While large companies must already fulfil non-financial reporting standards, listed SMEs will also have to adopt the European extra-financial reporting language, as defined by the new Corporate Sustainability Reporting Directive. An important step towards more transparency, but also towards more administrative burdens.
The Tower of Babel of Extra-Financial Information
While companies must comply with the same accounting standards, they have, on the contrary, enjoyed a great deal of freedom in the communication of their non-financial information. While standards such as IFRS (International Financial Reporting Standards) provide a common language for managers, investors and shareholders, the absence of non-financial reporting standards creates a Tower of Babel where companies' statements do not necessarily align with investors' expectations in terms of sustainable investments.
If the European Green Deal is to transform the European Union's economy in order to offer a sustainable future to all, it must therefore establish a standard framework for the dissemination of relevant and comparable sustainable information among all economic actors. This has been achieved with the 2017 NFRD directive, which set a certain number of standards for non-financial reporting. A few years later, a new step was taken with the institution of the EU green taxonomy which aims to identify “environmentally sustainable” economic activities, and therefore, to redirect capital towards these activities.
As 2022 marks the first anniversary of the adoption of the EU Green Taxonomy, 11 000 companies are now asked to follow reporting standards of this ambitious classification. Companies subject to Non-Financial Reporting Directive (NFRD) must indeed classify their sustainable activities in accordance with the EU Green Taxonomy.
The Corporate Sustainability Reporting Directive, a more ambitious framework
Things are changing though. NFRD has left companies with extensive freedom in their extra-financial reporting and has therefore opened the way to very uneven publications by companies of non-financial information. Following a review of NFRD in 2021 (voted in June 2022 at the European Union Parliament) called Corporate Sustainability Reporting Directive (CSRD), the scope of NFRD requirements is now to be extended.
If SMEs had not fallen under the scope of NFRD previously, all large companies, whether they are listed or not, and listed SMEs will now have to track their environmental and social impacts and risks, as well as their governance practices. CSRD is far more ambitious: companies newly scoped-in by the directive will have to determine how resilient their business model and strategy are to risks related to sustainability issues. They will have to broadcast the details of the evolution of their activities in the light of extra-financial performances based on the EU Green taxonomy – the Corporate Sustainability Reporting Directive naturally follows the EU Taxonomy. A sustainable development strategy with a clear and explicit line as well as concrete means to implement this strategy are expected to be reported.
As the previous 500-employee threshold disappears, 49,000 entities will report sustainability information by 2024. About 15,000 small and medium-sized enterprises, capital market-oriented, are now publicly accountable for the impact on people and the environment and have three years ahead to comply with the current regulations (2026) – listed SMEs are allowed to opt-out until 2028.
Non-listed SMEs: when is it their turn?
Lawmakers in Brussels want to take this legislation one stage further: they are now willing to extend the current reporting framework to non-listed small and medium-sized companies. Indeed, if non-listed companies with fewer than 250 employees remain outside of this classification, one cannot exclude the possibility that every single business in the EU will be labeled at some point as green-friendly or not by the EU Taxonomy. Non-listed SMEs will not escape the green momentum. Companies must now face pressure coming from environmentally aware customers, investors, bankers. Jobseekers are also paying more attention to how sustainable and committed to fighting climate change businesses are when looking for employment. But it remains to be decided when non-listed SMEs will fall under the scope of CSRD.
SMEs must face multiple challenges in implementing CSRD requirements
While businesses face macroeconomic turbulences and the threats posed by inflation, health crisis, supply chain disruptions and, on the long term, climate change, constrain companies to redesign their strategies and positions in their markets. The alignment on sustainability reporting rules provides a formidable economic opportunity for SMEs. Stakeholders are proving to be attentive to the decarbonization of the economy and reluctant to engage with companies that are not making a carbon transition. Companies working on minimizing carbon footprint have everything to gain: the ability to raise new ESG (Economic Social Governance) funds, expand their customer base and boost their teams’ morale. It is in their best interest to integrate ESG issues into their decision making in a concrete way.
Obviously, important challenges remain to be tackled: if SMEs are stepping up their greening efforts, they often don’t have neither competences nor resources to achieve their green transitions and therefore align on the taxonomy framework. With a higher level of requirement, SMEs will have to collect superior quality ESG data. Thus, SMEs must be accompanied by other actors – public and private – so they can efficiently and thoroughly succeed in delivering compliance with regulatory requirements. An absence of ESG indicator in extra-financial reporting could make SMEs invisible to potential investors, whereas large, listed groups are obliged to publish them.
Consultant at AION Consulting