Corporate sustainability reporting: double materiality, impacts, and legal risk

ABSTRACT

Following the enactment of the Corporate Sustainability Reporting Directive and the creation of the European Sustainability Reporting Standards (ESRS rules), the European Union has set a new regime of mandatory corporate sustainability reporting in motion. However, most of the ESRS rules will be mandatory depending on, or subject to, the assessment of double materiality. This article sheds light on the double materiality requirement. More particularly, the analysis focusses on the materiality assessment of the impacts of corporate actions, the challenges involved in such determination, and the associated legal risks. Challenges examined include the legal risk in the company-stakeholders engagement process, the accuracy and completeness of reporting, and the uncertainty about the legal criteria for determining impact materiality. This article recommends (1) that a sound legal strategy guide the company-stakeholders interaction regarding external impacts, (2) that enforcement strategies be designed to accommodate unintentional greenwashing, and (3) that assurance practices for sustainability reporting be expeditiously implemented.

KEYWORDS:

• CSRD
• corporate sustainability reporting
• double materiality
• sustainable finance
• ESG
• compliance

I. Introduction

In the context of corporate financial reporting, companies have long relied upon the materiality principle to identify which information is or is not included in their financial reports.¹ In the European Union (EU), a test of materiality has been provided by the Accounting Directive whereby materiality refers to ‘the status of information where its omission or misstatement could reasonably be expected to influence decisions that users make on the basis of the financial statements of the undertaking.’² Unlike financial reporting, corporate sustainability reporting has developed its own, novel approach to materiality. More particularly, it has adopted a ‘double materiality’ requirement. First introduced by the Non-Financial Reporting Directive (NFRD),³ the double materiality requirement has more recently been confirmed by the Corporate Sustainability Reporting Directive (CSRD)⁴ [replacing the NFRD in full and amending the Accounting Directive] and the European Sustainability Reporting Standards (ESRS rules).⁵ Although materiality in financial reporting is a well-understood concept, there is less clarity about the meaning and operation of double materiality in corporate sustainability reporting under the CSRD and the ESRS rules.⁶

In basic terms, the CSRD requires that eligible companies include in their annual management report (1) the information necessary to understand the impacts of the company’s activity on sustainability matters and (2) the information necessary to understand how sustainability matters affect the company’s financial performance.⁷ The ESRS rules will guide the implementation of this obligation to disclose, and although compliance with a defined set of ESRS rules is mandatory in all cases, the general approach has been that the ESRS rules are mandatory subject to the assessment of double materiality.⁸ Having completed the double materiality evaluation, the company is obliged to report material information, whereas non-material information need not be reported.⁹ In short, the assessment of double materiality has become a central requirement driving the process of corporate sustainability reporting.¹⁰

This article concentrates on the double materiality requirement. The ‘double’ term qualifying ‘materiality’ indicates that materiality has two dimensions: financial materiality, on the one side, and impact materiality, on the other side.¹¹ Although this article explains both dimensions of materiality and their interaction, attention will be largely drawn to impact materiality. Unlike financial materiality, whose definition under the ESRS rules borrows to some extent from the better-known materiality principle in corporate financial reporting,¹² the notion of impact materiality is relatively new and untested in a setting of mandatory rules.¹³ Impact materiality provides criteria that guide the reporting company in the process of selecting and disclosing information on the impacts of its activity on society and the environment.¹⁴ It is argued in this article that, at least in the early phases of implementation, the reporting companies will face serious challenges to adequately disclose material impacts, a fact that may expose these companies to increased legal risk.

Section II of this article explains the obligation to disclose sustainability-related information under the NFRD and CSRD. The double materiality requirement is examined in Section III following the ESRS rules. Section IV critically analyses the process of evaluating impact materiality and identifies compliance problems. This analysis is conducted through different subsections that examine problems associated with (a) the determination of relevant impacts through the company-stakeholders engagement process, (b) the quality of impact-related reporting and greenwashing, and (c) the legal criteria for determining impact materiality. Section V of this article offers a discussion around three propositions. First, the company-stakeholders engagement process must be conceived as a central part of a broader impacts management framework and guided by a sound legal strategy. Second, there is a need to define legal criteria for greenwashing misconduct. Problems of scarcity and poor quality of impact-related data render greenwashing events more likely, especially unintentional forms of greenwashing. The challenge faced by the National Competent Authorities (NCAs) is to put in place enforcement strategies that accommodate this complex situation. Rule-makers are expected to continuously monitor the performance of this new disclosure framework and determine whether the wide scope of the current disclosure mandates requires reform given data and greenwashing problems. Third, the current state of uncertainty about the definition and practical operation of the assessment of the materiality of impacts and impact-related information highlights the critical value of an expeditious implementation of a sound assurance services regime under the CSRD. Section VI offers final considerations and identifies paths for future enquiry into the theme of corporate sustainability reporting.

II. The reporting obligation in the NFRD and the CSRD

The NFRD first introduced the obligation to disclose non-financial information by inserting, among other relevant provisions, article 19(a)(1) in the Accounting Directive: ‘Large undertakings (…) shall include in the management report a non-financial statement containing information to the extent necessary for an understanding of the undertaking’s development, performance, position and impact of its activity, relating to, as a minimum, environmental, social and employee matters, respect for human rights, anticorruption and bribery matters (…).’¹⁵ This provision was nevertheless drafted in a way that generated confusion about the actual scope of the newly created reporting obligation. More particularly, the construction of the term ‘impact’ of corporate activity was unclear, as was how this term fitted in the traditional, single materiality assessment.¹⁶ This ambiguity was clarified later by the 2019 Guidelines on Reporting Climate-Related Information (2019 Guidelines) issued by the European Commission (Commission).¹⁷ In the 2019 Guidelines, the term ‘impact’ was interpreted as reflecting the obligation to disclose the impacts of corporate activity on people or the environment. In turn, the selection of this impact-related information for the purpose of reporting gave rise to a novel materiality approach, namely environmental and social materiality, as follows:

The reference to ‘impact of [the company’s] activities’ indicates environmental and social materiality. Climate-related information should be reported if it is necessary for an understanding of the external impacts of the company. This perspective is typically of most interest to citizens, consumers, employees, business partners, communities, and civil society organisations. However, an increasing number of investors also need to know about the climate impacts of investee companies in order to better understand and measure the climate impacts of their investment portfolios.¹⁸

According to the Commission’s 2019 Guidelines, the non-financial disclosure obligation enshrined in the NFRD was to be discharged through a process of selection of material information that departed from the conventional single materiality principle ordinarily applied to financial reporting. More specifically, the 2019 Guidelines explained that the information disclosure obligation under Article 19(a)(1) Accounting Directive required eligible companies to undertake two materiality assessments: financial materiality, on the one side, and environmental and social materiality, on the other side—this latter dimension of materiality has been more recently referred to as ‘impact materiality’. This conceptualisation confirmed the use of a ‘double materiality’ principle in sustainability reporting. It also confirmed that although these two dimensions of materiality overlapped to some extent, they ought to be considered separately as they constitute independent dimensions.¹⁹

According to the 2019 Guidelines, financial materiality in sustainability reporting reflects the fact that sustainability factors (e.g. climate-related factors) generate financial risk to businesses.²⁰ Conversely, social and environmental materiality concentrates on information that explains the external impact of corporate activity on sustainability factors.²¹ This is information depicting the extent to which corporate activity influences society (e.g. respect for human rights) or the environment (e.g. pollution).²² This information is of particular interest to investors, creditors, and other stakeholders, including NGOs, consumers, government and civil society, among other actors, monitoring the impact (positive or negative) of corporate activity on the environment and society.²³ The 2019 Guidelines also noted that the impacts from corporate activity may also produce financial effects affecting the reporting company’s financial performance or position and, therefore, prove financially material for investors and creditors of the reporting company.²⁴

Further progress on developing the disclosure obligation and the materiality principle in the sustainability context was made following the enactment of the CSRD. Replacing in full the NFRD, the CSRD has rewritten Article 19(1)(a) of the Accounting Directive, which now states that companies ‘shall include in the management report information necessary to understand the undertaking’s impacts on sustainability matters, and information necessary to understand how sustainability matters affect the undertaking’s development, performance and position.’²⁵ The ESRS rules have confirmed that, as a general principle, compliance with this reporting obligation will, in most cases, require companies to undertake a double materiality evaluation. This evaluation will guide the selection of the information to be reported.²⁶

The reporting obligation under the CSRD has also introduced the phrase ‘sustainability matters’ to demarcate those sustainability factors encompassed in the obligation to report.²⁷ Drawing from the text of the CSRD, sustainability matters means ‘environmental, social and human rights, and governance factors, including sustainability factors defined in point (24) of Article 2 of Regulation (EU) 2019/2088’.²⁸ Sustainability matters have been identified more punctually in the ESRS rules covering a range of topics, sub-topics, and sub-sub-topics.²⁹ Topics categorised as sustainability matters include climate change, pollution, water and marine resources, biodiversity and ecosystems, circular economy, a company’s own workforce, workers in the value chain, affected communities, consumers and end-users, and business conduct.³⁰ There are separate sets of ESRS rules for each one of the topics mentioned above (10 topical ESRS).³¹ Yet this enumeration of sustainability matters is non-exhaustive, and it is not a substitute for the process of determining material matters based on each company’s specific circumstances.³²

An important difference between the NFRD and the CSRD is the mandatory character of rules. The NFRD relied on a ‘comply or explain’ basis, whereas the CSRD operates a regime of mandatory reporting obligations subject to materiality assessment. Some ESRS rules, specifically those in the ESRS 2 General Disclosures, are mandatory in all cases regardless of materiality assessment, whereas a few other ESRS rules operate on a voluntary basis. However, most of the ESRS rules follow the general principle whereby companies report only on those items constituting material sustainability matters, disclosure requirements, and datapoints.³³ In this context, the section below explains the workings of double materiality.

