The EU’s Corporate Sustainability Reporting Directive (CSRD), adopted in November 2022, establishes a transformative framework that requires detailed reporting on sustainability performance from EU and non-EU undertakings that meet certain thresholds. Undertakings within the scope of the CSRD must publicize comprehensive annual sustainability reports alongside their financial statements.

Complying with the CSRD can be challenging due to continued changes in the regulatory landscape and the lack of existing systems to collect sustainability performance information. Despite these challenges, private equity firms have an opportunity to enhance their positioning through diligent CSRD reporting. This reporting will also help many firms comply with the pending Corporate Sustainability Due Diligence Directive (CSDDD), which will oblige firms exceeding certain thresholds to identify, mitigate, and prevent environmental and social damage.

1. CSRD in a nutshell

The CSRD introduced a new corporate sustainability reporting regime under which in-scope EU undertakings, including eligible subsidiaries of undertakings outside the EU, report the likely social and environmental impact of the undertaking’s operations and value chain, and the likely impact that social and environmental matters will have on the undertaking. The directive aims to enhance transparency, enabling investors, analysts, consumers, and other stakeholders to effectively assess undertakings’ sustainability performance and understand the associated business impacts and risks.

The CSRD will apply on a staggered basis, from 2024 through 2029, requiring that undertakings’ annual reports contain both detailed sustainability reports and financial statements. It authorizes the introduction of varied reporting standards that will cater to the specific needs and capacities of different undertakings across a broad spectrum of industries and geographical locations:

• The European Sustainability Reporting Standards (ESRS), adopted in July 2023, apply to large EU subsidiaries and large issuers in EU-regulated markets, ensuring uniformity and comparability in reporting practices among significant market players.
• Additional sector-specific standards will also be developed for reporting on environmental, social and governance (ESG) issues for undertakings within certain sectors (e.g., energy production and utilities, finance).
• Sets of simplified standards will be tailored for in-scope Small and Medium Enterprises (SMEs), captive insurance and reinsurance undertakings, and non-EU undertakings that will be indirectly brought into scope starting in 2028.

2. Determining scope

The CSRD applies to large EU undertakings that meet at least two of the following three thresholds: at least 250 employees, a balance sheet total of €25 million, or a net turnover of €50 million. Additionally, it covers EU parent undertakings of large groups that meet these criteria on a consolidated basis (including both EU and non-EU subsidiaries) . Large undertakings which have their equity or debt securities listed on an EU-regulated market under the Markets in Financial Instruments Directive also fall within scope. The same applies to EU-listed SMEs with simplified reporting standards currently being developed. The CSRD also applies to large undertakings and parent undertakings of large groups incorporated outside the EU but listed in the EU, as well as non-EU SMEs with EU listings.

Furthermore, non-EU undertakings typically outside the scope of the CSRD can become indirectly subject to its requirements starting in 2028 if they have an EU subsidiary that falls into scope or an EU branch generating revenues over €40 million. Such undertakings must report on a global consolidated level—including the non-EU parent and all its subsidiaries—if the non-EU parent’s consolidated revenue in the EU exceeds €150 million. This requirement may coexist with the reporting obligations of the EU subsidiary itself. However, there is an exemption if the non-EU parent already produces a consolidated sustainability report that meets EU standards or an equivalent.

3. The double materiality assessment

While all undertakings covered under the CSRD must report the information specified in the ESRS, the information specified in the ESG standards must be reported only if it is material. The CSRD adopts a double-materiality approach, requiring undertakings to assess:

• Impact materiality: the short-, medium-, and long-term impact their operations and value chain have or are likely to have on the environment and people (e.g., carbon emissions, workforce diversity, respect for human rights).
• Financial materiality: the risks and opportunities that sustainability matters present or are likely to present on the organization’s financial performance in the short-, medium- and long-term (e.g., cash flows, risk, access to funding).

Reporting according to the double materiality principle goes beyond the disclosures proposed by the International Sustainability Standards Board by mandating the disclosure of information that is not financially material.

The CSRD requires that an external third party audits and assures the sustainability information and data reported by organizations.

