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One of the key objectives of the European Green Deal is to achieve climate neutrality by 2050. The initiative is seeking to transform the EU into a modern, resource-efficient and competitive economy with the aim of reducing greenhouse gases and ultimately reducing the reliance on natural resources.
As part of these objectives, the EU has introduced the Corporate Sustainability Reporting Directive (“CSRD”) which sets the standard by which EU companies will have to report their climate and environmental impact. The European Commission has also adopted the European Sustainability Reporting Standards (“ESRS”), which formulate the reporting standard which is used to meet the reporting requirements under the CSRD.
Both of these initiatives are crucial in the EU’s effort to transform sustainability reporting practices across member states. While both the CSRD and the ESRS are interconnected, they still operate independently and have distinct objectives in relation to corporate sustainability.
Corporate Sustainability Reporting Directive
The CSRD was adopted by Ireland on 5th July 2024 and mandates certain large and listed companies (“CSRD Companies”) to disclose detailed information on Environmental, Social and Governance (“ESG”) matters. In effect, the focus of the legislation is on the impact of a company’s operations and how these operations may potentially impact people and the environment.
European Sustainability Reporting Standards
While the CSRD sets out the relevant reporting requirements and obligations to be followed, the ESRS provides the framework and methodology for the actual reporting.
The ESRS was developed by the European Financial Advisory Group (“EFRAG”) and adopted as a delegated act by the European Commission on 31st July 2023. The ESRS (“Reporting Standards”) provide a structured framework for reporting and set out the ESG criteria that CSRD Companies will need to report on in order to comply with the provisions of the legislation.
For the most part, SMEs do not fall within the scope of the CSRD, save for those listed on an EU regulated exchange or small credit institutions and captive insurance undertakings. However, it is envisaged that small and medium undertakings may find themselves subject to the oversight of the CSRD due to their status as either a distributor or supplier within the value chain of a larger CSRD Company.
Upstream and Downstream Value Chain
Articles 19(a)(3) and 29(a)(3) of the CSRD require companies to disclose information, not just about their own activities, but also about their “upstream and downstream value chain”. The upstream and downstream value chain includes relevant products, services and business relationships that CSRD Companies engage in.
The Reporting Standards define the value chain as “the full range of activities, resources and relationships related to a CSRD Company’s business model and the external environment in which it operates”. The value chain is also said to include “actors upstream and downstream from the undertaking”.
By way of classification, “actors upstream” from the CSRD Company are suppliers of goods or services to the company which facilitate the development of the company’s products. The “downstream actors” would be the company’s distributors and customers who receive the actual products or services from the company.
Impact on SMEs in the Value Chain
Given the status of the upstream and downstream actors, non-listed SMEs who are not immediately within the scope of the CSRD may find themselves within the value chain of the larger CSRD companies and consequently, will in turn feel the impact of the ESRS. These SMEs may find themselves acting in the role of either a supplier to or a distributor on behalf of a reporting CSRD company and this in turn will result in their own ESG practices coming under scrutiny.
General Requirements for Disclosures
The general requirements relating to disclosures by a CSRD Company can be found in the ESRS 1 General Requirements annex (“ESRS 1”). Chapter 5 of ESRS 1 sets out the requirement for value chain reporting under which a CSRD Company must provide a sustainability statement showing the “material impacts, risks and opportunities” affecting the company from an ESG perspective.
Any in-scope CSRD Company of 500+ employees must include their first CSRD compliant sustainability report in 2025, covering the 2024 financial year and it’s likely that they are now engaging with the SMEs in their value chain as they complete their materiality assessments. As part of this process, any SME who finds itself as either an upstream or a downstream actor within the value chain, should be openly engaging with the CSRD Company to ascertain the ESG information required as part of any potential assessment.
Likewise, the value chain SMEs will need to show their commitment to environmental and governance indicators including the implementation of energy-efficient measures, reduction of carbon footprints, adoption of circular economy practices and effective governance and ethical practices. While the obligation on SMEs to focus on reporting requirements and internal assessment can present challenges, it also provides these companies with an opportunity to showcase their compliance.
Voluntary Sustainability Reporting Standard
EFRAG has developed a voluntary sustainability reporting standard for those SMEs who are currently outside the scope of the CSRD. On 21st January 2024, EFRAG published its “Exposure Draft VSME” (“Draft Standard”) which provides SMEs with an overview of the disclosures that will be required. The Draft Standard also includes a materiality assessment in relation to the level of reporting in scope.
The Draft Standard is an attempt to satisfy the market need to have a common point of reference for SMEs who find themselves in the value chain and who face growing sustainability requests from CSRD Companies. Once finalised, it is hoped that the Draft Standard will provide SMEs with the relevant tools and information to assist them in navigating the reporting obligations within the value chain.
Conclusion
The legacy of the value chain reporting obligations arising from the CSRD is that SMEs who were originally outside the scope of the CSRD, may now find themselves subject to ESG reporting.
However, the Draft Standard, once finalised, will provide these SMEs with a common point of reference and structure to fulfil these reporting obligations, which in turn will assist in the navigation of the value chain.
Further Information
For advice on Corporate Sustainability requirements, please contact a member of our Corporate & M&A or Commercial Contracts Team.