furthermore, small and non-complex banks and company-owned insurance entities will fall into this 3rd group.

Group 4: Finally, for financial years starting on or after 1 January 2028, non-EU companies with a net annual turnover within the EU of more than EUR150 million in the last two financial years and a subsidiary within the EU belonging to Group 2 or 3, or a branch within the EU with a net annual turnover of more than EUR40 million, will also be subject to reporting requirements.

Contents of the sustainability reports

The above-mentioned companies must include in their management report information that is necessary for understanding the impact of the company's activities on sustainability aspects as well as the impact of sustainability aspects on the company's business performance, business results and situation ("double materiality"). According to Art. 19a of the Accounting Directive, this information must include the following:

(a) a brief description of the company's business model and strategy, including, in particular, the resilience of the company's business model and strategy to risks and the company's opportunities in relation to (i) sustainability issues; (ii) how the company intends to ensure that its business model and strategy are consistent with the transition to a sustainable economy and the limitation of global warming to 1.5°C in accordance with the Paris Agreement and the objective of achieving climate neutrality by 2050 as set out in the European Climate Change Act (including, where applicable, the company's exposure to activities related to coal, oil and gas); and (iii) how the company addresses the concerns of its stakeholders and the impact of its operations on sustainability issues in its business model and strategy;
(b) a description of the time-bound sustainability targets that the company has set, including, where applicable, absolute targets for the reduction of greenhouse gas emissions for at least 2030 and 2050, a description of the progress the company has made towards achieving those targets;
(c) a description of the role of the administrative, management and supervisory bodies in relation to sustainability aspects and their expertise in performing that role;
(d) a description of the company's policy on sustainability;
(e) information on the existence of incentive schemes linked to sustainability aspects offered to members of the administrative, management and supervisory bodies;
(f) a description of: (i) the due diligence process carried out by the company with regard to sustainability aspects and, where applicable, in accordance with the EU requirements for companies to carry out a due diligence process (cf. CSDDD-E); (ii) the main actual or potential negative impacts associated with the company's own operations and with its value chain; (iii) any measures taken by the company to prevent, mitigate, remedy or terminate actual or potential negative impacts and the success of those measures;
(g) a description of the main risks to which the company is exposed in relation to sustainability aspects, including a description of the main interdependencies in this area, and the company's management of these risks;
(h) indicators relevant to the disclosures referred to in points (a) to (g).

Sustainability reporting standards

While no reporting standard has been specified for non-financial reports according to the NFRD so far and therefore a wide variety of standards were applied, companies will have to comply with technical standards for sustainability reports defined by the EU (European Sustainability Reporting Standards, or ESRS for short) in the future. In November 2022, the European Financial Reporting Advisory Group (EFRAG), which was given the task of preparing such standards, submitted the first set of twelve cross-sectoral ESRS to the EU Commission; implementation is expected by 30 June 2023.

This first set of draft cross-sectoral ESRS covers the following reporting areas:

Cross-sectoral standards: ESRS 1 – General requirements and ESRS 2 – General disclosures.
Subject-specific ESG standards: environmental (ESRS 1 Climate change, ESRS 2 Pollution, ESRS 3 Water and marine resources, ESRS 4 Biodiversity and ecosystems, ESRS E5 Resource use and circular economy), social (ESRS S1 Own workforce, ESRS S2 Workers in the value chain, ESRS S3 Affected communities, ESRS S4 Consumers and end-users) and governance (ESRS G1 Business conduct).

The CSRD also provides for the preparation of sector-specific, third-country-specific and SME-specific standards by 30 June 2024.

Taxonomy Regulation

Under Art. 8 of the Taxonomy Regulation, companies that are obliged to report non-financially in accordance with the NFRD must already provide information, independently of the CSRD, on how and to what extent the activities of the company are linked to economic activities that are to be classified as environmentally sustainable economic activities in accordance with Articles 3 and 9 of the Taxonomy Regulation. In the future, the companies required to report under the CSRD will generally have to disclose such information in accordance with the Taxonomy Regulation.

Duties of business managers in connection with sustainability reporting

The management of the reporting companies must ensure, within the scope of their compliance obligation, that all legal requirements applying to the company are met. With a view to non-financial reporting or future sustainability reporting, business managers must therefore take appropriate measures so the company can fulfil its reporting obligations. This refers in particular to the sometimes challenging task of compiling the information and data required for it.

Furthermore, the description of the future sustainability reporting items is partly interpreted to mean that the CSRD presupposes that the companies − and therefore also their business managers − define actions and targets with regard to certain sustainability issues and make progress in achieving these targets. This applies in particular to the 'description of the time-bound sustainability targets' (including greenhouse gas emission reductions, if applicable) and 'the progress the company has made towards achieving these targets' as well as the 'way in which the company intends to ensure that its business model and strategy are compatible with the transition to a sustainable economy and the limitation of global warming'.

However, the discussion on the existence and content of any such obligation for action to be derived from the CSRD with regard to the definition and achievement of sustainability goals has only just begun. Regardless of the further development, there is enough reason for business managers to intensively deal with the sustainability issues relevant to their company and to take them into account when making decisions.

Dr. Daniel Walden
Dr. André Depping