The Corporate Sustainability Reporting Directive (CSRD) represents a significant evolution in sustainability reporting, requiring companies to extend their focus beyond immediate operations to encompass the entire value chain. This directive, articulated through Articles 19(a)(3) and 29(a)(3), mandates the disclosure of information related to both upstream and downstream activities, including products, services, and business relationships. The European Sustainability Reporting Standards (ESRS) Delegated Act further emphasizes the need for companies to understand and report on sustainability impacts comprehensively, aligning with international due diligence standards. This article delves into how businesses can effectively map out and report on their value chain’s sustainability impacts, risks, and opportunities to ensure compliance and foster sustainable business practices.  

Understanding the Value Chain 

It is essential to clearly understand the term “value chain,” as it is often misunderstood as being synonymous with the supply chain. However, the value chain encompasses a broader spectrum of activities, resources, and relationships. According to the ESRS, the value chain includes all activities, resources, and relationships connected to a company’s business model and its external environment. This definition spans from the conception to the delivery, consumption, and end-of-life of products or services. It incorporates actors both upstream (e.g., suppliers) and downstream (e.g., distributors and customers).  

This expansive definition sets the stage for companies to assess their connections with Impacts, Risks, and Opportunities (IROs) through both direct and indirect business relationships within their value chains. Understanding the concept of “business relationships” is crucial in this context. Annex 2 of the delegated act defines business relationships as not limited to direct contractual relationships but also including indirect relationships beyond the first tier and shareholding positions in joint ventures or investments. This means a company must consider all relevant actors, not just Tier 1 suppliers, to identify IROs in the value chain fully.  

Focusing on Material Impacts, Risks, and Opportunities 

The broad scope of assessing both direct and indirect business relationships can complicate the identification of IROs. However, the reported information needs to cover only those factors where material IROs are likely to arise. The European Financial Reporting Advisory Group (EFRAG) suggests focusing on the following:  

• Actors in the value chain are associated with “hot spots,” which indicate the likelihood of actual and potential impacts.  
• Actors where the business model of the reporting entity shows critical dependencies in terms of products or services, thus generating risks and opportunities for the company.  

Connection with Impacts 

Identifying risks and opportunities in the value chain can be straightforward by examining the financial impact on the reporting entity and its business model. However, identifying material impacts in the upstream or downstream value chain, particularly their connection to the undertaking, can be more challenging. The CSRD requires the identification of material impacts connected with the company through its direct and indirect business relationships.  

EFRAG specifies that a reporting entity can relate to an impact in various ways:  

• Direct impacts are caused by the company’s operations, products, or services, and they are generally easier to identify during the Double Materiality Assessment (DMA).  
• Contributed impacts: These are impacts not directly and solely caused by the company’s operations but in conjunction with a third party.  
• Linked impacts are caused by business relationships and occur within the upstream or downstream value chain. They must be identified as they are intrinsically linked to the company’s core activities.  

Understanding the nature of these relationships is crucial to focus on those where the company is expected to have significant negative impacts.  

EFRAG specifies that a reporting entity can relate to an impact in various ways: 

• Direct impacts are caused by the company’s operations, products, or services, and they are generally easier to identify during the Double Materiality Assessment (DMA). 
   
• Contributed impacts: These are impacts not directly and solely caused by the company’s operations but in conjunction with a third party. 
   
• Linked impacts are caused by business relationships and occur within the upstream or downstream value chain. These impacts must be identified as they are intrinsically linked to the company’s core activities. 

Understanding the nature of these relationships is crucial to focus on those where the company is expected to have significant negative impacts. 

Implications for CSRD Reporting 

IROs identified in the upstream and downstream value chain during the Double Materiality Assessment are subject to reporting. Companies must disclose their policies, actions, and targets (PATs) related to material impacts, risks, and opportunities. For instance, if an impact related to resource use is identified in the upstream value chain, a company might set a target for suppliers to use a certain percentage of recycled materials.  

Quantitative information primarily pertains to the company’s operations and usually does not require data from value chain actors. However, there are exceptions, such as Scope 3 GHG emissions. Additionally, while few metrics require value chain data under topical standards, companies must provide additional disclosures, including metrics, if existing ESRS requirements do not adequately address a material IRO in the value chain. 

Reasonable Effort to Collect Value Chain Data 

For the Double Materiality Assessment and value chain data inclusion mandated by metrics, companies can gather information directly from their value chain, use estimates or proxies, or a combination of both. Establishing a reliable data collection system with value chain partners is a gradual process. Initially, sector data or similar sources may serve as a foundation until more specific value chain data is developed.  

Companies should collect value chain information only to the extent of reasonable effort. If primary data is unavailable, they should rely on reasonable and supportable information obtainable without undue effort or cost. The definitions of “reasonable effort” and “undue cost or effort” depend on the resources and processes a company has in place for value chain data collection. Entities must balance the challenge of acquiring direct data with the potentially diminished quality of information from not pursuing such data.  

Transitional Measures 

The ESRS provides transitional provisions, giving companies three years to adapt to the new reporting requirements regarding their value chains. Companies must still include the value chain in their DMAs to identify and assess IROs, but data collection from value chain actors may be limited during this period. These provisions offer time to gather necessary value chain information, encouraging steps like stakeholder engagement, infrastructural preparations, contractual updates, and enhanced value chain understanding.  

Suppose complete value chain data is unavailable during this period. In that case, companies should explain the efforts made to collect the data, the reasons for any shortcomings, and the plans to obtain this data. Initially, companies may rely on in-house and publicly available data to report on policies, actions, and targets related to the value chain and are exempt from reporting on upstream and downstream value chain metrics (except those required by other EU laws). By the fourth year, complete value chain reporting in line with ESRS is expected, outlining a structured approach to integrating comprehensive value chain information into sustainability reporting.  

Conclusion 

The CSRD’s broad requirements for value chain reporting signify a major change in sustainability practices. By requiring detailed reporting on both upstream and downstream activities, the directive pushes companies to take a more comprehensive view of their impacts, risks, and opportunities. Although early stages may present challenges in data collection and analysis, the long-term benefits are significant. These include greater transparency, better stakeholder engagement, and a more substantial commitment to sustainable business practices. For example, companies must now disclose information on their entire value chain, impacting over 49,000 entities in the EU. This shift not only ensures compliance but also promotes a deeper integration of sustainability into core business strategies. 

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