The Corporate Sustainability Reporting Directive (CSRD) imposes reporting requirements around environmental and social impact activities on large companies and listed small and medium enterprises (SMEs), meaning these companies must describe the impacts related to their value chain — including business relationships and supply chains. Consequently, in-scope companies will need to gather comprehensive sustainability information from their suppliers, which may include exempted non-listed SMEs.

Read on to find out how the CSRD aims to address sustainability issues across the supply chain and how this impacts different types of businesses — whether directly or indirectly.

A little background on the CSRD and supply chain transparency

According to the European Commission, the CSRD enhances transparency and accountability by — among other things — expanding the scope to large and listed companies while modernizing and strengthening reporting rules. The new requirements ensure stakeholders have access to the information they need to assess the impact companies pose on people and the environment. Companies under the obligation to report must comply with the European Sustainability Reporting Standards (ESRS) developed by the European Financial Reporting Advisory Group (EFRAG).

While the CSRD doesn’t directly address non-listed SMEs and its implementation will be incrementally phased in, allowing listed SMEs not to comply before 2026 (or 2028 if they wish to opt-out for two extra years), the demands of larger companies and investors might push SMEs towards early compliance. Luckily, EFRAG is developing separate and simpler reporting standards to help them navigate sustainability reporting requirements. That being said, what’s the overall impact of the CSRD on companies, and what does it mean for listed and non-listed SMEs and large companies?

How does the CSRD apply to different businesses?

The CSRD modifies the sections of Directive 2013/34/EU (the “Accounting Directive”) pertaining to non-financial disclosures initially introduced by the Non-Financial Reporting Directive (NFRD). The sustainability reporting mandates outlined in Article 1 of the CSRD will be phased out gradually between 2024 and 2028 for four distinct categories of companies.

1. As of January 2025, for reporting related to the sustainability performance of the year 2024, companies that already fall under the NFRD and meet the following conditions: have over 500 employees and are classified as public interest.
2. As of January 2026, large European companies will have to start reporting on their sustainability performance for the year 2025. This includes companies that meet two criteria: employ more than 250 employees, have a net turnover of more than EUR 50 million, or have over EUR 25 million in total assets. The size threshold was modified by the European Commission via a delegated act. The updated thresholds will be effective for financial years starting from 1 January 2024. However, EU member states have the option to permit undertakings to utilize the new thresholds for the financial year starting from 1 January 2023.
3. As of January 2027, for the sustainability performance of the year 2026, listed European SMEs that are listed on EU-regulated markets (and which are not micro-undertakings) that have securities listed on a regulated EU market, must comply. However, they can opt-out for two extra years by explaining why their management fails to capture sustainability information.
4. As of January 2029, non-EU parent companies with at least one European branch and a turnover of EUR 150 million in the EU for each of the last two financial years must also comply with the non-financial reporting requirements.

Double materiality

The CSRD mandates that companies within its scope disclose extensive information on “sustainability matters” following the “double materiality” principle — covering the company’s impact on these issues and the influence of these matters on the company. Furthermore, management reports under the CSRD must include information on the resilience of the company’s business model to sustainability risks, on its plans that align with climate targets, its time-bound sustainability goals, progress tracking, and related processes. Additionally, companies must report on due diligence processes related to sustainability, outlining actions to address adverse impacts in their value chains and operations.

Complying with the ESRS

Regarding reporting standards, the CSRD requires companies to implement a detailed set of sustainability reporting standards — a proposal the European Parliament and Council have agreed with, pending formal adoption. Nevertheless, the first set of ESRS is already in effect, and companies should prepare for upcoming reporting obligations while anticipating further developments in sector-specific standards.

This implies that companies must focus on implementing the first set of ESRS developed by EFRAG, which encompass environmental, social, and governance aspects and address issues such as climate change, pollution, workforce conditions, and business conduct. Non-EU parent companies under the CSRD can utilize equivalent standards, with guidelines for determining equivalence to be provided by the Commission.

Moreover, acknowledging concerns about “greenwashing”, the CSRD includes provisions for third-party audit assurance requirements on sustainability information, with legislation for limited and reasonable assurance engagements expected by October 2026 and October 2028, respectively.

This means that non-listed SMEs aren’t directly mandated to comply with the CSRD, while listed SMEs don’t have to comply before 2027 and have the option to opt-out for the first two years. But can their role in the supply chain — and interaction with large companies which are mandated to report as soon as 2025 — lead to indirect reporting obligations?

What the CSRD means for SMEs

In-scope companies, including listed SMEs, under the CSRD must disclose sustainability-related issues following the comprehensive set of reporting standards formulated by EFRAG.

It’s important to note that the CSRD emphasizes proportionality and relevance to SME capacities, characteristics, and activity scale. According to Article 19a paragraph 6 of the CSRD, listed SMEs may focus their sustainability reports on key areas such as:

• Principal adverse impacts on sustainability and actions taken
• Policies related to sustainability matters
• Risks related to sustainability and risk management

Specific ESRS for SMEs are on the way

EFRAG is currently in the process of drafting sustainability reporting standards specifically tailored for SMEs. A public consultation on two exposure drafts of these standards is underway until 21 May 2024. Both mandatory and voluntary standards are being drafted.

The mandatory draft standard — ESRS for listed small and medium-sized enterprises (ESRS LSME) exposure draft — targets listed SMEs, encompassing entities with transferable securities traded on EU-regulated markets and small and non-complex institutions, captive insurers, and reinsurers.

