In the wake of the ever-increasing importance of the sustainability issue and due to the EU's "Green Deal", which aims to achieve climate neutrality for the EU by 2050, there is a concrete need for all companies and organizations within the EU to act sustainably.
In order to promote sustainable investments in companies and projects, the EU has in recent years anchored the EU Taxonomy Regulation, the EU Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD) as the three pillars of its "Sustainable Finance Strategy" in different regulatory frameworks. The aim is to make the sustainable economic activities of all companies transparent as part of ESG reporting. Environment, social and governance (ESG) reporting refers to the disclosure of data on a company's business activities in the three areas of "Environment", "Social affairs" and "responsible corporate Governance". It helps investors better assess a company's business activities and potentially avoid companies that may pose greater financial risk due to their environmental performance or other social or governance practices.
The EU taxonomy as a general set of rules for climate and environmentally friendly economic activities within the EU provides the framework according to which investments and activities are considered environmentally sustainable on the basis of binding criteria (=6 environmental goals of the EU). Based on these criteria, companies must demonstrate whether and how "green" they are operating and investing. The aim is to stimulate the sustainable transformation of the European economy towards a more resource-efficient and low-emission economy.
The focus is on the following 6 climate/environmental goals:
1. climate protection
2. adaptation to climate change
3. sustainable use and application of water or marine resources
4. pollution prevention and control
5. transition to a circular economy
6. protection and restoration of biodiversity and ecosystems.
An activity is considered taxonomy-compliant if it makes a significant contribution to achieving at least one of these goals and does not significantly compromise any of the other goals. In addition, it must meet international standards, for example with regard to human rights and social issues.
The EU Taxonomy Regulation results in new reporting requirements for companies: Capital market-oriented companies with more than 500 employees must provide qualitative information on the extent to which their economic activities are sustainable in the sense of the taxonomy targets. This initially relates to Goals 1 (climate protection) and 2 (adaptation to climate change). The concrete formulation of goals 3-6 will be completed by the end of 2023.
EU Disclosure Regulation (SFDR)
The EU Disclosure Regulation (SFDR), which came into force on 10.03.2021, obliges all participants in the financial market to disclose the sustainability of financial products. The aim is to create better transparency, comparability and assessment possibilities of financial products for investors. All financial market participants (asset managers, banks, capital management companies, insurance companies) must disclose at company and product level the extent to which sustainability factors are included in the decision-making process for their financial products and what the adverse sustainability impacts of their financial products are (PAI Statements - Principal Adverse Impact Statements). In addition, financial market participants must account for the success of their sustainable decisions and activities in periodic SFDR reports. The required report contents must be published on the provider's website, in the pre-contractual information of the financial products and in the annual report.
The link between the EU taxonomy and the SFDR is that financial market participants must disclose the sustainable portion of the total investment and taxonomy compliance for all SFDR-relevant financial products based on the criteria of the EU taxonomy.
Large and listed companies (with more than 500 employees) are also subject to a reporting obligation on sustainability aspects of their business activities. Until now, the Non Financial Reporting Directive (NFRD), developed as a European directive, regulated these non-financial reporting obligations for EU member states. The version of the NFRD transposed into German law in 2017 is the CSR Directive Implementation Act or the CSR Directive. This regulates the disclosure of non-financial information in a "non-financial" report.
From 2024, the NFRD Directive will be expanded by the Europe-wide Corporate Sustainability Reporting Directive (CSRD) and its scope significantly extended. The aim is to implement a uniform standard for non-financial reporting throughout Europe. The extension not only increases the number of companies affected (according to estimates from 11,600 to 49,000), but also the scope and content of the reporting obligation. In future, the companies required to report under the phased introduction of CSRD will have to disclose more comprehensive sustainability information about their business activities than before and in accordance with more uniform standards. The first draft standards are currently being developed by EFRAG (European Financial Reporting Advisory Group).
Another central innovation of the CSRD compared to the NFRD is the so-called double materiality, according to which companies are obliged to report both on the impact of their own business operations on people and the environment and on the impact of sustainability aspects on the company.
The audit requirements for sustainability reporting will also be strengthened with the introduction of the CSRD directive: in the future, more detailed external audits will have to be carried out in accordance with defined auditing standards.
The CSRD Directive applies
The EU taxonomy and NFRD or CSRD (from 2024) are linked in two areas. On the one hand, NFRD/ CSRD reporting companies are obliged to comply with the requirements from the EU taxonomy. Secondly, the content from the EU taxonomy will be reported together with the NFRD/ CSRD requirements in the non-financial part of the annual financial statements.
The fact that financial market participants rely on data from the invested companies to meet the SFDR requirements means that there is also a close connection between NFRD/ CSRD and SFDR. However, due to the phased implementation of the CSRD Directive, in some cases not all of the required company data is yet available, which makes the rule-compliant implementation of the SFDR more difficult and leads to missing data points.
Based on the three major sets of rules of the EU Sustainable Finance Strategy - "EU Taxonomy Regulation", "EU Disclosure Regulation (SFDR)" and "Corporate Sustainability Reporting Directive (CSRD)" - all companies operating in the EU market will have to file ESG reporting in the future, regardless of their stock exchange listing and number of employees.
While large capital market-oriented companies such as banks and insurance companies with more than 500 employees have already been reporting on their ESG activities (environmental and climate protection, employee concerns, social aspects, corporate governance) since 2017 and financial market participants have also been obliged to do so since the implementation of the EU Disclosure Regulation (SFDR) at the latest, an estimated further 35,000 companies will be affected by ESG reporting obligations by 2026 in accordance with the CSRD Directive.
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