Governance & Compliance 1: EU Omnibus impacts UK sustainability reporting

Will:

Welcome to the first in our series of AGC Ashurst Governance and Compliance Podcasts, where we'll focus on the latest developments in the world of governance, compliance, and reporting. I'm Will Chalk, a partner in our corporate governance team. Sometimes, these will be round up to the latest issues, whereas, today, will focus on a single issue. Given the significance of events over the last week or so, we thought we'd focus on sustainability reporting and due diligence, and in particular the impact of the EU's Omnibus package. And, frankly, given the breadth of what's going on, I'm delighted to be joined by my colleague, Becky Clissmann, who's a counsel focused on sustainability, and the inimitable Claire Bodanis, the founder and a director of the excellent Reporting and Comms Agency, Falcon Windsor.

Before we get into the subject matter, a few ground rules. This is a podcast, it's not meant to be a webinar. The aim is to highlight some of the key issues for companies to consider, particularly those companies that were in scope of the regulations, and now may be out, or are still in scope, but may have potentially altered requirements to adhere to. Now, for those of you who really want to get into the weeds, we'll link some publications on the web page. So, Becky, without further ado, it's almost unfair to ask you. There's so much to unpack here, but could you start us off by giving us a potted history of how we've got to where we are today?

Becky:

Thanks, Will. Sure. So, yes, there is a lot to unpack. So just by way of background, the EU sustainability reporting and due diligence legislation includes, obviously, a number of pieces of legislation. But three key pieces are the Corporate Sustainability Reporting Directive, the Corporate Sustainability Due Diligence Directive, and the EU Taxonomy. And there is quite a bit of overlap between these three pieces of legislation, and they are very complex beasts. And just to say, the first reports under CSRD have only just been published in the last month. So there's been a lot building up to the system that we have today. But following pressure from several quarters, the EU announced, at the end of February, that in its Omnibus package that it would be amending this legislation to improve EU competitiveness. So that's the landscape, really.

Will:

So just explain what exactly we mean by this Omnibus package?

Becky:

Yeah, so it's become a bit of a word, really. So the package includes a number of things, but two key things are two amending directives. And the first of these is what people are calling a stop the clock directive. So its effect is to postpone CSRD reporting by two years for certain of the in-scope companies. And the other effect is to postpone the transposition of the Corporate Sustainability Due Diligence Directive, and the deadline for that, that member states will be subject to. The second amending directive that I mentioned is one that will make more substantive proposals that will change the underlying reporting and due diligence obligations. And that is more likely to take more time, and will be the subject, I'm sure, of intense negotiations. So it's a big package, and it does two things. It stops the clock and, also, it proposes some significant changes to the legislation.

Will:

So we've got two directives, one which will effectively put things on hold for those companies yet to meet their requirements, and another which will go to the substance of what's in the underlying legislation, which will probably take longer. Okay, thank you, that's clear.

Becky:

That's right, yeah.

Will:

So, Claire, focusing on sustainability reporting under CSRD, from your perspective of somebody who's helped many companies prepare for reporting, what should companies be doing in response to what are likely to be significant changes, or at least significant changes that have been proposed?

Claire:

Well, I guess you're saying aside from a few expletives, plus a sigh of relief, Will, I guess.

Will:

Yes, quite.

Claire:

The first and most important thing is to check whether or not you're still in scope. The CSRD requirements originally brought a whopping 50,000 companies into scope, whereas, before, under the old reporting requirements, it was about, I think, 11,000. But the changes that they're proposing mean that only 10,000 will now be still in scope, which is a huge 80% reduction. So check whether or not they still apply to you. Now, for non-EU companies in particular, I imagine there'll be some listening to this, it probably means far fewer will be caught by the requirements.