III. Double materiality: the European sustainability reporting standards

The ESRS rules have further elaborated on the meaning and application of the double materiality principle in corporate sustainability reporting.³⁴ These rules have confirmed the utilisation of double materiality composed of two dimensions, namely impact and financial materiality.³⁵ The reporting company utilises criteria to identify information that is financially material and information that is material from an impact perspective. This process allows the reporting company to identify ‘material sustainability matters’ and, on that basis, prepare the information to be disclosed in terms of material disclosure requirements (DRs)—including application requirements (ARs)—and datapoints applicable to such sustainability matters.³⁶

In terms of criteria, a sustainability matter is deemed to be material from a financial materiality perspective when such matters trigger or could trigger financial effects (e.g. financial loss resulting from climate-change related phenomena) on the reporting company. Further meaning is given to such ‘financial effects’:

A sustainability matter is material from a financial perspective if it triggers or could reasonably be expected to trigger material financial effects on the undertaking. This is the case when a sustainability matter generates risks or opportunities that have a material influence, or could reasonably be expected to have a material influence, on the undertaking’s development, financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term. Risks and opportunities may derive from past events or future events. The financial materiality of a sustainability matter is not constrained to matters that are within the control of the undertaking but includes information on material risks and opportunities attributable to business relationships beyond the scope of consolidation used in the preparation of financial statements.³⁷

According to the ESRS rules, financially material sustainability matters will be identified through the evaluation of the likelihood of occurrence and severity of such financial effects. In setting out criteria for determining financially material information—covering disclosure requirements and datapoints, the ESRS rules have defined financial materiality by borrowing heavily from the more established definition of materiality found in corporate financial reporting.³⁸ According to the ESRS rules, sustainability-related information ‘is considered material for primary users of general-purpose financial reporting if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that they make on the basis of the undertaking’s sustainability statements.’³⁹ Primary users of general-purpose financial reporting include, among others, ‘existing and potential investors, lenders and other creditors, including asset managers, credit institutions, [and] insurance undertakings.’⁴⁰ As this article will later explain, however, the materiality of sustainability-related information (disclosure requirements and datapoints under the ESRS rules) will be subject to a broader information ‘relevance’ test, which includes, but is not necessarily limited to, the users’ utility approach.⁴¹

By performing an evaluation of the materiality of impacts, the company selects information that explains the impacts that its activity has or could have on people or the environment (that is, impacts on sustainability matters, including environmental, social and governance matters).⁴² The first step in the impact materiality process is to identify relevant impacts. In such a process, the ESRS rules foster the collaboration between the reporting company and the affected stakeholders. Affected stakeholders are those ‘individuals or groups whose interests are affected or could be affected’ by corporate activity.⁴³ This interaction between the reporting company and the affected stakeholders is strongly promoted—although it is not a mandatory requirement—by the ESRS rules: the ‘[e]ngagement with affected stakeholders is central to the undertaking’s on-going due diligence process (…) and sustainability materiality assessment. This includes its processes to identify and assess actual and potential negative impacts (alongside other elements), which then inform the assessment process to identify the material impacts for the purposes of sustainability reporting (…)’.⁴⁴

Impacts can be positive or negative, actual or potential.⁴⁵ They may produce effects in the short-term, middle-term, or long-term.⁴⁶ Impacts may have been caused or contributed to by the reporting company or by those other actors that are part of the company’s value chain, either upstream or downstream, including actors linked to the company’s own operations, products, or services through the company’s business relationships.⁴⁷ Business relationships ‘include the undertaking’s upstream and downstream value chain and are not limited to direct contractual relationships.’⁴⁸ In terms of criteria, the materiality analysis for actual negative impacts is based on the severity (scale, scope and irremediable character) of the impact, whereas materiality analysis for potential negative impacts is based on the severity and likelihood of occurrence of the impact.⁴⁹ A similar approach applies to evaluate the materiality of positive impacts.⁵⁰ The evaluation of material impacts leads to the identification of material sustainability matters. As in the case of financial materiality, the materiality of information (disclosure requirements and datapoints) that the company is required to disclose for each material matter identified is guided by criteria based on the relevance of that information.⁵¹

Under the double materiality approach, financial and impact materiality constitute, conceptually, two separate materiality dimensions whose design has been influenced by distinct sources including, respectively, the standards produced by the International Sustainability Standards Board (ISSB) and those issued by the Global Reporting Initiative (GRI).⁵² The ISSB standards rely on a single materiality approach to corporate sustainability reporting based solely on financial materiality.⁵³ In other words, ISSB disclosures focus on sustainability-related financial information that is useful to capital providers such as investors and creditors.⁵⁴ This is sustainability-related information that ‘could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term.’⁵⁵ and it includes climate-related information.⁵⁶ But in relation to the impact materiality rules, the drafters of the ESRS rules have aimed to incorporate ‘to the greatest extent possible the content of GRI standards, including key concepts in the GRI Universal Standards.’⁵⁷

Adopted voluntarily by companies worldwide, the GRI reporting is limited to material topics defined as ‘topics that represent the organisation’s most significant impacts on the economy, environment, and people, including impacts on their human rights.’⁵⁸ Impact is defined as ‘the effect an organisation has on the economy, the environment, and/or society, which in turn can indicate its contribution (positive or negative) to sustainable development’.⁵⁹ Therefore, the material status of information is closely connected to information showing the contribution of a company’s activity to sustainable development, especially to the United Nations (UN) Sustainable Development Goals.⁶⁰ The GRI rules have defined sustainable development as ‘development that meets the needs of the present without compromising the ability of the future generations to meet their own needs.’⁶¹ The material status of information is also closely connected with responsible business conduct.⁶²

But even when financial and impact materiality are separate materiality dimensions, the ESRS rules have clearly noted the interrelationship that exists between these two dimensions.⁶³ More particularly, the ESRS rules have acknowledged that impacts on the environment or people (e.g. actions undertaken by the reporting company that undermine the working conditions or other rights of supply chain workers) may concomitantly affect the reporting company financially (e.g. reduced costs and/or higher risk of labour-related litigation).⁶⁴ In this sense, the ESRS rules have recognised that: ‘[as] markets and public policies evolve in response to climate change, the positive and/or negative impacts of a company on the climate will increasingly translate into business opportunities and/or risks that are financially material.’⁶⁵ The current ESRS rules have proposed the assessment of impact materiality as the starting point of analysis while acknowledging that ‘[a] sustainability impact may be financially material from inception or become financially material, when it could reasonably be expected to affect the undertaking’s financial position, financial performance, cash flows, its access to finance, or cost of capital over the short-, medium-, or long-term.’⁶⁶ Drawing from this interrelationship between financial and impact materiality, commentators have noted a degree of overlap between these two materiality dimensions.

According to Baumüller and Sopp, a large fraction of environmental and social impacts will, in the long run, be relevant from the perspective of corporate value, making the distance that separates financial materiality from impact materiality shorter than initially thought.⁶⁷ IOSCO has noted that ‘[t]here can be significant overlap in reporting under the two lenses [namely, financial and impact materiality]. In particular, a company’s external sustainability impacts can feed back to a company’s financial performance and position in the short-, medium-, or long-term.’⁶⁸ Following this thinking, arguments supporting a single materiality approach to corporate sustainability reporting, such as an approach based solely on the ISSB model, have been advanced. More particularly, to the extent that a high proportion of impacts from corporate activity on, for example, the environment, will end up influencing the financial position of the reporting company in the short, middle, or long term, this impact-related information would prove to be, and ultimately be reported as, financially material information.

Although the double materiality approach has sparked controversy, the importance of upholding it has been emphatically stressed in the European context.⁶⁹ The impact materiality approach allows stakeholders to scrutinise the sustainability outcomes delivered by companies.⁷⁰ It is reiterated that the impacts of a company’s activity are relevant to not only investors and creditors but also other stakeholders, including NGOs, consumers, government, and civil society, among other actors monitoring the influence of corporate activity on people and the environment.⁷¹ Many of these stakeholders are likely to show motivations that need not correspond to a business view of sustainability.⁷² The underlying rationale appears to be that actors, such as NGOs concerned with environmental protection, are more preoccupied with the negative environmental or social impacts of company activity (e.g. deforestation and biodiversity loss) than they are with the financial impact of such activity on the reporting company.⁷³ It has been noted that ‘NGOs or concerned citizens might want to understand the differential performance of companies on socially and environmentally material factors; that is, they want to understand which companies deliver real sustainable change.’⁷⁴ Impact materiality can also be seen as providing a way to identify and manage negative externalities from economic activity.⁷⁵ Moreover, capital allocation decisions by investors have increasingly been driven by the investment’s environmental and social outcomes, in addition to financial performance, and the availability of information on such outcomes is essential for these investors to make decisions.⁷⁶

According to the ESRS rules, the evaluation of the impacts of corporate activity focusses on the improvements or impairments that the activity has done or could do to the interests of stakeholders (e.g. consumers, local community, or nature).⁷⁷ By allowing for an impact materiality approach, these rules have recognised that information related to the external impacts of a company’s activity is, in and of itself, relevant to the extent that it shows a company’s sustainability performance. Such environmental and/or social outcomes, like pollution, greenhouse gas emissions, or human right violations, to mention a few, are meaningful to sustainability, and they so are irrespective of their effects, if any, on the financial position of the reporting company: ‘impacts are captured by the impact materiality perspective irrespective of whether or not they are financially material.’⁷⁸ Having been identified and examined, such material impacts can be reported separately from financially material information, although the ESRS rules allow the reporting company to organise the materiality evaluation process and the sustainability reporting differently depending on its own characteristics and needs.⁷⁹

More broadly, the recognition of impact materiality in the ESRS rules reflects core EU public policy objectives. The CSRD is a product of the European Green Deal and other related legislative efforts aimed at fighting climate change, protecting biodiversity and restoring nature.⁸⁰ Corporate sustainability reporting has also proved central to the EU Sustainable Finance policy, which aims to promote not only the management of sustainability risk (financial risk) but also the allocation of capital to sustainable investments, which includes environmental and social objectives.⁸¹ Efforts to enact the Corporate Sustainability Due Diligence Directive seek to promote accountability in corporate conduct in light of EU sustainability policy goals.⁸² Although double-materiality will operate within this vast policy framework, it is nevertheless a legal and accounting innovation whose implementation poses challenges. The following section of this article examines some of these challenges.