Concurrently, a voluntary standard is being developed for non-listed SMEs (VSMEs). Known as the Voluntary European Sustainability Reporting Standards (VSME ESRS) exposure draft, this standard is crafted explicitly for non-listed SMEs operating within the European Union. It serves as a straightforward reporting tool to facilitate these SMEs in responding to requests for sustainability information from various stakeholders, including banks, investors, and larger companies — for whom they serve as suppliers.

The overarching goal of the voluntary standard is to empower SMEs by providing a structured framework for reporting environmental, social, and governance (ESG) aspects, even if they’re not publicly listed entities. By doing so, these standards aim to facilitate the transition towards a sustainable economy, offering tailored reporting solutions that align with SMEs’ specific needs and capacities.

While non-listed SMEs aren’t directly within the scope of the CSRD, they will likely be de facto obliged by their business partners and investors to report accordingly. In other words, even though the CSRD doesn’t explicitly apply to non-listed SMEs, market pressures and stakeholder expectations may drive them to adopt sustainability reporting practices.

All-in-all, the proposed standards incorporate key features to uphold the principle of proportionality. Principally, there is a deliberate focus on materiality, ensuring that SMEs report on sustainability aspects crucial to their business context. The standards introduce a streamlined materiality assessment process, providing clear guidance on conducting these assessments efficiently.

What should SMEs do about the CSRD?

As already established, although only listed SMEs meeting specific criteria are legally obligated to adhere to the CSRD, it’s crucial to recognize that as part of the supply chain of bigger companies, SMEs might be asked to provide ESG data — even those not listed on the market. Therefore, SMEs are advised to start monitoring their sustainability practices to accommodate clients and prevent the loss of contracts.

The upside to what appears to be rushed compliance is that current trends indicate a growing consumer preference for more sustainable businesses. These trends suggest that banks and investors will gradually turn away from financing unsustainable SMEs as they increasingly factor in ESG risks in portfolio evaluations.

Logically, larger corporations will also prioritize the most sustainable providers to enhance their sustainability standings. This implies that voluntary compliance by listed and non-listed SMEs will provide a competitive advantage if they position themselves as forward-thinking and environmentally conscious entities.

Therefore, while not mandated, voluntary adoption of sustainability practices allows non-listed SMEs to mitigate risks proactively, align with market expectations, and capitalize on growing consumer preference for sustainable businesses. By starting to collect relevant ESG data from now, all SMEs can maintain their relationships with larger companies that will soon require it as part of their own mandatory reporting.

Not only will early and voluntary CSRD compliance help SMEs maintain business relationships with their current clients, but compliance with ESG regulations in general present significant growth opportunities for smaller businesses. Here are a few of the potential benefits:

• Sustainability-linked loans (SLLs), which tie financial incentives to achieving ESG objectives
• Attracting new customers
• Positioning themselves for regulatory advantages

Moreover, engagement in sustainability reporting provides SMEs with valuable insights into non-financial indicators related to business activities. This understanding uncovers cost-saving opportunities (such as optimizing energy usage) and potential innovations, as well as enhancing clarity on alignment with mandatory regulations.

CSRD compliance makes organizations more agile and future-proof, granting them a competitive edge. Therefore, SMEs are advised to proactively monitor their sustainability practices as soon as possible to accommodate clients and prevent the potential loss of contracts.

Considering the growing consumer preference for sustainable businesses, early voluntary compliance by SMEs can offer a competitive advantage, further contributing to their forward-thinking and environmentally conscious image.

Big businesses need to help SMEs with CSRD compliance

As Mary Foley points out in this article published in Forbes, the CSRD puts pressure on corporations to ensure supplier accountability. Hence, companies may face reputational and financial impacts due to non-compliant small suppliers. This presents a dilemma for companies heavily reliant on supplier networks.

They must choose between a punitive approach (severing ties with non-compliant suppliers) or a collaborative stance (aiding suppliers in meeting the relevant standards). A shift towards the latter aligns with the rise of ethical supply chains, emphasizing top-tier companies’ responsibility to involve suppliers in the sustainability journey. While the effectiveness of this approach on a larger scale is uncertain, it reflects a more ethical supply chain perspective compared to punitive measures or ignorance of supplier actions.

Therefore, large corporations can and should help SMEs align with the requirements of the CSRD in order to secure the relationships they’ve grown dependent on, noting that severing them might be more costly than assisting their current supply chain to comply.

How to help SMEs with CSRD

Corporation contributions can manifest in various ways:

• For example, large companies can organize workshops and training sessions to enlighten SMEs on CSRD mandates, reporting standards, and optimal approaches. By providing guidance materials such as templates and checklists, these corporations can help SMEs comprehend reporting necessities and structure their sustainability disclosures effectively.
• Establishing mentorship programs and partnerships to guide SMEs through the intricate reporting process fosters shared knowledge and resources, benefiting both parties.
• Providing SMEs access to reporting tools, including software and platforms simplifying sustainability reporting, proves advantageous.

All these options might be more cost effective than severing ties and re-building new relationships with new suppliers.

Moreover, aiding SMEs in adhering to CSRD goes beyond individual entities — it enhances the entire business ecosystem, advocates for sustainable practices, and bolsters the economy’s resilience. Through such collaborative endeavors, businesses of varying sizes can shape a more sustainable and responsible future.