Highlights

• ESG offers voluntary guidelines for ethical corporate behavior, while the EU's CSRD mandates detailed and audited sustainability reporting.
• ESG focuses on environmental impact, social responsibility, and governance practices, guiding companies in improving their ethical standards.
• The CSRD aims to elevate ESG reporting to the rigor of financial reporting, impacting thousands of businesses with specific disclosure requirements.
• CSRD enforces comprehensive sustainability reporting across the EU, significantly influencing corporate accountability and transparency.
• CSRD's reporting requirements will be phased in over several years, starting in 2024, with specific deadlines for different types of companies, including SMEs and foreign companies with EU subsidiaries.

Overview

In today's rapidly evolving corporate landscape, terms like ESG (Environmental, Social, and Governance) and CSRD (Corporate Sustainability Reporting Directive) are becoming increasingly common. But what do these acronyms really mean,what makes them distinct, and how do they impact businesses?

This article will take a look at the origins and goals of ESG, tracing its roots back to a time when corporate social responsibility (CSR) initiatives were gaining momentum. It will also look at how ESG served as the impetus for CSRD, the European Union's ambitious endeavor to translate ESG principles into enforceable regulations.

This breakdown includes the key differences between ESG's voluntary guidelines and CSRD's mandatory reporting requirements, as well as how these directives are reshaping the corporate landscape. 

What’s The Difference Between ESG vs. CSRD?

Let’s first take a look at what makes these two frameworks different. ESG and CSRD are closely related but play different roles in the corporate world. ESG began as a way for companies to voluntarily address and report on their ethical and sustainability practices. It gave businesses a framework to improve their impact on the environment, treat employees fairly, and ensure transparent governance.

On the other hand, the CSRD takes ESG principles and makes them mandatory. It transforms the aspirational goals of ESG into specific, legally binding regulations that require detailed and audited reports on a company's sustainability practices. While ESG provides the guidelines, CSRD enforces them, ensuring that companies within the EU adhere to strict reporting standards.

In summary, ESG is the framework for ethical corporate behavior, while CSRD is the regulatory directive that mandates compliance with these principles in the EU.

The Origins of ESG: A Replacement for CSR Initiatives 

How did ESG come to be?

The acronym “ESG”—which stands for environmental, social, and governance—first appeared in a 2004 report produced by a group of financial institutions at the request of then-United Nations Secretary General Kofi Annan. Following on the heels of the corporate social responsibility (CSR) initiatives of the 2000s, ESG more comprehensively captured many of the new issues companies–and shareholders–were finding themselves facing in the 21st century. 

Since the late 2010s, ESG has evolved from an idea into a popular framework for thinking about and measuring how corporations are fulfilling their moral responsibilities to individuals and the planet. Today, the concept has spread to a variety of spaces, including company boards and compliance departments, investor relations, and the wider business media landscape. Another sign of ESG’s reach and influence can be seen by the growing number of rating agencies that claim to definitively measure a company’s ESG performance. 

Since the late 2010s, ESG has evolved from an idea into a popular framework for thinking about and measuring how corporations are fulfilling their moral responsibilities to individuals and the planet.

The Three Pillars of ESG 

Part of what has made ESG such an effective lens for thinking about and measuring corporate behavior and ethics—and, arguably, a superior concept to the vague, squishy “corporate social responsibility” that preceded it—is how specificity and concreteness are baked into the term. ESG consists of the three “pillars” in its name, and these categories each contain several interrelated ideals and objectives. Because of the clarity and directness of the acronym, companies interested in pursuing its principles, investors keen to carefully vet a business’s ethical bona fides, and all manner of other stakeholders can use the ESG framework as a clear roadmap for achieving their ends. 

ESG: The Environmental Pillar 

The first letter in ESG refers to the way a company’s actions affect our environment and the planet more broadly. Traditionally, this includes things like energy consumption, greenhouse gas emissions, carbon footprint, and ecological impact on wildlife and biodiversity loss (a catastrophic development that runs parallel to climate change but doesn’t receive even a fraction of the same action or attention). In addition, many ESG directives require that corporations develop and implement a climate change strategy that may include goals for decarbonization, climate adaptation, and risk mitigation. 

ESG: The Social Pillar 

ESG’s social pillar encompasses issues related to the way a corporation treats people. This includes not only its own employees, but also those individuals in its larger orbit. The pillar covers compensation issues like fair pay and living wages, workplace safety standards, and labor practices that reject forced labor, child labor, and exploitation in all its various manifestations. It also establishes companies’ responsibility for cultivating ethical sourcing habits and playing an active, assertive role in maintaining a responsible supply chain. 