IV. Impact materiality: problems, uncertainty and legal risk

Unlike financial materiality, which involves adjusting known principles of corporate financial reporting to resolve a different objective (e.g. climate risk reporting),⁸³ impact materiality is a distinct, novel concept whose workings in a setting of mandatory reporting are thus far untested. Implementing the impact materiality assessment is not a clear-cut process, and new sources of legal risk will emerge. First, the reporting company is expected to engage the affected stakeholders in the process of identifying relevant impacts, and such engagement may involve legal risks. Second, problems in the availability and quality of impact-related information may undermine the accuracy of disclosures and make the occurrence of misleading statements or omissions more likely. Third, the criteria for materiality appear to differ depending on the type of materiality (financial versus impact materiality) and on the stage of the materiality assessment (material sustainability matters versus material information), and the role played by the users of information is not necessarily central to a finding of material information. These new elements create uncertainty about what a legal test of impact materiality looks like. This section will examine these three issues.

A. Impacts determination and stakeholder engagement

The process of determining relevant impacts opens a new front of legal risks for the reporting company. As part of this process, the reporting company is expected to engage affected stakeholders.⁸⁴ In addition to cost and execution problems, this process of company-stakeholders engagement raises legal questions that do not find clear answers. Stakeholders are primarily concerned with protecting their interests from actual or potential negative impacts. In this context, the determination (or recognition) of such impacts for the purpose of reporting is only a first step towards the adequate management of impacts by the reporting company. These stakeholders expect that the reporting company recognise and explain the extent to which its activity has affected or could affect their interests; such stakeholders also expect that the reporting company submit a plan to safeguard or remedy their interests.⁸⁵

In this sense, the reporting company shall disclose information on how it conducts its materiality assessment, including a description of the due diligence process aimed to ‘identify, prevent, mitigate, and account for how they address the actual and potential negative impacts on the environment and people connected with their business.’⁸⁶ All such processes, measurements, and targets will be subject to scrutiny by the very affected stakeholders and the other users of the sustainability report.

This scenario of company-stakeholders engagement poses several questions. Is this engagement process solely aimed at collecting feedback from stakeholders? Or is it a more formal process whereby the reporting company makes commitments (e.g. action plans and targets) or promises? Would such commitments or promises be legally binding? Would a breach of such commitments, promises, or expectations result in legal implications for the reporting company (e.g. a breach constituting a cause of legal action)? Both the determination of impacts and the materiality decisions may generate disaccord between the actors involved. For example, could there be disagreement surrounding the classification of stakeholders as ‘affected’ stakeholders or as to the determination of the nature and scope of the interests being affected by the company’s activity? Would such disagreements trigger conflict with ensuing legal implications?

It is reiterated that the notion of impact materiality relies importantly on those stakeholders (individuals or groups) whose interests are or could be affected by the activity of the reporting company.⁸⁷ It is apparent that the definition of affected stakeholders is by no means a narrow definition. Since the interests of the individuals or groups ‘are or could be’ affected, this standard opens the door to broad considerations covering a wide range of interests that could potentially be exposed to the company’s activity.⁸⁸ Moreover, these impacts may be caused not only by the company itself but also by the company’s ‘direct and indirect business relationships across its value chain’,⁸⁹ entailing that the affected stakeholders can emerge from any place across the reporting company’s value chain. The characterisation of degrees and types of impacts in the ESRS rules is also broad.⁹⁰ In this context, it is conceivable that company officers may misclassify stakeholders due to problems in recognising and/or delineating affected interests. Would there be consequences if the reporting company mistakenly or deliberately ignores a stakeholder’s affected interests? From the perspective of the ESRS rules, it seems to be the case that the reporting company can decide whether or to what extent it engages its stakeholders, as such engagement is initially not mandated.⁹¹ However, ex-post legal implications cannot be ruled out, given the mounting volume of lawsuits against companies initiated in recent years by stakeholders on environmental and human rights grounds.⁹²

On a different note, the ESRS rules state that ‘[n]ature may be considered as a silent stakeholder. In this case, ecological data and data on the conservation of species may support the undertaking’s materiality assessment’.⁹³ Several questions follow. What is the scope of the term ‘nature’?⁹⁴ In individual cases, who is in charge of deciding whether nature is an affected stakeholder? Is nature as a stakeholder subject to representation? If yes, how is this representation determined? For instance, would actual or potential negative impacts on plant ecosystems be accepted as an affected interest of those NGOs whose purpose is to protect (and thus represent) nature? These are questions that will require further clarification and consideration. It is most likely that multiple stakeholders, including civil society groups, NGOs, and the Government, will, as they currently do, seek to protect the interests of nature when such interests are or could be affected by the activity of the reporting company.⁹⁵

All this is not to say that rules promoting company-stakeholders engagement will prove irrelevant. By mandating disclosure on the extent and type of engagement with stakeholders, the ESRS rules may well help mitigate problems of stakeholders’ unmet expectations observed in the past.⁹⁶ Evidence suggests that stakeholders’ expectations and informational needs have often been ignored. Conducting a literature review on sustainability reporting and stakeholders’ expectations, Silva et al. conclude that ‘stakeholders in practice are dissatisfied with existing approaches’ and that such dissatisfaction is in part explained by ‘a lack of explicit consideration of stakeholder expectations in the sustainability performance measurement and assessment’.⁹⁷ A more systematic and better-structured company-stakeholders engagement process should alleviate this deficit. It may also improve the communications between the reporting company and its stakeholders. Companies showing poor communication with their stakeholders have been found to also produce inferior sustainability-related disclosures.⁹⁸

B. Reporting accuracy and completeness

Inaccurate impact measurements may stem from problems in the determination of facts that are external to the company. Such determinations contain factual uncertainty, namely uncertainty about facts in the world, and may be affected by observability and/or measurement problems.⁹⁹ A company’s poor resources or limited capacity to observe facts further constrain its ability to learn about these facts and measure them.¹⁰⁰ Observations can also be costly: ‘even basic visual, oral, and olfactory observation requires a person’s time; techniques requiring specialized equipment or expertise will often be more expensive.’¹⁰¹ The quality of the data collected and disclosed can also be impaired by error. In discussing factual uncertainty, Muchmore explains that ‘[t]he data may be prone to error, or there may be errors in the collection and communication of the data. The data may be subject to time lag fluctuations, bottlenecks, and other costs not associated solely with the problem-solver's effort.’¹⁰²

Inaccuracy in impact metrics may also emerge where the impact-related information is presented as estimations (e.g. when metrics cannot be measured directly, such as estimations of the likelihood of occurrence of impacts) and such estimations are based on weak assumptions.¹⁰³ All these elements can impair the proper identification and measurement of impacts and the evaluation of their materiality, increasing the chances that the reporting company will ultimately end up misstating, omitting, or obscuring material information in the sustainability report.¹⁰⁴ Although there can be many other sources of inaccuracy in the determination of impacts, an important issue to note from the perspective of law is that inaccuracy problems may correlate with greenwashing behaviour. In a recent report, the European Securities and Markets Authority (ESMA) has defined greenwashing as ‘a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, financial product, or financial service. This practice may be misleading to consumers, investors, or other market participants.’¹⁰⁵

As a phenomenon, greenwashing has been widely discussed in the academic literature in the context of corporate sustainability reporting,¹⁰⁶ and it represents a top concern in the agenda of policy- and rule-makers as well as law enforcers.¹⁰⁷ In the ESMA report, greenwashing risk has been identified at the level of issuers, among other levels, including misleading claims on impact-related performance, be it past performance or forward-looking statements of performance.¹⁰⁸ Such misleading claims ‘can occur and spread intentionally or unintentionally, whereby intentionality, negligence, or the lack of robustness and appropriateness of due diligence efforts could, where relevant, constitute aggravating factors in the context of supervisory and enforcement actions.’¹⁰⁹ In addition, greenwashing behaviour does not require immediate damage to individual consumers, investors, or competitors either.¹¹⁰ To the extent that greenwashing can result from unintentional conduct and without immediate harm to investors, reporting companies acting in good faith might nevertheless be exposed to greenwashing-related enforcement actions even when such companies showed no intention to greenwash. This problem is exacerbated when value chain considerations are accounted for.

This is because companies are required to report material impacts in relation to activities up and down their value chain process (e.g. scope 3 emissions standards requiring the reporting of greenhouse gas emissions from the entire value chain).¹¹¹ And since a company’s value chain has been defined broadly, operational challenges are forecasted in terms of identifying impacts and collecting, at reasonable cost, quality information that is accurate, comparable, and reliable.¹¹² In large companies the size of value chains can be considerable. For instance, Siemens, the German multinational technology conglomerate, has reported operations with roughly 65.000 suppliers in about 145 countries.¹¹³ Or Unilever, the British multinational consumer packaged goods company, which has reported nearly 52.000 suppliers in 155 countries.¹¹⁴ Therefore, depending on the characteristics of the value chain, the flow and quality of information may suffer at the point of disclosure, exacerbating greenwashing risk. Again, as in the previous subsection, the analysis in this section highlights the critical importance of adequate due diligence processes for sustainability-related impact management and reporting.¹¹⁵

C. Determining the materiality of sustainability matters and impact-related information

The conceptualisation of financial materiality in the context of financial reporting has relied critically upon the utility of the reported information to the users of that information. That is, the information is material to the extent that it influences the decision-making of the users of the financial statements.¹¹⁶ It has been industry practice in Europe to define those ‘users’ in terms of a company’s capital providers such as investors or banks.¹¹⁷ The central role of information users in the definition of financial materiality can also be illustrated by reference to the conventional legal test of materiality developed in the US federal courts to evaluate information omissions or misstatements in corporate reporting. These courts have thus far relied on a single materiality standard to assess the materiality of financial information.¹¹⁸ According to this practice, not all misrepresentations or omissions may create liability on the part of the company defendant, but only those misstatements or omissions deemed to be material.¹¹⁹ Information is material when there is a ‘substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available’¹²⁰ The users of information have long been central to this legal test. Information is material because it influences the decision-making of such users or, in terms of the US securities laws, the decision-making of the ‘reasonable investor’. Although the conceptualisation of the reasonable investor has been subject to academic scrutiny, the reasonable investor model has long assumed that investors are basically driven by corporate value and make decisions based on financially relevant information.¹²¹ This conceptualisation of materiality developed in the US federal courts has been construed to accommodate financial materiality.¹²²

In the context of financial materiality under the ESRS rules, the users of information have also been given an important role. These users are referred to as the ‘primary users of general-purpose financial reporting’ including investors, lenders, and other creditors: ‘The financial materiality assessment corresponds to the identification of information that is considered material for primary users of general-purpose financial reports in making decisions relating to providing resources to the entity. In particular, information is considered material for primary users of general-purpose financial reports if omitting, misstating, or obscuring that information could reasonably be expected to influence decisions that they make on the basis of the undertaking’s sustainability statement.’¹²³ Beyond these basic concepts, the criteria for determining financial materiality and impact materiality in the ESRS rules show innovations and a few twists.

