Why is CSRD important for UK businesses?

1. Introduction

              The pursuit of environmental, social, and governance (ESG) objectives has grown more closely linked to a company's financial performance in the current corporate environment. Yet, even with an increased focus on sustainability initiatives, companies need to ensure success by retaining profitability. Enter materiality assessments, strategic frameworks that enable businesses to openly assess the sustainable implications of their overall initiatives, with an emphasis on internal business operations and the value chain. These evaluations help stakeholders make decisions by identifying important ESG concerns that pertain to their operations.

              Along with ESG reporting, the importance of incorporating sustainability into business strategy has been further cemented through policies such as those in the European Green Deal of 2019, and the Corporate Sustainability Reporting Directive (CSRD) of 2021. The European Green Deal, which aims to achieve carbon neutrality by 2050, has provided businesses with a clear path to align their operations with environmental goals. In turn, the CSRD’s focus is to standardise the reporting processes across the EU with the aim of improving transparency and evaluating corporate sustainability performance. When taken as a whole, these programmes offer businesses a roadmap for navigating the ever-changing sustainability landscape.     

               This article will explore how, despite no longer being bound by EU regulations post-Brexit, CSRD is important to UK businesses for a multitude of reasons. Specifically, this will be done by explaining what the CSRD entails, who it affects, its benefits and its challenges.

2. Understanding CSRD

              The CSRD seeks to enhance transparency and comparability in corporate sustainability reporting. It uses the double materiality principle, assessing a company’s operational, financial, environmental and societal impact, rather than single materiality, which solely assesses a company’s financial performance. As such, the concept of “double materiality” encapsulates the impact that an organisation has on the environment and society at large, and in turn how this impacts financial performance. It’s a nuanced difference with single materiality, but an important one. In this manner, an organisation’s external impacts can be understood in a more holistic manner covering not only their own operations but also their upstream and downstream activities. Upstream activities relate to the production of products and services, while downstream activities relate to the use and disposal of these products and services.

              This evaluation was first defined by the European Commission and recognised as part of the Non-Financial Reporting Directive (NFRD) in 2019 and expanded upon with the adoption of the CSRD by the European Parliament in November 2022. This guideline, which has started to be slowly implemented in 2024, highlights a more thorough framework for assessing the whole range of sustainability consequences. An aim of this new reporting directive is to support decision-making at the executive level of diverse organisations, by providing an improved understanding of their businesses’ impact on the wider world. While likely to entail the implementation of firmer measures to comply with the European Green Deal, potentially disrupting operational processes, double materiality assessments can also help identify financial opportunities, not just financial risks. This forward-looking thinking is not always carried out through the ESG prism, and this potential source of innovation is more unique to the CSRD.

              While you may be reading this working from an organisation based outside the EU and think this doesn’t concern you, unfortunately (or fortunately, depending on your perspective), you’d be wrong! Certain non-EU undertakings will also be impacted and need to comply with the CSRD, depending on if they fall under one of the following two categories:

1. The company is listed on an EU regulated market with securities such as stocks or bonds.
2. The company is not listed on an EU regulated market but has:

• Generated over €150 million in revenue in the EU for each of the last two financial years; and
• An EU subsidiary which generated annual net turnover of over €40 million in the last financial year (also known as the “EU Turnover Test”)

Notably, while the CSRD reporting periods officially began on January 1st 2024, the implementation is actually staggered and will gradually apply to organisations from 2024 to 2028. Drawing directly from the EU Directive Article 5, this table shows which types of organisations will be affected and when:

To clarify, for when the language refers to differently sized enterprises, here’s a little cheat sheet:

If an organisation matches at least two of the above three criteria for any row, they will need to comply with the CSRD from the given year illustrated in Table 1.

3. Importance and Benefits of CSRD for UK Businesses

              As seen above, many UK businesses – given that they fall under the “non-EU” bracket – will need to comply with the CSRD in a regulatory manner at some point within the next 5 years, highlighting the importance of this directive. Here are some other key benefits:

1. Meeting and Anticipating Regulatory Demands

              If companies wish to continue trading within the EU, UK companies must prepare for increased accountability and transparency regarding their sustainability performance. However, even beyond EU-related requirements, the UK government has recently committed to adopt the International Financial Reporting Standards (IFRS) Sustainability Disclosure Standards (SDS). Following this decision, the government is now developing Sustainability Reporting Standards (SRS) and has stated its aim to publish two UK SRSs in Q1 2025, as reported by the UK Department for Business and Trade. Subsequent reporting requirements will be established later in 2025. In this manner, taking the necessary steps to set up and start thinking about sustainability reporting is paramount for UK businesses as they will likely have to comply to some standard or another before the end of the decade.