4. Public disclosure requirements

Sustainability disclosures under the CSRD must adhere to EU rules on using a single electronic reporting format for financial reports. Undertakings must make their sustainability reports accessible free of charge on their website or, in the case of EU undertakings, on the central, commercial, or company register of their Member State. To ensure reliable reporting, sustainability reports by non-EU undertakings should be accompanied by an assurance opinion of an authorized person or firm.

From 10 January 2029, Members States must ensure that sustainability disclosures are published on the European Single Access Point, a centralized data space offering free digital access to detailed information on EU corporations that was established by EU Regulation in 2023.

5. Looking ahead

CSRD applies to any undertaking meeting the prescribed thresholds, regardless of the industry; asset and fund managers are also in-scope if they meet these thresholds or are listed. Although EU funds themselves are exempt (as they are covered by the Sustainable Finance Disclosure Regulation), non-EU funds can generally still qualify to be in scope. For example, non-EU funds that hold majority stakes in portfolio companies that are within scope of CSRD could be considered a parent undertaking and thus brought into scope in 2028. For non-EU funds structured in the form of partnerships, there is room to argue that they are out of scope.

Challenges. We anticipate that for many organizations, meeting CSRD’s obligations presents a significant challenge. Many undertakings lack the existing systems and processes to gather the necessary information, which is often not easily accessible. Additionally, the regulatory environment is rapidly evolving. Several EU jurisdictions have yet to formally adopt the CSRD into local legislation before the July 2024 deadline. These jurisdictions may introduce additional requirements beyond those specified in the CSRD, complicating compliance for undertakings operating across multiple EU countries. Further, the CSDDD will introduce additional ESG-related requirements and increase the risk of sustainability-related litigation, allowing parties to bring civil liability claims for damages resulting from undertakings’ failure to comply with due diligence obligations. Finally, businesses should be vigilant about new reporting mandates emerging outside the EU, such as the recent approval by the U. S. Securities and Exchange Commission of a comprehensive set of final rules regarding climate-related disclosures for public undertakings.

Opportunities. Private Equity (PE) firms can benefit from their efforts in CSRD reporting beyond the satisfaction of a compliance requirement. The data gathered for CSRD reporting (along with comparable and accurate data of portfolio companies not covered by CSRD), provides valuable insights for PE executives and deal teams into understanding market trends and how sustainability issues could impact the financial outcomes of portfolio companies or investment targets. This information is crucial for collaborating with portfolio company leaders to discover potential business opportunities and risks, leverage mechanisms for value creation, manage threats effectively, and enhance their equity narratives. Further, being prepared for the CSRD can influence the valuation of a portfolio company at the time of exit, as some buyers are already considering the future costs associated with CSRD compliance and annual reporting in their acquisition strategies.

Action points. We encourage PE firms to start actively preparing for CSRD requirements. Producing CSRD reports can be time-consuming and require coordination among different teams (e.g., finance, information technology, sustainability, risk management, and legal functions). PE sponsors should:

• Determine whether any of their undertakings or portfolio companies fall within regulatory scope. They should consolidate their information and assess sustainability issues, data points, impacts, risks and opportunities.
• Evaluate their reporting capabilities and set up the necessary processes to ensure that reporting is accurate, consistent, and ready for auditing assessments. This might include educating and sharing best practices on CSRD reporting with undertakings in-scope, setting up internal reporting structures and processes to collect required data, and preparing for information requests they might receive from undertakings in supply and distribution chains.
• Consider the status of structures such as holding companies, co-investment vehicles, and non-EU funds and determine to what extent they could be considered covered parent undertakings, thus bringing themselves and their subsidiaries into scope. Undertakings consolidated for financial reporting within a group will generally likely to be consolidated for sustainability reporting under the CSRD.
• Consider CSDDD’s forthcoming due diligence obligations (starting from 2027) when developing their strategies for CSRD compliance. Preparation for the CSRD should include integrating due diligence processes and ESG factors into investment strategies and improving portfolio companies’ compliance with the CSDDD.

Private Equity Report Spring 2024, Vol 24, No 1