ESG: The Governance Pillar 

The third pillar, governance, is probably the most ambiguous, least-discussed of ESG’s three letters. Governance frequently takes a back seat to the seemingly more pressing matters of protecting the environment and treating workers and other supply chain stakeholders with fairness and equity. But the framework’s third letter absolutely matters, because it signifies how a corporation governs itself. This includes companies’ internal controls and guardrails, compliance measures, and the extent to which their tax and accounting behavior is transparent, responsible, and legally above-board. Good corporate governance eschews or otherwise roots out unethical business practices like bribery, corruption, and corporate malfeasance. 

When the ESG framework initially rose to prominence around a half-decade ago, it was embraced as a highly effective strategy for holding businesses accountable for their actions and compelling them to develop internal mechanisms for reversing or otherwise ameliorating the far-reaching consequences of those actions. Since then, however, it has evolved beyond its function as a largely aspirational concept with a voluntary set of objectives. Today, it serves as the foundation for legitimate, legally binding rules. That transformation is embodied by the European Union’s sweeping new set of regulations, the Corporate Sustainability Reporting Directive (CSRD). 

What is the Corporate Sustainability Reporting Directive (CSRD)? 

Originally conceived as a successor to the European Union’s Non-Financial Reporting Directive (NFRD), the EU issued the initial proposal for the Corporate Sustainability Reporting Directive in April 2021. In December of the following year, the CSRD was published in the Official Journal of the European Union. The directive entered into force on January 5, 2023. 

In replacing the NFRD and establishing more ambitious reporting requirements for companies, the EU is seeking to enhance transparency across the corporate sector and give investors, consumers, and other stakeholders clearer, more direct access to corporations’ ESG impact. Though part of a larger, decades-spanning vision for combating climate change and transitioning into an economy oriented around sustainability, the overarching aim of the new regulation can be distilled into a relatively simple, straightforward idea: to raise ESG reporting to the level of financial reporting in the EU. 

In replacing the NFRD and establishing more ambitious reporting requirements for companies, the EU is seeking to enhance transparency across the corporate sector and give investors, consumers, and other stakeholders clearer, more direct access to corporations’ ESG impact.

The new EU directive draws on the sustainability concept to implement a broad set of ESG reporting requirements for thousands of businesses operating in the EU’s 27 member nations. These obligations are divided into the European Sustainability Reporting Standards (ESRS), a set of 12 categories that outline what specific disclosures companies are required to make. At the time of their adoption in 2023, Mairead McGuiness, the European Commissioner for Financial Services, Financial Stability, and Capital Markets Union, declared the standards an “important tool underpinning the EU’s sustainable finance agenda.” They would, she said, enable companies “to show the efforts they are making to meet the green deal agenda.” 

What are the CSRD Standards?

The standards are separated into four categories that directly invoke the framework that inspired CSRD: environmental, social, governance, and “cross-cutting.” These categories include disclosure requirements that are both expansive and granular, running the gamut of issues surrounding the three pillars. Companies will need to report on everything from precise measurements of their environmental impact to labor practices along their respective supply chain. Individuals and businesses can view the specific language and requirements of the CSRS in the Official Journal of the European Union. 

Environmental Standards

• Climate Change
• Pollution
• Water and Marine Resources
• Biodiversity and Ecosystems
• Resource Use and Circular Economy

Social Standards

• Own Workforce
• Workers in the Value Chain
• Affected Communities
• Consumers and End-Users

Governance Standards

• Business Conduct

Cross-Cutting Standards

• General Requirements
• General Disclosures 

CSRD Compliance Requirements

Before delving into the particulars of the directive and all their textual intricacies, organizations should understand the types of companies the CSRD is set to impose reporting obligations on, and when those obligations will take effect. 

Which Companies Must Comply with CSRD Requirements?

The EU has divided businesses covered under the CSRD into four primary groups. 

• Listed Companies: This group covers the majority of businesses listed on an EU-regulated market exchange. An important exception here are “micro-enterprises” that fall below a specific threshold based on certain criteria outlined by the EU. 

• Non-Listed Large Companies: This group encompasses businesses operating in the EU that meet two of following three criteria in two consecutive years: a minimum of 20 million euros in total assets; a net turnover of at least 50 million euros; and a workforce with at least 250 employees, on average, over the course of the year. 

