September 15, 2023

Private Equity: CSRD May Impact You Too

This Debevoise update may be a little different from our usual blog topics, but I worry that the EU’s Corporate Sustainability Reporting Directive (“CSRD”) — which requires companies to disclose significant sustainability information — is a “sleeper issue” that isn’t getting the attention it deserves. The update notes that private equity firms need to start considering the impact of CSRD now and outlines important next steps for those firms. It categorizes these impacts and next steps in two buckets — first, it discusses the application of CSRD to sponsors that are themselves in scope (which “may comprise the whole group (if headed by an EU parent company) or particular EU entities or sub-groups within the larger group”) and then the application of CSRD to in-scope portfolio companies — with more direct actions needed for sponsors that are themselves in scope.

The update discusses how a sponsor should consider the scope of required reporting on its own operations and the scope of required reporting on its value chain, and then dives into some thorny issues on how the value chain concept applies to asset managers. Here’s an excerpt:

In the ESRS climate change reporting standard, there is a requirement for “financial institutions”, when reporting on Scope 3 emissions, to consider the GHG Accounting and Reporting Standard for the Financial Industry, specifically the parts dealing with Financed Emissions and Insurance-Associated Emissions. This amounts to a requirement for asset managers (and insurers) to report on the GHG emissions in their portfolios, which is a familiar concept in existing climate change reporting frameworks.

Otherwise, the application of the value chain concept to asset managers, and specifically whether it will broaden the scope of a firm’s reporting to include other environmental and social impacts at the portfolio company level, is presently unclear. Many firms act as sub-advisors or delegated portfolio managers to other entities, including within their group. These other entities are “customers” and hence part of their “value chain”, but there are open questions as to whether, and to what degree, they should report on the social and environmental impacts of these other entities.

EFRAG, the EU body responsible for the reporting standards, published a paper in February 2023 that signals future work on sector-specific reporting standards for financial institutions and notes in the paper the “broad implications” of reporting throughout the value chains of financial institutions. The paper also notes that the forthcoming Corporate Sustainability Due Diligence Directive “will be a relevant point of reference for sector specific guidance for financial institutions and appropriate consideration in the timeline and approach should be given on how to ensure compatibility”. However, given EFRAG’s prioritisation of sector-specific standards for industries with high environmental and social impacts (such as mining and agriculture), it does not expect to issue draft financial services sector standards until 2024.

I think the most important takeaway is to start engaging your advisors on the CSRD now, if you haven’t already, and given the proliferation of sustainability & related disclosure requirements, consider how you get updates on important developments in this space so you’re not caught playing catch-up. We provide timely updates on ESG through our free blog and membership site, including the “7 Things You Need to Know About the EU’s CSRD” Checklist.

– Meredith Ervine