In principle, under the ESRS rules the process of evaluating financial and impact materiality appears to involve a two-step process.¹²⁴ The first step consists in determining material sustainability matters. The second step concentrates on the determination of material information (disclosure requirements and datapoints) that must be provided for each material sustainability matter. Each one of these two steps is guided by different criteria.¹²⁵ In the first step, the company identifies a list of impacts (as well as risks and opportunities) that either fall in the ESRS-provided categories of sustainability matters or represent sustainability matters that are entity-specific.¹²⁶ Next, a prioritisation of impacts is made based on the criteria of severity and likelihood of occurrence of such impacts.¹²⁷ The prioritisation of risks and opportunities (financial materiality) is based on the severity and likelihood of occurrence of financial effects.¹²⁸

In the second step, concerning the evaluation of the materiality of the information related to each material sustainability matter (disclosure requirements and datapoints), the criterion guiding the materiality assessment in both financial and impact materiality seemingly relies on the ‘relevance of the information’ to be disclosed. Relevance is based on ‘(a) the significance of the information in relation to the matter it depicts or (b) its decision-usefulness.’¹²⁹ According to the ESRS rules, the information can be relevant ‘from one or more’ of these two perspectives.¹³⁰ Information that is decision-useful is information capable of meeting ‘the users’ decision-making needs, including the needs of primary users of general-purpose financial reporting described in paragraph 48 and/or the needs of users whose principal interest is in information about the undertaking’s impacts.’¹³¹ This ESRS criterion based on relevance entails that decision-usefulness in only one path for the information to acquire the status of material. The ‘significance of the information’ constitutes a separate, alternative path for materiality, broadening this way the conceptualisation of materiality.¹³²

Drawing from the above, the reporting company complies with the ESRS disclosures that require impact materiality assessment by evaluating the materiality of impacts and sustainability matters, and the materiality of disclosure requirements and datapoints. The company must undertake these materiality assessments adequately to make sure that it does not omit, obscures or misstate material impacts, matters or information. In this process, the company is given substantial discretion to organise the process of impact materiality assessment and define thresholds guiding the impact materiality evaluation. Here, the reporting company has discretion to set thresholds of severity and likelihood of occurrence and to prioritise impacts. More particularly, in the assessment of ‘the materiality of its actual and potential impacts and determination of the material matters (…), the undertaking shall adopt thresholds to determine which of the impacts will be covered in its sustainability statement.’¹³³ This legal basis to determining impact materiality creates ample room for discretional judgments by company officers in a complex setting. It is not obvious what incentives will drive this discretion and how much uncertainty this process will originate in detriment of all participants.¹³⁴

The adoption by the ESRS rules of the user’s utility theory as central driver of the test of materiality is neither conclusive nor consistent. In the process of determining material sustainability matters, the user’s decision-making need not be a factor to account for because the materiality test, as mentioned earlier in this section, is guided by thresholds of severity and likelihood of occurrence of impacts (or severity and likelihood of occurrence of financial effects in the case of financial materiality). As presented in the ESRS rules, it is seemingly a discretion of the reporting company how to interpret and account for the informational needs of stakeholders when determining material impacts and sustainability matters. The ESRS rules do not mandate the participation of the affected and other stakeholders in this process of materiality evaluation insofar as the reporting company may solicit their ‘inputs or feedback on [the company’s] conclusions regarding its material impacts, risks and opportunities.’¹³⁵ This role in the process of materiality evaluation granted to the affected stakeholders and to the reporting company’s wider stakeholder base is one of feedback or input providers. It seems to be the reporting company’s option to seek or not to seek such inputs or feedback.¹³⁶

Although the user’s decision-making needs are important to the assessment of the materiality of information (materiality assessment of disclosure requirements and datapoints), accounting for such needs do not constitute the only path for determining materiality. The ESRS rules have provided an alternative path to materiality given by a criterion based on the ‘significance’ of the information in relation to the matters it depicts. A more elaborated explanation of this latter criterion is needed, and this author has not found such explanation in the ESRS rules and related documents. From a users’ utility perspective, it has been noted earlier in this article that the disclosure of impact-related information is of interest to a range of users including not only the company’s capital providers but also the wider group of stakeholders. All these stakeholders bear dissimilar informational needs, a fact that creates a challenging environment for the reporting company who needs to acquire a clear understanding of the context in which it operates.¹³⁷

To conclude, the treatment of materiality under the ESRS rules shows complexities that will, at least in the short term, create uncertainty and potential controversy around the impact materiality assessment (and possibly also around the assessment of financial materiality). The ample discretion given to companies to organise the whole process of materiality evaluation has been generally viewed as beneficial to better reflect each company’s facts and circumstances,¹³⁸ although the lack of clarity as to how to determine thresholds on severity and likelihood of occurrence of impacts has been noted.¹³⁹ The criterion based on the ‘significance of information’ that renders information to be ‘relevant’ for the purpose of disclosure requires deeper elaboration. Without further clarification, the determination of materiality of impact-related information may prove an ambiguous exercise, allowing multiple interpretations during the implementation process, and creating legal uncertainty about the requisite scope of disclosures.

V. Discussion

Drawing from section IV.A of this article, it is apparent that the adequate disclosure of information on the sustainability impacts of companies will require, from an operational perspective, that the reporting company clearly identify those stakeholders that have been or could be affected by the impacts of its activity and, ideally, achieve a fluent communication and interaction with them through engagement. In this context, this article has stressed the importance of companies putting in place adequate due diligence processes to manage this engagement as well as the legal risks arising from it. Put differently, the company-stakeholders engagement is expected to occur and develop within a broader system of impact management designed and implemented by the reporting company. It is noted that a central policy objective underlying the CSRD and the ESRS rules is precisely to influence companies towards setting up and implementing systems to adequately manage sustainability-related impacts (and risks). This policy objective can be inferred from the type of information disclosure sought by the ESRS rules.

The ESRS rules require a wide range of disclosures regarding impacts. They include the disclosure of information on the processes adopted by the company to identify and evaluate the materiality of impacts.¹⁴⁰ Very importantly, the company is also required to disclose, on a mandatory-in-all-cases basis, the policy, targets, actions and metrics it has put in place in order to ‘prevent, mitigate and remediate actual and potential material impacts (…)’¹⁴¹ including metrics to measure the effectiveness of the actions to achieve the policy targets.¹⁴² The policy vision underpinning such disclosures is aimed at promoting business accountability that, operationally, is implemented through sound impacts management systems.¹⁴³ According to the CSRD and the ESRS rules, the company-stakeholders interaction is a key component of such impacts management. Most companies have already developed engagement policies in the past, especially in the context of corporate social responsibility goals or in response to GRI reporting.¹⁴⁴ Unlike those experiences, however, by immersing the company-stakeholders engagement into a wider framework of impacts management and mandatory reporting, it is expected that greater corporate accountability and purpose will ensue.¹⁴⁵

In addition, a model of impacts management can also prove instrumental for the company to adequately manage the legal risks generated by its external impacts, including those legal risks that may emerge from the very actions of engaging stakeholders. It is reiterated that the reporting company is not legally obliged to engage its stakeholders. That means that the company could lawfully choose not to engage. However, since the new rules mandate the public disclosure of this engagement strategy, such reporting may ultimately lead the reporting company towards more and better engagement. This is because public disclosures strengthen the ability of investors and other stakeholders to more effectively monitor corporate decision-making related to, among other issues, impacts management.¹⁴⁶ Another conduit towards conduct change is benchmarking by industry rivals. Market or social actors may negatively react to information showing that the reporting company underperforms its peers. In order to avert such public backlash, the company may feel pressured to change behaviour.¹⁴⁷ Therefore, reporting can lead the company to alter its engagement policy. To the extent that the company chooses to engage, and since such engagement generates legal risk, as discussed in section IV.A of this article, a sound legal strategy becomes an essential instrument to accompany and guide the engagement process.¹⁴⁸

Section IV.B identified and examined problems of quality and availability of impact-related data leading to poor reporting and increased greenwashing risk. Such problems have been anticipated by the lawmakers insofar as the CSRD and the ESRS rules will be phased in progressively. The CSRD contains phase-in rules whereby those companies currently not reporting under the NFRD (including large private companies and large non-EU listed companies) have been granted an additional year—relative to those companies currently falling under the scope of the NFRD—to prepare for sustainability reporting before the obligation to report kicks in.¹⁴⁹ An even longer time horizon has been prescribed for the start of reporting by SMEs.¹⁵⁰ Reporting related to the company’s value chain has also been subject to a phase-in process. Here, for the first three years of implementation of the ESRS rules, the companies whose reporting is hindered by value chain data problems are allowed to explain, first, their inability to gather the data and, second, their plans to obtain the necessary information in the future.¹⁵¹

These prescriptions in the CSRD and the ESRS rules can alleviate problems of data and greenwashing in the process of transitioning towards this new reporting regime. A phase-in strategy, however, is not expected to fully resolve such problems, as sorting them out will demand more time, resources, and experience. Another way of mitigating data and greenwashing problems is to curtail the scope of the mandatory information disclosures, particularly when disclosures are based on information that is difficult to acquire or test by, or is out of the control of, the reporting company. The European Commission has already utilised this mechanism. It converted a limited number of information datapoints from mandatory into voluntary after deeming such datapoints ‘most challenging or costly for companies’, such as ‘reporting a biodiversity transition plan and certain indicators about self-employed people and agency workers in the undertaking's own workforce’.¹⁵² Depending on the reporting problems and performance observed by the Commission during the early phases of reporting implementation, future proposals of this type cannot be ruled out. An additional mechanism available to rule-makers to curtail the legal risk arising from data problems and greenwashing is to restrict the legal effects (i.e. liability) triggered by greenwashing to conduct that is qualified by a state of mind, such as intention or gross negligence. Industry actors have proposed this approach in the context of the work on greenwashing undertaken by the European Supervisory Agencies (ESAs).