2. Market Expectations and Corporate Reputation

              It’s no secret that society is becoming increasingly climate conscious with investors, consumers and employees all demanding greater transparency in a more sustainable world. In taking steps to adopt the CSRD, UK businesses can really put into action their commitment to sustainability. Thus, they can enhance their attractiveness to investors who include ESG criteria in investment decisions. This can also help enterprises improve their reputation and differentiate themselves in a competitive market. Some additional benefits from this include increased employee retention, attracting top talent, improved customer loyalty and strengthening stakeholder trust.

3. Preparing for the Future

              While so far we’ve spoken mainly about sustainability from a regulatory perspective, it’s important to remember the context of these initiatives. I recently attended an event at Chatham House titled “How to Manage the Unthinkable” (which I would absolutely recommend listening to if you have a moment) where we explored what it might mean to overshoot the Paris Agreement objective of 1.5°C. Notably, one of the experts on the panel explicitly said that we will overshoot, and that we need to come to terms with this reality. In this manner, incorporating sustainability reporting through the CSRD is paramount to building long-term resilience as it helps businesses understand the risks they are responsible for. It’s also a brilliant opportunity to drive innovation, by finding areas to optimise resource utilisation and build revamped sustainable business models. Ultimately, as highlighted in a 2022 study by the Indian Journal of Commerce and Management Studies, adopting sustainability reporting is linked with improved long-term profitability. And this is not just one study, there’s wider evidence to support this claim, tying it back to the overarching importance of preparing for the future by anticipating risks and regulatory changes.

4. The Challenges of Adopting CSRD

               As you may expect, despite emphasising the importance of CSRD and similar reporting standards, transitioning to this level of reporting is not an easy feat. The first challenge lies in collecting the correct information across the supply chain. To address this, the European Sustainability Reporting Standards (ESRS) places crucial emphasis on engaging with all affected stakeholders including employees, suppliers, customers, trade unions, governments and more. This must be supported by systems to collect accurate and traceable data – as the data needs to be of good quality to maintain an effective audit trail. It’s also worthwhile to perform a gap analysis, to understand where current operational practices fall short or cannot be measured against CSRD requirements, and the gap to reach them progressively. Another challenge also lies in aligning CSRD with frameworks such as the IFRS and Global Reporting Initiative (GRI).

5. Next Steps

               To support with these multitude of challenges, Wavestone has tremendous experience and can help businesses on their journey to sustainability reporting. From conducting double materiality assessments and producing a gap analysis, to collecting the right level of data and engaging the various stakeholders, we can assist. We have tools that can facilitate in aligning with the frameworks mentioned above and can support the long-term evolving governance required to uphold sustainability reporting. So, if this is something that you would like support with, please don’t hesitate to get in touch!

              As has been discussed, CSRD is a new reporting directive, which is shaping the world of tomorrow. While the UK continues to develop its own frameworks, businesses should consider aligning with CSRD imminently to anticipate these regulatory changes and build greater long-term resilience. And for those who already comply with the EU regulation, this is an excellent opportunity to position yourselves competitively within the EU market by emphasising your commitment to sustainability.

6. Additional Resources

If you would like some more information, please find below a series of resources that helped me write this article and which provide more information on CSRD.

Regulatory Documentation:

• Full CSRD EU Directive Published on December 14th, 2022
• Harvard Paper on the CSRD and its relevance for non-EU companies
• UK Government SDR Update Published on May 16th, 2024
• IFRS Sustainability Standards Navigator

Wavestone Resources:

• Regulation: Accelerator or brake in the quest for sustainable performance?
• CSR Barometer 2024
• Sustainable Banking Practices in the EU: Shaping the Future of Finance
• Sustainability: Embracing Change, Creating Value
• Wavestone’s CSR Commitments

Glossary:

• ESG: Environmental, Social and Governance
• CSRD: Corporate Sustainability Reporting Directive
• NFRD: Non-Financial Reporting Directive
• IFRS: International Financial Reporting Standards
• SDS: Sustainability Disclosure Standards
• SRS: Sustainability Reporting Standards
• ESRS: European Sustainability Reporting Standards
• GRI: Global Reporting Initiative