• SMEs: The European Commission defines this group, rather straightforwardly, as small and medium-sized enterprises listed on an EU-regulated market exchange (with the exception, again, of micro-enterprises). 

• Foreign Companies with an EU Subsidiary: Finally, the fourth group comprises foreign businesses that have both an EU subsidiary and an annual EU revenue exceeding 150 million euros (calculated based on the average revenue over the previous two years). 

What’s the CSRD Reporting Timeline?

ESG reporting requirements for the CSRD has a complex, staggered rollout that will take place over the next several years. The Council of the European Union, European Parliament, and the European Commission laid out their timetable for CSRD compliance through a recent “Legislative Train Schedule.”

(It’s also worth noting that, as of April of this year, the EU approved a two-year delay on the directive’s reporting requirements for companies headquartered outside the EU, as well as certain sector-specific standards. Exempted companies will now have until June 30, 2026 to comply with the CSRD.)

• Beginning on January 1, 2024, all EU companies already subject to the EU’s NFRD must comply with the reporting requirements. Reporting for these companies will be due in 2025. 

• Beginning on January 1, 2025, all companies not currently subject to the NFRD that fulfill the above criteria for a non-listed large company must comply with the reporting requirements. Reporting for these companies will be due in 2026. 

• Beginning on January 1, 2026, all SMEs listed on an EU-regulated market must comply with the reporting requirements. Reporting for covered SMEs will be due in 2027. 

• Beginning on January 1, 2028, all foreign companies that have an EU subsidiary and meet the aforementioned revenue threshold must comply with the reporting requirements. Reporting for these foreign businesses will be due in 2029.  

ESG Reporting Conventions: Third-Party Auditing and “Double Materiality” 

While the full sweep of the CSRD’s obligations exceed the scope of this article, two key mandates warrant further discussion because of their all-encompassing impact on how businesses carry out the directive’s ESG reporting. 

First, the EU will eventually require all corporations covered by CSRD to have their sustainability data audited. Beginning in 2025, the law will require businesses to provide “limited assurance” from an external auditor. Further along the directive’s timetable, in 2028, the EU intends to implement “reasonable assurance” standards, which will stipulate more rigorous analysis of the CSRD reporting from a third party. 

Of arguably even greater consequence is the concept of double materiality. Double materiality refers to a reporting standard that looks at both “impact materiality”—the specific, measurable impacts a company is having on the three ESG pillars—and “financial materiality”—the consequences those sustainability issues have on the business’s financials. As explained by Reuters, the double materiality mandate for CSRD reporting “necessitates that organizations assess both their outward impacts on environmental and social matters, and the interrelation between sustainability matters and their financial outcomes.” 

Double materiality refers to a reporting standard that looks at both “impact materiality”—the specific, measurable impacts a company is having on the three ESG pillars—and “financial materiality”—the consequences those sustainability issues have on the business’s financials.

Double materiality assessments are complex and multifaceted, and require a great deal of highly specific information. Due to the sheer scale of data required to fulfill them, many companies will need to engage and leverage an array of internal departments to meet the EU’s reporting expectations. So while the European Commission’s timeline for CSRD compliance appears relatively generous on its face, companies will need to demonstrate a great deal of resourcefulness and wherewithal to achieve compliance. The magnitude of information the administrative body is requiring businesses to submit—and the novel mechanisms companies may have to create out of whole cloth just to procure that information—will present a formidable challenge for thousands of organizations.

While ESG may have started as a framework for encouraging good corporate governance and quantifying sustainability practices among large businesses, CSRD has transformed the aspirational concept into comprehensive regulatory law stitched through much of Europe. Loosely endeavoring to reduce one’s carbon footprint, participate in equitable labor practices, and pursue related ESG principles is one thing. But complying with legally binding obligations to meticulously report on your adherence to those principles—as many companies are now in the earliest stages of discovering—is a dramatically different and more serious undertaking altogether. 

In Summary

• ESG offers voluntary guidelines for ethical corporate behavior, while the EU's CSRD mandates detailed and audited sustainability reporting.
• ESG focuses on environmental impact, social responsibility, and governance practices, guiding companies in improving their ethical standards.
• The CSRD aims to elevate ESG reporting to the rigor of financial reporting, impacting thousands of businesses with specific disclosure requirements.
• CSRD enforces comprehensive sustainability reporting across the EU, significantly influencing corporate accountability and transparency.
• CSRD's reporting requirements will be phased in over several years, starting in 2024, with specific deadlines for different types of companies, including SMEs and foreign companies with EU subsidiaries.