More specifically, the ESAs called for a public consultation seeking inputs from market participants on diverse aspects of greenwashing (‘ESAs’ Call for Evidence’).¹⁵³ Among other objectives, the ESAs sought inputs from market participants to ‘[c]learly defin[e] greenwashing and better understanding the phenomenon, its scale and potential related risks (…)’.¹⁵⁴ Respondents, such as the Spanish Securities and Markets Authority (CNMV)¹⁵⁵, Finance Denmark¹⁵⁶, the German Investment Funds Association (BVI)¹⁵⁷ and Eurosif¹⁵⁸ argued that the conduct of greenwashing ought to be defined narrowly to include only intentional conduct. Nevertheless, respondents including the European Fund and Asset Management Association (EFAMA),¹⁵⁹ the International Capital Markets Association (ICMA),¹⁶⁰ and the European Banking Federation (EBF),¹⁶¹ sponsored a broader definition also encompassing conduct qualified by gross negligence. Other respondents supported the existence of unintentional greenwashing conduct based on simple negligence.¹⁶² The ESAs have tentatively advanced a definition of greenwashing misconduct that may be construed to rely on a strict liability standard.¹⁶³ Defining greenwashing misconduct is crucial to unambiguously delineate the scope for liability faced by the reporting company. When this definition is narrow, so is the scope for liability, and vice versa. The unclear meaning of unintentional greenwashing is particularly worrisome. It can be reasonably argued that the widespread problem associated to the scarcity and poor quality of impact-related data renders these unintentional forms of greenwashing more likely (e.g. greenwashing due to mistakes, misinterpretation, dependency situations owing to the reporting company’s lack of control over data across the value chain). How the NCAs’ enforcement strategy and actions will approach instances of unintentional greenwashing is hard to predict. All these conceptual and operational deficits are the source of legal uncertainty about the state of the law and the corresponding legal effects.

The materiality of information is another relevant factor to account for in the management of legal risk. This is because the materiality principle has not only accounting but also legal implications. From an accounting perspective, it provides a basis for preparers to determine the scope of the information to be reported. From a legal standpoint, it delimits the liability space applicable to the reporting company. Whenever the obligation to report is conditional on a finding of materiality, legal effects will emerge when information has been misstated, obscured, or omitted, and such information is deemed to be material information. The analysis conducted in section IV.C of this article shed light on the intricacies of the criteria for determining the materiality of impacts and of impact-related information. It described the impact materiality assessment process. It highlighted the wide discretion given to companies to make materiality decisions following their own thresholds of severity and likelihood of occurrence of impacts, as well as the legal uncertainty generated by the test of ‘relevance’ applied to disclosure requirements and datapoints. In the presence of these problems, doubts remain as to how adequately the materiality assessment will function in practice and how contentious this assessment may ultimately prove from the perspective of compliance and liability. A more accurate inventory of obstacles and limits will most likely emerge as the companies implement the new rules and report following the double materiality approach.

As in financial reporting, it is expected that the evaluation of materiality will rely on analytical tools such as the materiality matrices and the analysis of patterns according to countries, industries, and the characteristics of the companies.¹⁶⁴ As in financial auditing (auditors do create materiality thresholds to assess whether material information has been misstated or omitted),¹⁶⁵ the CSRD has also innovated by creating a regime for the assurance of corporate sustainability reports. This mandatory assurance requirement, if properly implemented, will prove of critical value. It precisely aims at reducing uncertainty by providing confidence to all the parties involved in the accuracy and completeness of the information contained in the report. This new assurance regime will first operate on a ‘limited assurance engagement’ basis. This means that the auditors will verify that the reporting company has duly performed the evaluation of materiality insofar as such auditors shall provide an opinion as to the compliance of a company’s sustainability reporting with the CSRD rules and applicable reporting standards.¹⁶⁶ The Commission has explained that ‘[t]he conclusion of a limited assurance engagement is usually provided in a negative form of expression by stating that no matter has been identified by the practitioner to conclude that the subject matter is materially misstated.’¹⁶⁷ The assurance providers will thus state in their reports that they have identified no issues leading them to conclude that the sustainability report contains material misstatements or omissions.

Starting with a model of limited assurance engagement, the assurance services regime aims to ultimately mutate towards a more rigorous ‘reasonable assurance engagement’ model. As noted by the Commission, in a model based on limited assurance engagement, the auditor performs fewer tests than in a reasonable assurance engagement model.¹⁶⁸ The amount of work involved in a model of reasonable assurance engagement ‘entails extensive procedures including consideration of internal controls of the reporting undertaking and substantive testing’, whereas such procedures are not part of a limited assurance engagement model.¹⁶⁹ The assurance services industry estimates that a reasonable assurance engagement model will prove trustworthy as it ‘will provide to the market the same level of comfort as financial information and demonstrate that sustainability information is as crucial for business viability and stakeholder decision-making as financial information.’¹⁷⁰ Although assurance services covering voluntary sustainability reports have been provided for many years (the service being provided by different types of firms such as accounting, consulting, and engineering firms),¹⁷¹ the assurance services industry is expected to evolve and develop new practices to adequately accommodate the CSRD and ESRS rules.

VI. Conclusion

The reporting obligation set out in the CSRD and, by way of reform, in the Accounting Directive, underpins policy goals central to the European Green Deal as well as to the EU sustainable finance policy. More and better sustainability-related information will be made available to the benefit of reporting companies, stakeholders, and markets.¹⁷² Changes in corporate behaviour towards greater accountability will desirably follow as companies adjust their business strategies and practices to increment their sustainability performance.¹⁷³ Within this framework, the adequate implementation of the double materiality requirement is paramount to ensure due compliance with the CSRD’s reporting obligation and achieve the CSRD’s intended policy objectives.

However, as argued in this article, compliance with the double materiality requirement poses difficult challenges to the reporting companies. More particularly, this article has examined the impact materiality requirement as treated in the ESRS rules to shed new light on several implementation problems and associated legal risks. Among other hurdles, rule compliance can be hindered by problems in the process of identifying impacts through company-stakeholders engagement, problems in the availability and quality of impact-related information, and problems of uncertainty as to the legal criteria for determining the materiality of impacts and of impact-related information. A better understanding of these problems is important to assist companies in discharging their reporting obligations. The Securities and Markets Stakeholder Group stated in its recent advice to the European Securities and Markets Authority (ESMA) that ‘untrue, incomplete, or misleading statements in non-financial reports will in the future have the same consequences as if such statements were made in financial reports.’¹⁷⁴

It is submitted that reporting companies will define policies, actions, targets, and metrics to identify, evaluate, and manage external impacts, and put adequate due diligence processes in place to this effect.¹⁷⁵ In the past, the absence of clear guidelines on how to undertake impact measurements and management had resulted in companies implementing multiple, different mechanisms.¹⁷⁶ Although the ESRS rules aim to improve this situation, the administration of such complex due diligence processes will increase the costs borne by the reporting companies and, as claimed by Baumüller and Sopp, it is unclear to what extent these greater costs will be matched or surpassed by the benefits for the company from sustainability reporting.¹⁷⁷ More research can provide a better understanding of the operation of these due diligence processes. Within the scope of such processes, this article has emphasised the importance of adequate company-stakeholders engagement for determining impacts while highlighting key legal risks that this process of engagement may generate for the reporting companies. As a corollary of this analysis, it has been recommended that a company’s strategy of stakeholder engagement be coupled with a strategy of legal risk management.

This article has also pointed out that the legal criteria against which to evaluate misstatements and omissions originated from sustainability reporting have thus far been unclear. Among other problems, there is uncertainty as to whether a finding of greenwashing misconduct will require the presence of negligence, gross negligence, intention, or will be guided, instead, by strict liability. The operation of the legal criteria for determining the materiality of impacts has not been apparent either. A blend of standards, impact thresholds, discretionary powers, and broad criteria for determining the materiality of impact-related information, has given rise to a complex process whose legal risks and implications are difficult to predict. What the current state of the law precisely is and how the rules should be construed and applied are questions that have yet to find clear answers. The association between complex rules and noncompliance events has been documented in the literature. Complex rules involve a greater compliance burden, making more probable that the typically law-abiding company ends up breaching rules unintentionally.¹⁷⁸ In this light, this article has recognised that the reporting of external impacts by companies under the CSRD regime will face serious compliance hurdles—especially at the early phases of rule implementation—such as problems of data or interpretation, rendering unintentional breaches not only plausible but also likely.¹⁷⁹ From the perspective of compliance and enforcement, how NCAs will manage and respond to such unintentional breaches is a key issue.¹⁸⁰

More generally, a workable model for the supervision and enforcement of corporate sustainability reporting has yet to be articulated. The CSRD has relied on a regime whereby NCAs supervise and enforce compliance with sustainability reporting rules. At the level of the reporting company, the CSRD has required that ‘the persons responsible … confirm in the annual financial report that, to the best of their knowledge, the management report is prepared in accordance with the sustainability reporting standards.’¹⁸¹ In connection to this, the CSRD, like its predecessor the NFRD, has set out a regime of ‘[c]ollective responsibility of the company’s administrative, management, and supervisory bodies for ensuring that sustainability information is drawn up and published in accordance with the CSRD’s requirements’.¹⁸² Under this framework, compliance with the double materiality requirement is certainly a critical component of accountability in corporate sustainability reporting. Early drafts of the CSRD had included a section prescribing penalties for rule violations,¹⁸³ but the final CSRD document appears to have reserved such determination to Member States.¹⁸⁴ In turn, the CSRD has empowered ESMA to issue guidelines to promote the convergence in supervision across Member States.¹⁸⁵ New developments in relation to compliance and enforcement of rules in this field will be paramount to ensure that the policy objectives pursued by the CSRD are effectively achieved. Such developments must be monitored closely and they will provide a critical path for future research.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Notes on contributors

Félix E. Mezzanotte

Félix E. Mezzanotte is assistant professor of financial services law and Director of the MSc Programme in Law and Finance at the School of Law, Trinity College Dublin, Ireland. He has taught modules in financial services law, legal aspects of sustainable finance, company law and insolvency law. His most recent research tackles legal problems in the field of EU sustainable finance including themes of investor protection, compliance and enforcement, and corporate sustainability reporting. Prior to Trinity, Félix taught law at the Faculty of Business of the Hong Kong Polytechnic University and acted as a policy advisor for the World Bank in Washington DC.

