This post is continuing a text posted last week.
It is safe to say that there is no business yet that is perfectly sustainable in every conceivable way. Some businesses may have made more of an effort and come further than others but even those at the top of the class are still working on how to improve their environmental and social impacts. If you are running a business with the ambition to make it as sustainable as possible or if you are working in business sustainability, this leads to the question: what does the discussion of our last two posts mean for you?
Before we can reasonably answer this question for the smallest types of businesses, we need to have a look at the formal thresholds of business sizes in the Corporate Sustainability Reporting Directive (CSRD). Since the CSRD has entered into force on 5 January 2023, we already know its scope of application. Awaiting its respective national implementations, it will oblige at least the following sizes of businesses:
- For financial years starting on or after 1 January 2024, the CSRD applies to large undertakings which exceed at least two criteria out of the following three: a balance sheet total of 20 million EUR, a net turnover of 40 million EUR, 500 employees. It also applies to publicly listed parents of undertakings meeting these criteria.
- For financial years starting on or after 1 January 2025, the CSRD expands to large undertakings which exceed at least two criteria out of the following three: a balance sheet total of 20 million EUR, a net turnover of 40 million EUR, 250 employees. It also applies to publicly listed parents of undertakings meeting these criteria.
- For financial years starting on or after 1 January 2026, the CSRD finally expands to publicly listed small and medium-sized undertakings. It applies to publicly listed medium-sized undertakings which do not exceed at least two criteria out of the following three: a balance sheet total of 20 million EUR, a net turnover of 40 million EUR, 250 employees. It also applies to publicly listed small undertakings which do not exceed at least two criteria out of the following three: a balance sheet total of 4 million EUR, a net turnover of 8 million EUR, 50 employees.
Explicitly exempt in the CRSD are micro undertakings which are defined as not exceeding two of the following criteria: a balance sheet total of 350.000 EUR, a net turnover of 700.000 EUR, 10 employees. Even so, the CSRD will eventually apply to a much greater number of businesses than the preceding Non-financial Reporting Directive (NFRD) ever did, since publicly listed small and medium-sized enterprises (SMEs) will have to implement it.
This leaves the question of how SMEs that are not publicly listed should proceed. There are several options. Until recently, these have been based on interpretation by virtue of the fact that CSRD does not bind these SMEs but binds their potential larger business partners. Since these larger businesses have to extend their sustainability work – to an extent at least – into their value chain, such SMEs may very well face sustainability demands from such larger partners, even if these demands are not of a legal nature. We ended our previous blog post on this note.
Which reporting standard should you use?
Now that we know what kinds of companies are not legally covered by the CSRD, we can address a question that is particularly relevant for such smaller, non-listed companies: Which reporting standard should you use? And not only that. If you care about using a legitimate standard, we should also ask: Who developed the reporting standard you are using? Generally speaking, you should base your sustainability reporting on a standard that leads to meaningful and high-quality reports and that comes from a trustworthy source without obvious conflicts of interest.
The European Financial Reporting Advisory Group (EFRAG) is the developer of the European Sustainability Reporting Standards (ESRS). It is a private association serving the public interest by providing technical advice to the European Commission. Its recently expanded role is manifest in its development of the ESRS. As a close partner of the European Union and no direct origins in business, it should be reasonably free of conflicts of interest. Now EFRAG has also released draft voluntary ESRS for non-listed SMEs. As such, its contents are of course subject to possible future changes. Nevertheless, even as a draft they provide great insights for SMEs that do not fall under the CSRD.
According to the draft ESRS for SMEs, they cover the same topics as and are consistent with the draft ESRS for large undertakings. Importantly though, they do so based on the key concept of proportionality. The draft ESRS for SMEs lack legal authority and offer non-listed SMEs a voluntary tool for reporting on their sustainability work. If they so wish, they may also use the ESRS for large undertakings on a voluntary basis. Before we dive into the ESRS in more detail, we will now have a brief look at some other options.
Like the ESRS, the Sustainable Development Performance Indicators (SDPIs), developed in cooperation with UNRISD, the United Nations Research Institute for Social Development, come from a legitimate source with a low risk of conflicts of interest, unlike for instance standards developed with the backing of corporate interests. The established and well-known reporting standards of the Global Reporting Initiative (GRI) have their origins in the non-profit sector and, like the above, should carry more legitimacy than standards developed by a self-governing private sector. One such case is the International Sustainability Standards Board (ISSB) whose standards are prominent in the contemporary reporting landscape. The ISSB, however, is a body founded by major business actors and faces heavy criticism from more progressive actors in the sustainability debate.
If you genuinely care about running a business that is as sustainable as possible in environmental, social, and governance terms, you must consider these questions when deciding which reporting standards to follow. More technical aspects related to what we have discussed in this blog series should also be part of your decision: we now know that the ESRS employ a double materiality approach and sustainability due diligence. The SDPIs even state to employ a triple materiality approach through a context dimension that adds thresholds against which to compare one’s reporting data. They also briefly mention due diligence but do so not as centrally as the ESRS. The GRI standards do not explicitly speak of double materiality but describe something quite similar and they have integrated due diligence in response to the UNGPs. Their disadvantage with regard to responsible behaviour of major businesses is of course their voluntary nature. For non-listed SMEs though, all reporting is voluntary in a legal sense.
Other reporting standards with which CSRD and ESRS state to be in alignment, however, may implicitly employ a single materiality approach. The ISSB standards, for instance, use a single materiality approach. In other words, businesses following ISSB reporting standards select what topics and issues to report on solely based on the question which topic and issue impacts their – or rather their investors’ – financial bottom line. Aspects of their operations that negatively impact people or the environment but that have no negative consequences for their finances may very well fall through the metaphorical cracks of such sustainability reporting. Not surprisingly, sustainability-oriented due diligence plays no role at all in the ISSB standards.
This kind of reasoning is simply not up to speed, given the urgency needed to tackle current environmental and social crises. As many critics and voices in the sustainability debate have pointed out, a unitary focus on financial materiality is simply incompatible with any attempt to establish a business entity’s genuinely intentioned sustainability work. Our advice is to familiarise yourself with the CSRD and ESRS, whether you are soon legally required to report in line with them or not. Now you can also have a look at the draft ESRS for SMEs. These will form the backbone of the sustainability reporting in the EU for years to come. The more concise SDPIs add a valuable context dimension which we also suggest you consider.
We will discuss the ESRS in more detail going forward.
Now that you’ve gained insights into ESRS and CSRD, it’s time to take the next step towards a sustainable future. At MorrowX, we’re passionate about simplifying sustainability for you. Whether you’re a business organisation looking to enhance your environmental and social impact or an SME eager to begin your sustainability journey, we’re here to guide you.
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