But now what complicates the picture, of course, is that some countries have already transposed the CSRD and, therefore, the European Sustainability Reporting Standards, or ESRS, into national law, while some haven't, even though they were all supposed to have done it ages ago. But, anyway, some companies, therefore, already started reporting, using the original ESRS. And under the new proposals, these are being quite significantly simplified. Now, these latest proposals from the EU, they don't actually postpone companies already reporting, or about to report, in countries where it's already the law. So if you're already doing it, there's a potential situation here where companies might have been in scope under the old requirements, and are having to do it at the moment, but won't necessarily be required to do so under the new requirements. So there's this period where you might be required to do it for a bit and then no longer.

Now, what do they do? Now, I have to be very, very careful here because, of course, I am on a panelists here... Not a panel, a podcast rather, and my fellow podcastees are lawyers. Because, of course, common sense would probably tell you to do one thing, wouldn't it? Whereas, actually, we must obey the law.

Will:

The law tells you to do something else.

Claire:

Exactly. So in my view, but please do check with your own lawyers here, if your country hasn't transposed CSRD international legislation yet, then I would wait and see what happens with the new requirements before reporting. Now, I have a client in Germany, for example, who was preparing to report under CSRD using the new ESRS, pretty much up to the last minute. And then the Audit Committee decided not to because Germany hadn't transposed it into law. So they decided to do what was required by German law. So that's one client, one example. But if your country has already transposed CSRD into national law, and you are in this first wave of companies required to report now, but even if you're likely to fall out of scope later, my view would be, you should probably do the minimum of reporting to comply with what's in place now.

Now, this must seem a real pain, of course, for companies that have invested a lot in this exercise already. But don't forget if you've done that work rigorously, investigating your material impacts, risks, and opportunities, in environmental and social issues, which is really what this is all about, then that exercise in itself should have given you some valuable insights into managing your business.

So, lastly, Will, just in response to your question about what should companies be doing, I think it's really important to say, this is a situation that's moving very quickly. So, first, do stay on top of the developments. And as Will said, Ashurst will publishing a lot about this as it comes up, and so will we at Falcon Windsor. And, second, a reasonable explanation in your reporting as to why you're doing it, and where you are at as a company with CSRD and what's going on, is very, very useful. In fact, that German client I mentioned just a moment ago, that's exactly what they've done. You put an explanation in your sustainability statement, explaining this is the picture now and, therefore, you're reporting XYZ in this way to do your best to comply with what's going on. And remember that reporting is, after all, trying to communicate something to a reader. So if you explain what you're doing, then that's the most important thing.

Will:

So comply with the law, to state the obvious, but continue with your preparations, I guess. But, ultimately, soft-pedal it somewhat until we've got some clarity.

So you've mentioned non-EU companies, i.e. UK incorporated companies, but what are your thoughts there? Assuming that they weren't caught in that first wave, I suppose, Claire.

Claire:

Well, which I don't think... I think it's unlikely, unless they're dual listed, of course, so they might have been.

Will:

Exactly, yeah.

Claire:

But many UK companies that were expecting to report in the wave four, which is the financial year 2028, as I said, may well be out of scope now. And that does include quite a lot of our clients. And I know that many have already invested in the preparation. So I'll say now to your audience here what I've said to them, aside from the gnashing of teeth and sighs of relief aspect, so I think for me there are three key points. So first of all, as I alluded to earlier, your prep work, if done well, will not go to waste. Because aside from what I said about effectively the double materiality analysis that you had to do for ESRS being a useful exercise in and of itself, the ISSB's sustainability reporting standards, IFRS S1 and S2, are likely to be adopted in the UK as well as in other jurisdictions. So even if you end up not doing CSRD, some of the work you've done to prepare for it will be useful in preparing for ISSB.

And, of course, although the ISSB only talks about materiality, not double materiality, nonetheless, understanding your impact on the environmental and social issues around you, the so-called impact materiality, as well as their impact on you, the so-called financial materiality, does mean that ultimately you will understand them better in the round.