Notes

1 J Baumüller and MM Schaffhauser-Linzatti, ‘In Search of Materiality for Nonfinancial Information—Reporting Requirements of the Directive 2014/95/EU’ (2018) 26 NachhaltigkeitsManagementForum 101–11, 103; R Torelli, F Balluchi and K Furlotti, ‘The Materiality Assessment and Stakeholder Engagement: A Content Analysis of Sustainability Reports’ (2020) 27(2) Corporate Social Responsibility and Environmental Management 470–84, 470 (materiality is the driver through which companies can identify and select issues to be included in their reports); M Bossut, I Jürgens, T Pioch, F Schiemann, T Spandel and R Tietmeyer, ‘What Information is Relevant for Sustainability Reporting? The Concept of Materiality and the EU Corporate Sustainability Reporting Directive’ (July 2021) Sustainable Finance Research Platform Policy Brief 5–6 <https://wpsf.de/wp-content/uploads/2021/09/WPSF_PolicyBrief_7-2021_Materiality.pdf> accessed 15 January 2023.

2 Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC, (29.6.2013) OJ L182/19, art 2(16) (hereinafter ‘Accounting Directive’).

3 Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, OJ L330/1 (hereinafter ‘NFRD’).

4 Directive 2022/2464/EU of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting, (16.12.2022) OJ L322/15 (hereinafter ‘CSRD’). Entered into force on 5 January 2023. Members States will have 18 months to transpose this legislation into their national legal regimes.

5 Commission Delegated Regulation (EU) 2023/2772 of 31 July 2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards (OJ L, 22.12.2023) (‘ESRS DR’). The text of ESRS DR has heavily relied on prior drafts produced by of the European Financial Reporting Advisory Group (‘EFRAG’).

6 ibid ESRS DR, Annex I, ESRS 1 General Requirements, para 2 and para 21 (‘The undertaking shall report on sustainability matters based on the double materiality principle as defined and explained in this chapter.’ (Black and indented letters removed)).

7 A more formal approach to the CSRD’s reporting obligation is developed in section II. For the sake of simplicity this article very often utilises the term ‘company’ instead of the term ‘undertakings’ used in the CSRD, the ESRS rules and other EU legislation. The scope of the term ‘undertakings’ is however wider than the scope of the term ‘company’. Yet this distinction makes no difference to the analysis hereby presented.

8 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.2 para 29 (identifying mandatory information disclosure requirements that must be complied with regardless of materiality evaluation such as the requirements in ESRS 2 General Disclosures).

9 ibid para 2 and para 21.

10 The role of the double materiality assessment became even more prominent following the last-ditch changes introduced by the Commission to the November 2022’s draft ESRS rules produced by EFRAG.

11 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, ss 3.2–3.5.

12 ibid s 3.5 para 47.

13 Impact materiality is a concept already recognised by the reporting standards created by the General Reporting Initiative (GRI), yet such GRI reporting standards have operated only on a voluntary basis, GRI website <https://www.globalreporting.org/how-to-use-the-gri-standards/gri-standards-english-language/> access 8 May 2023. A relevant question is to what extent the burden of those companies that voluntarily complied with GRI standards in the past will increase following the adoption of the CSRD and ESRS rules as far as impact materiality is concerned. Although this article does not address this question, it is a question worth pursuing.

14 ESRS DR (n 5), Annex I, ESRS 1 General Requirements, s 3.4 para 46; CSRD (n 4) recital 29.

15 NFRD (n 3) art 1(1) (replacing art 19a(1) of the Accounting Directive).

16 Baumüller and Schaffhauser-Linzatti (n 1) 105–10.

17 European Commission, ‘Guidelines on Reporting Climate-Related Information’ 4409 final (July 17, 2019), 6–7 (hereinafter ‘2019 Guidelines’).

18 ibid.

19 ibid paras 6–8.

20 ibid.

21 ibid.

22 ibid.

23 ibid.

24 ibid. Also, section III of this article.

25 CSRD (n 4) art 1(4) (replacing art 19(a)(1) Accounting Directive). This reporting obligation can also be met following a consolidated sustainability reporting basis, CSRD (n 4) art 1(7) (replacing art 29(a) Accounting Directive).

26 Section III of this article. Also, CSRD (n 4) recital 29; ESRS DR (n 5), Annex I, ESRS 1 General Requirements, Objective section, para 2 and section 3, para 21.

27 CSRD (n 4), art 1(4) (replacing art 19(a)(1) Accounting Directive).

28 CSRD (n 4) art 2(2)(b) (adding art 2(17) to the Accounting Directive). Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability related disclosures in the financial services sector (OJ L317, 9.12.2019) (hereinafter ‘SFDR’), art 2(24) defining sustainability factors in terms of environment, society, employee matters, respect for human rights, anti-corruption and anti-bribery matters.

29 ESRS DR (n 5), Annex I, ESRS 1 General Requirements, Appendix A, Application Requirement (AR) 16.

30 ibid Appendix A, AR 16.

31 Ibid Annex I, section 1.1, paras 4–11.

32 ibid Appendix A, AR 16.

33 ibid, Annex I, ESRS 1 General Requirements, para 2, para 21 and para 29. For a more extensive elaboration, read the introductory sections in the ESRS DR (n 5).

34 ibid.

35 ibid s 1.3 and s 3.3 para 27.

36 ibid s 1.3 and s 3.

37 ibid s 3.5 para 49 (black and indented letters removed).

38 ibid s 3.5 para 47.

39 ibid s 3.5 para 48.

40 ibid s 3.1 para 22(b) (straight brackets added).

41 ibid s 3.5 para 31. EFRAG, ‘Implementation Guidance - Draft EFRAG IG 1 – Materiality Assessment’ December 2023 (non-authoritative implementation guidance for public feedback), s 2 and s 3. See section IV.C of this article.

42 ibid s 3.4 paras 43–44 and Appendix A.

43 ibid s 3.1 para 22(a).

44 ibid s 3.1 para 24 (black letters removed).

45 ibid s 3.4 para 43.

46 ibid.

47 ibid.

48 ibid.

49 ibid s 3.4 para 45 and Appendix A.

50 ibid s 3.4 para 46 and Appendix A. According to EFRAG, this mechanism for the prioritisation of impacts borrows from the due diligence processes as defined in the UN Guiding Principles on Business and Human Rights and in the OECD Guidelines for Multinational Enterprises, ibid s 3.4 para 45 and s 4 paras 59–60.

51 ESRS DR (5) Annex I, ESRS 1 General Requirements, s 3.2 para 31; EFRAG (41) ss 2.2–2.3 and s 3. See section IV.C of this article.

52 EFRAG, ‘Draft European Sustainable Reporting Standards’ Cover Letter, 22 November 2022, 2.

53 As of June 2023, the ISSB produced two sets of standards, namely the IFRS S1 and IFRS S2. IFRS website, ‘ISSB issues inaugural global sustainability disclosure standards’, 26 June 2023, https://www.ifrs.org/news-and-events/news/2023/06/issb-issues-ifrs-s1-ifrs-s2/ accessed 25 August 2023.

54 ISSB, IFRS S1 - General Requirements for Disclosure of Sustainability-related Financial Information, June 2023, Objective, para 1; Also, IFRS website, ‘IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information’, https://www.ifrs.org/issued-standards/ifrs-sustainability-standards-navigator/ifrs-s1-general-requirements/ accessed 25 August 2023.

55 Ibid ISSB, Objective, para 3.

56 ISSB, IFRS S2 – Climate-Related Disclosures, June 2023, Objective, para 1.

57 EFRAG (n 52) 2.

58 GRI (n 13) GRI 1: Foundations 2021, Glossary, term: material topics.

59 ibid term: impact.

60 GRI (n 13) (see how the GRI reporting for individual topics, e.g., GRI 11: Oil and Gas Sector, links material topics with the UN Sustainable Development Goals). The SDGs have been created by the Resolution A/RES/70/1 adopted by the UN General Assembly on 25 September 2015.

61 GRI (n 13) GRI 1: Foundations 2021, Glossary, term: sustainable development / sustainability (citing: World Commission on Environment and Development, Our Common Future, 1987).

62 The GRI has explicitly acknowledged the consistency of its objectives with those stated in the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights. Such instruments set out expectations for responsible business conduct, and so does the GRI reporting. GRI (13) GRI 1: Foundations 2021, s 1.1; ESRS DR (n 5), ESRS 1, Annex I, General Requirements, s 3.4 paras 45–46, s 4 para 59 and Appendix A.

63 ESRS DR (n 5), Annex I, ESRS 1 General Requirements, s 3.3 paras 37–38.

64 ibid s 3.3 para 38.

65 Communication from the Commission, OJ (C 2019) 1, 4. Similarly, 2019 Guidelines (n 17) 7 (‘These two risk perspectives already overlap in some cases and are increasingly likely to do so in the future. As markets and public policies evolve in response to climate change, the positive and/or negative impacts of a company on the climate will increasingly translate into business opportunities and/or risks that are financially material.’)

66 ESRS DR (n 5), Annex I, ESRS 1 General Requirements, s 3.3 para 38.

67 J Baumüller and K Sopp ‘Double Materiality and the Shift from Non-Financial to European Sustainability Reporting: Review, Outlook and Implications’ (2022) 23(1) Journal of Applied Accounting Research 8–28, 22.

68 IOSCO, ‘Report on Sustainability-Related Disclosures’, Final Report, FR04/21, June 2021, 25 (straight brackets added).

69 Arguments for and against the double materiality approach have been developed in E Faber, ‘Comptabilité d’entreprise: Exiger que la materialité s’etende au-delà du domaine économique est en réalité simpliste’, Le Monde newspaper, 10 October 2023; F Ducoulombier, ‘On the Triple Illusion of Double Materiality’ 10 October 2023, EDHEC – RISK Climate Impact INSTITUTE, https://climateimpact.edhec.edu/triple-illusion-double-materiality (accessed on 03 January 2024); IPE ‘Viewpoint: A response to ISSB’s Faber’s ‘triple illusion’ criticism of double materiality’ (by Frédéric Ducoulombier) 13 October 2023; D Raith, ‘The Contest for Materiality. What Counts as CSR?’ (2022) 24(1) Journal of Applied Accounting Research 134–48.

