Bracing for CSRD: A Guide for Chinese Corporates

On November 28, 2022, the European Council, the highest decision-making body of the European Union, signed off on the Corporate Sustainability Reporting Directive (CSRD). The bill was passed two weeks ago in the European Parliament by a vote of 525 to 60, with 28 abstained.

On December 16, 2022, the CSRD was published in the EU Official Journal and will come into effect on January 5, 2023 and replace the Non-Financial Reporting Directive (NFRD) issued by the EU in October 2014. New rules of the CSRD will be implemented by EU member states around 18 months later.

Who needs to pay attention?

According to new CSRD requirements, the number of companies required to comply with sustainability reporting will increase to nearly 50,000, more than quadrupled from 11,000 companies under NFRD.

What are the requirements of CSRD?

1. The Double Materiality Perspective

CSRD further emphasizes the principle of "double materiality", requiring companies to report the material topics from two dimensions:1) the impacts of the activities of the undertaking on people and the environment, and 2) how various sustainability matters affect the undertaking.

CSRD includes a mechanism for independent assurance, whereby all companies in-scope need to start seeking "limited assurance" for their sustainability reports. Once CSRD has been fully rolled out and implemented, "reasonable assurance" on the sustainability reports will then be required, to ensure reliability of information.

3. Business model and strategy

CSRD requires companies to disclose a wide range of sustainability-related information, including their business models and strategies, such as:

• The resilience of the undertaking’s business model and strategy to risks related to sustainability matters
• The opportunities for the undertaking related to sustainability matters
• The plans of the undertaking, including implementing actions and related financial and investment plans, to ensure that its business model and strategy are compatible with:
  • The transition to a sustainable economy
  • The limiting of global warming to 1.5°C in line with the Paris Agreement
  • The objective of achieving climate neutrality by 2050 as and where relevant
  • The exposure of the undertaking to coal, oil and gas-related activities
• How the undertaking’s business model and strategy take account of the interests of the undertaking’s stakeholders and of the impacts of the undertaking on sustainability matters
• How the undertaking’s strategy has been implemented with regard to sustainability matters

4. Sustainable Development Goals, Policy and Governance

Companies required to comply with CSRD must set clear sustainable development goals and provide progress of attaining these goals. At the same time, it is necessary to disclose the roles and responsibilities of the company's management and board regarding sustainability issues, the incentive plans of management and board related to sustainability, and sustainable corporate strategy.

In addition, CSRD requires companies to disclose key sustainability risks, measures taken to address such risks, and due diligence process for any actual or potential sustainability risks facing its own operations and value chains, etc.

When will CSRD come into effect?

CSRD has been formally approved by the European Commission and application of the regulation will take place in four stages:

1. Reporting in 2025 on the financial year 2024 for companies already subject to the NFRD;
2. Reporting in 2026 on the financial year 2025 for large companies that are not currently subject to the NFRD;
3. Reporting in 2027 on the financial year 2026 for listed SMEs (except micro undertakings), small and non-complex credit institutions and captive insurance undertakings;
4. Reporting in 2029 on the financial year 2028 for third-country undertakings with net turnover above 150 million in the EU if they have at least one subsidiary or branch in the EU exceeding certain thresholds.

How will this impact Chinese companies?

"The implementation of CSRD brings significant challenges to many Chinese companies with operations in the EU," states Hu Jianyu, Partner of Climate Change and Sustainability at Deloitte. "Unlike the relatively high-level ESG information disclosure requirements in China, CSRD requires companies to implement a sustainable development strategy from the inside out, incorporating sustainability in strategic planning, business model, operation, risk control, supply chain, etc. and raising the bar for ESG information disclosure and management. Also, the requirement for companies to seek external assurance will further promote standardization of ESG data management and disclosure."

Over the last decade, Chinese companies have greatly expanded their global footprint, but ESG disclosure has presented a roadblock for those seeking to expand into Europe. After CSRD takes effect, Chinese companies with listed equity or bonds in the EU market, and those with a net turnover of more than EUR 150 million in the EU and/or subsidiaries/branches in the EU should pay close attention to whether they will be required to comply with CSRD rules – and if so, they should prioritize their familiarization of regulatory requirements in advance, and respond early.

In addition, as CSRD requires companies to disclose value chain information, if a company's value chain extends beyond the EU, then relevant information would also need to be disclosed. First of all, European companies that import finished goods from China will give order priority to Chinese manufacturers (or exporters) with better ESG disclosures when making purchasing decisions. Secondly, while the Chinese subsidiaries of European companies are technically not within the jurisdiction of CSRD, some European leading companies (due to operational or other reasons) may reference and apply CSRD standards to their China operation pre-emptively – in which, Chinese suppliers with better ESG performance according to CSRD may stand out and win more business, even though they don’t export to the EU directly.

Just as CSRD aims to ultimately extend its coverage to SMEs in the various sectors' value chain, more and more European companies (whether they simply import from, or have sophisticated operations in, China) are expected to gradually enhance ESG disclosure requirement of their Chinese suppliers. Therefore, it is highly advisable for Chinese companies, even SMEs, to start looking into improving sustainability performance, in order to reduce potential business impact as a result of China's overall lower sustainability standard vis-à-vis that of Europe.

How Should Companies Prepare?

CSRD requires companies to abide by more stringent ESG disclosure rules. Deloitte recommends companies to gradually build ESG capabilities to meet CSRD requirement in three stages:

Step 1: Baseline Assessment and Gap Analysis

Keep up with the new requirements of CSRD, and conduct a baseline assessment of the company's existing ESG reporting procedures (including internal control, governance, policies and procedures, etc.) to discover the gap between the company's current practices against relevant standards, providing foundation and direction for improving ESG disclosure as the next step.

Step 2: Develop and Execute an ESG Roadmap

Improve ESG governance framework and work with key internal stakeholders to create a feasible ESG roadmap. Strengthen board and management supervision of ESG-related matters, and allocate adequate resources to ensure smooth implementation of the company's ESG action plan. Identify ESG risks and opportunities for the company as a whole, and build an internal control process for non-financial information. Formulate ESG training plans for key employees, and cultivate ESG specialist talents.

Step 3: Prepare for ESG Assurance

Enhance ESG data management, promote digitalization of ESG information management, standardize process of data collection and verification, ensure coverage and disclosure quality of ESG information, and prepare for ESG assurance as required by CSRD.

CSRD has raised the bar for ESG disclosure, presenting both challenges and opportunities for Chinese companies doing business in Europe. Deloitte provides comprehensive and one-stop set of solutions for companies in different stages of sustainability transformation, helping companies build ESG frameworks from scratch, formulate ESG strategies and business models, and carry out ESG information disclosure and assurance, with the ultimate goal of helping our clients adapt to a more sustainability-centric future.