Point two though, there is also a bit of a complication here because there is a draught reporting standard on the books called NESRS, the non-EU SRS for non-EU listed companies, which are less demanding than the original ESRS, not least in that they require companies only to report on impact, rather than financial materiality. But since the ISSB is likely to require companies to report on the equivalent of the ESRS financial materiality, you may end up having to do both anyway. But any case, at the time of doing this podcast, we're still waiting to hear the fate of the NESRS, I believe, unless Becky or Will have heard anything that I haven't at this point. And so, therefore, as to which subsidiaries or group entities will be caught by the main ESRS, and which are caught by the NESRS, you'll need to check that. It'll probably take an entire podcast to discuss who's in and out scope of all of those things. So you really should check for yourself.

Will:

Yes, but as we said, Claire, it's a podcast, not a webinar, so we're not going to get into that level of detail.

Claire:

Exactly.

Will:

People will no doubt be pleased to hear.

Claire:

No, indeed. And the last thing I think is to say, is that under the original scope, so point three under the original scope, a lot of companies that weren't caught themselves, nonetheless, found themselves in the value chain of an in-scope company, which would then be asking for the information anyway. So a lot of UK companies might have found themselves in this position. But as I understand it, the Omnibus is proposing provisions to prevent that trickle down of information. So, therefore, if you're not in scope, you can't reasonably be required to provide that. Now, that's my understanding of it, but as I said, I defer to my legal colleagues here if I've interpreted that correctly.

Will:

Well, I think there's some water to pass under the bridge before we get comfortable with that analysis, I guess, isn't there? So, Becky, what are you hearing about the market's reaction and assessment? Let's take CSRD changes first.

Becky:

So, yeah, well, there's been a very mixed set of reactions, really. Lots of comments around whether or not what the EU has proposed is actually simplifying the legislation or whether it amounts to deregulation. And I think whether or not you... What side of the line you fall on there depends on, probably, the cohort that you are in. So whether you're one of those first wave companies that's required to report this year, in respect of financial year 2024, things are likely to look a bit more complicated for you. Because you're in this slightly unusual situation where you are reporting on something that you know is going to change and that, potentially, you could fall outside of, as Claire has already alluded to. So you might be feeling that this is actually not simple at all.

For if you're a second wave company, you're probably going to feel that it is a simplification because you're going to benefit from a two year's postponement. And we're expecting the EU reporting standards to be simplified. So then, for you, it looks like a much more beneficial picture. So, yeah, from a CSRD perspective, question whether it really is simplified. It feels a bit more like deregulation.

But, again, people's perspectives on that may differ.

Will:

And, of course, as we've said, these are the Omnibus package are proposals at the moment.

Becky:

Exactly.

Will:

They're going to change. So that CSRD, CS3D, your thoughts?

Becky:

Yes, again, a mixed reaction. I think a lot of companies are being pleased to hear that the proposed, or the EU level liability that's proposed to be removed, so the national liability provisions kick in there. So that's of great comfort, I think, to a number of companies. Other people have expressed a level of concern about the proposed change to limit due diligence requirements from direct business partners, so that people would just be required to do due diligence on their tier one, or direct business partners, rather than those that they have an indirect relationship with. However, I don't know whether that change is really going to be significant because, for a number of companies that have signed up for the voluntary standards, like the UN Guiding Principles, there may be little practical change for them. And, also, should note that the proposals do include a requirement for indirect business partners to be the subject of due diligence where the company has plausible information of adverse impacts in its indirect value chain.

Will:

So this is all a concern, born of a worry, that the proposals effectively make this a rather meaningless standard?

Becky:

Yeah, again, depending on your perspective, this is a contraction in the ambition for the CS3D. And I think there's a real question as well as to whether these changes will go further. We know from clients and colleagues in Germany and France, who have got their own supply chain due diligence regulations, that there are a number of organisations that want to see them change significantly as well. So in order for that to happen, the EU's own regulation, the CS3D, needs to change significantly. So it looks like there is a real shift being planned but, again, whether that is more in terms of the perception, rather than the actuality, is a question. And it will depend on people's perspectives.