70 CSRD (n 4) recital 9; H B Christensen, L Hail and C Leuz, ‘Mandatory CSR and sustainability reporting: economic analysis and literature review’ 26 Review of Accounting Studies 1176–1248 (2021) 1210–18 (examining the incentives path from corporate disclosure to change in corporate conduct).

71 CSRD (n 4) recital 9; 2019 Guidelines (n 17) 6–7.

72 M Bradford, J B Earp, D S Showalter and P F Williams ‘Corporate Sustainability Reporting and Stakeholder Concerns: Is There a Disconnect?’ (2017) 31(1) Accounting Horizons 83–102, 93 (identifying a ‘potentially significant disconnect between the business view of sustainability as an instrument to achieve economic goals and the stakeholder view of sustainability as an end in itself.’).

73 See, for example, the approach to impacts adopted in GRI standards which are ultimately concerned with the impacts of company activity on sustainable development, GRI (n 13).

74 S Jørgensen, A Mjøs and LJT Pedersen, ‘Sustainability Reporting and Approaches to Materiality: Tensions and Potential Resolutions’ (2022) 13(2) Sustainability Accounting Management and Policy Journal 341–61, 357.

75 Christensen et al (n 70) 1186 (claiming that addressing negative externalities from corporate activity is one of the primary motivations for corporate sustainability reporting using double materiality).

76 ibid 1181 (‘Shareholders could have non-monetary preferences and, hence, care about a company’s (negative) impact on the environment or society even when this impact does not have (immediate) financial consequences (as is the case with externalities such as CO2 emissions’). For an examination of treatment of sustainability preferences of investors under MiFID II, see F E Mezzanotte, ‘Recent Law Reforms in EU Sustainable Finance: Regulating Sustainability Risk and Sustainable Investments’ (2023) 11(2) American University Business Law Review 215–76, 252–56.

77 ESRS DR (n 5), Annex I, ESRS 1 General Requirements, s 3.3 para 38 and Appendix A, ARs 6–7.

78 ibid.

79 EFRAG (n 41) para 5 and para 15.

80 European Commission, Communication from the Commission to the European Parliament, The European Council, The Council and the European Economic and Social Committee and the Committee of the Regions (European Green Deal), Brussels, 11.12.2019 COM(2019) 640 final.

81 EU Commission, ‘Action Plan: Financing Sustainable Growth’ Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions (Brussels, 08 March 2018 COM(2018) 97) 2.

82 European Commission Press Release, ‘Commission welcomes political agreement on rules enforcing human rights and environmental sustainability in global supply chains’ Brussels, 14 Dec 2023, https://ec.europa.eu/commission/presscorner/detail/en/ip_23_6599 (accessed on 03 January 2024). Further information on the draft Corporate Sustainability Due Diligence Directive, see https://commission.europa.eu/business-economy-euro/doing-business-eu/corporate-sustainability-due-diligence_en (accessed on 03 January 2024).

83 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.5 para 47 (‘The scope of financial materiality for sustainability reporting is an expansion of the scope of materiality used in the process of determining which information should be included in the undertaking’s financial statements’ (Black and indented letters removed)).

84 ibid s 3.1 para 24 and Appendix A, AR 8 and AR 9.

85 ibid s 4 (due diligence requirements).

86 ibid s 4 para 59; Annex I, ESRS 2 General Disclosures, s 4 (impact, risk, and opportunity management).

87 ESRS DR (n 5) Annex I, ESRS 1 General Requirements s 3.1 para 22(a) (defining affected stakeholders).

88 ibid. See more generally, CSRD (n 4) recital 9.

89 ESRS DR (n 5) Annex I, ESRS 1 General Requirements s 3.1 para 22(a).

90 Section III of this article.

91 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, Appendix A, AR 9 (the ESRS rules use the phrase ‘shall consider’ when referring to the reporting company’s engagement with stakeholders in impact determination and evaluation). The phrase ‘shall consider’ sets out an expectation but not a prescription, ibid para 18. Note, for example, that information disclosure on the company-stakeholders engagement is prescriptive, yet this prescription refers only to disclosure without imposing a conduct requirement to engage, ESRS DR (n 5) Annex I, ESRS 2 General Disclosures, IRO-1, para 53 ‘The undertaking shall disclose the following information: (…) (b) an overview of the process to identify, assess, prioritise and monitor the undertaking’s potential and actual impacts on people and the environment, informed by the undertaking’s due diligence process, including an explanation of whether and how the process: (…) III. includes consultation with affected stakeholders to understand how they may be impacted and with external experts; (…)’).

92 Sustainability-related lawsuits in US Federal Courts have been entered relying on a wide range of statutory provisions. However, success has been limited, see D Hackett, R Demas, D Sanders, J Wicha and A Fowler, ‘Growing ESG Risks: The Rise of Litigation’ (2020) 50 Envtl. L. Rep. 10849; C M Ajax and D Strauss, ‘Corporate Sustainability Disclosure in American Case Law: Purposeful or Mere “Puffery”?’ (2018) 45 Ecology Law Quarterly 703.

93 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, Appendix A, AR 7.

94 ibid, Annex II Glossary of Terms (the author has not found a definition of the term ‘nature’).

95 EFRAG has recently proposed approaches to these issues in EFRAG, ‘Implementation Guidance - Draft EFRAG IG 1 … ’ (n 41) s 5.4.

96 ESRS DR (n 5) Annex I, ESRS 2 General Disclosures, IRO-1, para 53.

97 S Silva, A K Nuzum and S Schaltegger, ‘Stakeholder Expectations on Sustainability Performance Measurement and Assessment. A Systematic Literature Review’ (2019) 217 Journal of Cleaner Production 204–15, 212; Bossut et al (n 1) 8–10.

98 Bradford et al (n 72) 97; Torelli et al (n 1) 470–84.

99 A I Muchmore, ‘Uncertainty, Complexity, and Regulatory Design’ (2016) 53 Hous. L. Rev. 1321, 1338–39.

100 ibid 1338.

101 ibid 1346–47.

102 ibid.

103 ESRS DR (n 5) Annex I, ESRS 1 General Requirements s 7.2; V Harper Ho, ‘Climate Disclosure Line-Drawing & Securities Regulation’ SSRN Working Paper 4339497, 22–28 (discussing estimations of climate risk in reporting and litigation risk in the context of the SEC’s proposed climate-related reporting rules).

104 The ESRS rules also utilise the term ‘obscuring’ to characterise problems of information in the context of financial materiality and sustainability reporting, ESRS DR (5) Annex I, ESRS 1 General Requirements s 3.5 para 48.

105 European Securities and Markets Authority (ESMA), ‘Progress Report on Greenwashing’ ESMA30-1668416927-2498, 31 May 2023, 11.

106 Moodaley and Telukdarie (n 55) s 2.2. Also, T P Lyon and A W Montgomery, ‘The Means and End of Greenwash’ (2015) 28(2) Organization & Environment 223–249.

107 European Securities and Markets Authority (ESMA), ‘ESMA prioritises the fight against greenwashing in its new Sustainable Finance Roadmap’ <https://www.esma.europa.eu/press-news/esma-news/esma-prioritises-fight-against-greenwashing-in-its-new-sustainable-finance> accessed 9 May 2023.

108 ESMA (n 105) 20–21 and 30–39.

109 ibid 12 (black letters omitted).

110 ibid 12–13.

111 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.4 para 43, s 5, and Appendix A.

112 EOPIA, ‘Opinion to the European Commission on EFRAG’s Technical Advice on European Sustainability Reporting Standards’ EIOPA-BoS-23-016, 26 January 2023, para 3.8.4; E Aliakbari and S Globerman, ‘The Impracticality of Standardizing ESG Reporting’ in Collected Essays. ESG: Myths and Realities, Fraser Institute, April 2023, 8–10 (arguing that the complexity of reporting scope 3 greenhouse gas emissions may generate a problem of multiple counting ‘resulting in a misleading measurement of aggregate carbon emissions.’ citing multiple sources).

113 Siemens website, https://www.siemens.com/global/en/company/sustainability/sustainablesupplychain.html accessed 03 January 2024.

114 Unilever website, https://www.unilever.com/files/8c652127-8ea5-4db0-bedb-f03a37637285/unilever-s-supply-chain.pdf accessed 03 January 2024.

115 ESRD DR (n 5), Annex I, ESRS 1 General Requirements, s 1.2 paras 12–13 and ESRS 2 General Disclosures.

116 Accounting Directive 2013/34/EU (n 2) art 2(16).

117 Baumüller and Schaffhausen-Linzatti (n 1) (explaining that the since the Accounting Directive did not explicitly define what type of users are included in the definition of financial materiality, market actors have relied on financial regulatory standards to so define, such as the International Financial Reporting Standards (IFRS) rules).

118 Referring to the legal test of materiality in securities fraud claims brought under the Securities and Exchange Act of 1934, section 10(b), and the Securities and Exchange Commission’s Rule 10b-5 (SEC Rule 10b-5), see C B Cooper, ‘Rule 10b-5 at the Intersection of Greenwash and Green Investment: The Problem of Economic Loss’ (2015) 42 B.C.Envtl. Aff. L. Rev. 405.

119 It is worth noting that in securities fraud claims materiality is only one of the conditions for the existence of securities fraud. Other criteria, such as the requirement for scienter, reliance, economic loss and causation, must also be established, Cooper (n 118) 414–22 and 423–25. Redress is based on economic loss. Even if greenwashing conduct may cause economic and non-economic loss to investors, it is not apparent that courts will accept non-economic loss as basis for granting remedies in favour of, or compensate, investors, ibid, 427–36 (discussing economic loss in the context of US securities litigation and greenwashing); S Dadush, ‘Identity Harm’ 2018 U. Colo. L. Rev. 89 863 (arguing for the recognition of moral loss in greenwashing-related litigation).

120 Cooper (n 118) 417 (by reference to case TSC Industries, Inc v. Northway, Inc., 426 U.S. 438, 449 (1975), and Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1318 (2011)).