The only other thing I wanted to draw out, really, was there's a proposal as well in the Omnibus that the due diligence would need to be done every five years, rather than annually. But, again, I don't know whether that's something that companies will take advantage of because we've heard clients express the view that they do annual reviews of their supply chain anyway, and that's part of their annual business cycle. So whether or not there's a requirement to do it every five years, doesn't really change anything. So, yeah, mixed reactions, but whether or not this is simplification, I have a serious doubt about.

Claire:

Can I pick up there?

Will:

And, Claire?

Claire:

Yeah, because I know I have a very strong view about the simplification of reporting. Because the reason, in my view, so much of this has been so difficult is because the ESRS were incredibly complicatedly written in the first place. So it's very, very difficult to actually understand them. So the only way this change will simplify reporting, and it should, given that if you look at the content of what companies are going to have to report, if we just think about the reporting end, there should be a lot less of it, but it'll only work, it'll only be simpler if they write the new reporting standards, the new ESRS, or anything else, in a manner that is clear, straightforward, and intelligible.

I'll give you an example. I read both the ISSB standards the IFRS standards, S1 and S2, when they came out, and they came out at about the same time. And I just spent an afternoon reading the ISSB. And it took me days to get through the ESRS, just to try to understand what they were doing. Now, I would argue that the reason that so many jurisdictions had brought the ISSB standards in, with no more than the usual complication, is because they were really clearly and simply written.

So please, please, please, to the ESRS, if anybody's listening, write them clearly, and then it'll be a lot easier and simpler for people to adopt them.

Will:

So, Claire, come on, finish this off. What's your advice to what must be some rather frustrated and confused sustainability and reporting teams out there?

Claire:

Well, as I always say about anything to do with reporting, it's about standing back and reminding ourselves why we are doing this. And I don't mean because the regulations say so, but why the regulations say so in the first place. We must, therefore, be guided by the spirit and the purpose of the standards. Which in the case of the sustainability reporting standards from the EU, is to get companies to properly understand, and thus be able to account for, their societal and environmental impacts. Impacts, risks, and opportunities, sorry. And I find that actually quite inspiring, and I support the EU in this endeavour. And it's also, if you think about it, in companies' interest to understand these things because it should enable them to do business better.

And then we must put this in the context of the purpose of reporting as a whole, which is, namely, to build a relationship of trust between the company and your investors and stakeholders through truthful, clear reporting that people believe because it tells an honest and an engaging story. That is the point, and that's why I go on about language so much. If you write from the point of view of, "What do I want our readers to understand?" Not, "What do I want to tell them?" Or, "What do the regulations say I must say?" But, "What do I need them to understand?" If you do that way, you will both report well for your investors and your principal stakeholders. And you'll be able to explain yourselves and what you're doing quite clearly to the regulators as well, in a regulatory context that's still pretty murky. And, finally, do add your voice if you have time to any consultations on the ESRS. Because if we can all put our perspectives forward, and encourage them to give us clear, well-written reporting standards, it will be in all our interests in the long run.

Will:

Hear, hear. So there's a lot to assimilate, some considerable way to go before the proposals settle down, as we've heard, particularly when you consider the UK government are yet to bring forward detailed plans for their own sustainability reporting environment. My sense is, obviously, they're waiting for the EU position to become clearer first.

If you want more information, you can find that through the links we've put on the web page. We'd, of course, be delighted to discuss these issues in more detail with you, and their implications for your business. Do get in touch.

Claire, thank you so much for joining us, and being so open with your thoughts, as always. It's been fascinating to hear your views. We'll undoubtedly be checking in with you on this topic in due course. And thanks also to you, Becky, not least for allowing us all to keep on top of the changes. And thank you for listening to our first podcast. There's more to come, many of which will develop the issues in our board priorities, which we published in January, and which you can also find on our website. Please do share the podcast with interested colleagues, and let us know what you think we can do to improve them in the future. Bye for now.