121 A I Saad and D Strauss, ‘A New “Reasonable Investor” and Changing Frontiers of Materiality: Increasing Investor Reliance on ESG Disclosures and Implications for Securities Litigation’ (2020) 17 Berkeley Bus. LJ 391–433, 292–397 (arguing that the modern investors also rely on ESG data to make investment decisions and that, to this extent, a broader scope of information should be deemed material under the US securities disclosure regime). C M Ajax and D Strauss (n 92) 706 (analysing the decisional practice of US Federal Courts, the authors found that claims by plaintiffs were more likely to succeed when ‘sustainability disclosures are concrete, repetitive, and fact based’ but less so when disclosures contain ‘“vague” and “aspirational” language.’).

122 There is an ongoing discussion in the United States related to the proposed SEC rules on climate-related reporting, see G S Georgiev, ‘The SEC's Climate Disclosure Rule: Critiquing the Critics’ 50 Rutgers L. REC. 101 (2022), s IV (distinguishing the materiality principle in the United States from the double materiality principle in the European Union). The approach to materiality in US federal courts does not contain an EU-like impact materiality dimension.

123 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.5 para 48 (black letters removed).

124 EFRAG (n 41) para 32, ss 2.2–2.3 and s 3.

125 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.2 para 31; EFRAG (n 41) ss 2.2–2.3 and s 3.

126 The ESRS-defined categories of sustainability matters are presented in ESRS DR (n 5), Annex I, ESRS 1 General Requirements, Appendix A, AR 16. Also, EFRAG (n 41) para 47 and para 71. See section II of this article defining sustainability matters.

127 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.4 paras 45–46, s 4 and Appendix A. Also, EFRAG (n 41) s 3.

128 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.5 para 51 and Appendix B ARs 8–10.

129 EFRAG (n 41) para 3 and para 50; ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.2 para 31.

130 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s 3.2 para 31.

131 Ibid para 31(b).

132 Ibid para 31(a).

133 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, Appendix A, AR 9(c).

134 Baumüller and Schaffhauser-Linzatti (n 1) 103 (Discretionary decision-making has been estimated to be more difficult in relation to sustainability-related information); Aliakbari and Globerman (n 112) 7 (arguing that ‘broadly defined reporting standards would give more leeway for managers to hide unfavourable information.’).

135 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, Appendix A, AR 8 (straight brackets added).

136 ibid.

137 EFRAG (n 41) s 3.1. Also, E Aliakbari and S Globerman (n 112) 4–7 (discussing problems of implementation caused by the different interests of stakeholders including investors).

138 ibid para 5 (‘The ESRS do not mandate a specific process or sequence of steps to follow when performing the materiality assessment, as so this is left to the judgement of the undertaking. Whichever process is used it should reflect the undertaking’s facts and circumstances.’).

139 EOPIA (n 112) para 3.9.2.

140 ESRS DR (n 5) Annex I, ESRS 1 General Requirements, s. 4 para 59 and s. 4.1.

141 ESRS DR (n 5) Annex I, ESRS 2 General Disclosures, s. 4.2 para. 60 (black and indented letters removed).

142 Ibid., s. 5 paras. 74–75 and paras. 78–81.

143 ESRS DR (n 5) Annex I, ESRS 1 ‘General Requirements’ s. 4, para. 59.

144 ESMA, ‘2022 Corporate reporting enforcement and regulatory activities’ Report ESMA32-63-1385. 29 March 2023, para 143 (showing proportion of companies in the European Economic Area adopting GRI standards as of 2022 prior to the enactment of the CSRD).

145 C A Adams, A Alhamood, X He, J Tian, L Wang, and Y Wang, ‘The Double Materiality Concept: Application and Issues’ published by the Global Reporting Initiative (2021) 6 (citing several sources) (‘[t]he enhanced stakeholder engagement required by the double-materiality analysis contributes to diverse and reciprocal accountability relationships between the organisations, their stakeholders, and the wider society and enables discussions and evaluations on sustainable development’.)

146 Christensen et al. (n 70) s. 5, 1210–18.

147 ibid. 1215.

148 See section IV.A of this article.

149 A timetable has been set out in the CSRD (n 4) art 5(2).

150 Ibid.

151 ESRS DR (n 5) Annex I, ESRS 1 ‘General Requirements’ s. 10.2 (Transitional provision related to chapter 5 Value chain).

152 European Commission, ‘Questions and Answers on the Adoption of European Sustainability Reporting Standards’ Brussels, 31 July 2023, 3.

153 European Supervisory Agencies (ESAs), ‘ESAs Call for Evidence on Better Understanding Greenwashing’ (2022), <https://www.esma.europa.eu/sites/default/files/library/esas_call_for_evidence_on_greenwashing.pdf> accessed 1 October 2023

154 Ibid, para 3(a) (straight brackets added).

155 Submission made by the Spanish Securities and Markets Authority (CNMV) to the ESAs Call for Evidence on Better Understanding Greenwashing, January 2023, 3 (internet search; submission with the author).

156 Submission made by Finance Denmark to the ESAs Call for Evidence on Better Understanding Greenwashing, 16 January 2023, 9 (internet search; submission with the author).

157 Submission made by the German Investment Funds Association (BVI) to the ESAs Call for Evidence on Better Understanding Greenwashing, 13 January 2023, 2 (internet search; submission with the author).

158 Submission made by Eurosif to the ESAs Call for Evidence on Better Understanding Greenwashing, 16 January 2023, 2–3 (internet search; submission with the author).

159 Submission made by European Fund and Asset Management Association (EFAMA) to the ESAs Call for Evidence on Better Understanding Greenwashing, 10 January 2023, 6 (internet search; submission with the author).

160 Submission made by the International Capital Markets Association (ICMA) to the ESAs Call for Evidence on Better Understanding Greenwashing, 11 January 2023, 1 (internet search; submission with the author).

161 Submission made by the European Banking Federation (EBF) to the ESAs Call for Evidence on Better Understanding Greenwashing, 16 January 2023, 2 (internet search; submission with the author).

162 Among others, submission made to the ESAs Call for Evidence on Better Understanding Greenwashing by the Association for Financial Markets in Europe (AFME), 10 January 2023, 1; and by Invest Europe, 10 January 2023, 2 (internet search; submission with the author).

163 See supra text preceding note 105; ESMA report (n 105) para 12.

164 See, for example, NYU-Stern, ‘Sustainability Materiality Matrices Explained’ Report, Centre for Sustainable Business, May 2019.

165 C Edgley, ‘A Genealogy of Accounting Materiality’ (2014) 25 Critical Perspectives on Accounting 255, 256–59; more generally, C Edgley, M J Jones and J Atkins, ‘The Adoption of the Materiality Concept in Social and Environmental Reporting Assurance: A field Study Approach’ (2015) 47 The British Accounting Review 1, 16.

166 CSRD (n 4) art 1(12) and art 1 (13) (amending art 34 Accounting Directive), and CSRD (n 4) arts 2–4.

167 ibid recital 60.

168 ibid.

169 ibid.

170 Accountancy Europe, ‘Sustainability Assurance Under the CSRD: Key matters to respond to the upcoming CSRD requirements’ Discussion Paper, Audit & Assurance, May 2022, 3. The CSRD has prescribed that the Commission set out standards on limited assurance engagement (1 October 2026) and on reasonable assurance engagement (1 October 2028).

171 K F Alsahali and R Malagueño, ‘An Empirical Study of Sustainability Reporting Assurance: Current Trends and New Insights’ (2022) 18(5) Journal of Organisation and Accounting Change 617–42, 620–23; ESMA (n 144) para 142 (Analysing non-financial reports in a sample of 113 issuers from 23 EEA countries during 2022 period: ‘For almost all issuers, the statutory auditor or audit firm verified whether the issuer provided a non-financial statement. For 66% of issuers, the information contained in the non-financial statement was verified by an independent assurance service provider (84% by a statutory auditor, 7% by another audit firm, 9% by a third-party assurance provider other that an audit firm) almost in all cases on a limited assurance basis.’).

172 ibid recitals 9–15.

173 To examine further the relation between information disclosure and change in corporate conduct, see Christensen et al (n 70) 1208–10.

174 Securities and Markets Stakeholder Group ‘Advice to ESMA: SMSG Advice to ESMA on the ESAs’ Call for Evidence on Greenwashing’ 18 January 2023, ESMA22-106-4384, para 28.

175 ESRS DR (n 5) Annex I, ESRS 1 General Requirements s 4, and ESRS 2 General Disclosures ss 4–5.

176 Baumüller and Sopp (n 67) 22.

177 ibid.

178 D W Lehman, B Cooil and R Ramanujam, ‘The Effects of Rule Complexity on Organizational Noncompliance and Remediation: Evidence from Restaurant Health Inspections’ Journal of Management, Vol. 46 No. 8, November 2020, 1436–1468; J P Mendoza, H C Dekker and J L Wielhouwer, ‘Firms’ Compliance with Complex Regulations’ (2016) 40(6) Law and Human Behavior 721–33; D B Spence, ‘The Shadow of the Rational Polluter: Rethinking the Role of Rational Actor Models in Environmental Law’ (2001) 89 California Law Review 917–98, 933–34; Timothy F. Malloy, ‘Regulation, Compliance and the Firm’ (2003) 76(3) Temp. L. Rev. 451; F E Mezzanotte, ‘EU Sustainable Finance: Complex Rules and Compliance Problems’ (2023) 42(2) Review of Banking & Financial Law 845–896.

179 E Aliakbari and S Globerman (n 112) 11 (‘complex and broad mandated reporting standards increase the likelihood that firms will inadvertently misrepresent their ESG activities.’).

180 Data of enforcement actions taken by NCAs in 2022 concerning non-financial reports show that a high percentage of all enforcement actions consisted of ordering the correction of the information in future non-financial statements, ESMA (n 144) para 149 Table no.3.

181 CSRD (n 4) recital 79 and art 2(2)(a) (modifying art 4(2)(c) of Directive 2004/109/EC).

182 ibid art 1(11) (modifying art 33, para 1, Accounting Directive; and upholding the same principles that the NFRD had adopted; NFRD (n 3) art 1(9) (amending art 33, para 1, Accounting Directive).

183 Draft CSRD (version of 21 April 2021) art 1(12) (replacing art 51 of the Accounting Directive 2013/34/EU and proposing minimum administrative measures and sanctions, including reputational ‘name and shame’ measures, cease-and-desist orders, and administrative monetary sanctions).

184 CSRD (n 4) recital 59 and recital 79.

185 ibid art 2(4) (modifying art 28(d) Directive 2004/109/EC) and recital 79.