Decoding CSRD: A Deep Dive into the Value Chain Requirements

The Corporate Sustainability Reporting Directive (CSRD) marks a pivotal shift in sustainability reporting, extending its reach beyond immediate operations to the entire value chain. Articles 19(a)(3) and 29(a)(3) of the CSRD mandates companies to disclose information not just about their own activities but also about their upstream and downstream value chain, including their products, services, and business relationships. This expansive view demands a nuanced understanding of the value chain, as delineated in the European Sustainability Reporting Standards (ESRS) Delegated Act, challenging companies to identify, address, and report on sustainability impacts in a way that aligns with international due diligence standards.

This article aims to provide clarity on how businesses can effectively map out and report on their value chain's sustainability impacts, risks and opportunities under the CSRD, ensuring compliance and fostering a deeper commitment to sustainable business practices.

In this article, we will cover the following:

• What is the Value Chain? 
• Where should Companies Focus in their Value Chain to Identify Material Impacts, Risks, and Opportunities? 
• What Does it Mean to be Connected with an Impact?
• Implications for reporting
• The notion of reasonable effort to collect value chain data
• Transitional measures 

Want to improve your understanding of CSRD fundamentals before going further? Take a look at our comprehensive CSRD ebook.

What is the Value Chain? 

Gaining a precise understanding of the term "value chain" is crucial, as it is frequently misconceived as synonymous with the supply chain. However, the value chain encompasses a broader array of actors and activities. According to the ESRS, the value chain is defined as:

“the full range of activities, resources and relationships related to the undertaking’s business model and the external environment in which it operates. A value chain encompasses the activities, resources and relationships the undertaking uses and relies on to create its products or services from conception to delivery, consumption and end-of-life. Value chain includes actors upstream and downstream from the undertaking. Actors upstream from the undertaking (e.g., suppliers provide products or services that are used in the development of the undertaking’s products or services). Entities downstream from the undertaking (e.g., distributors, customers) receive products or services from the undertaking.” 

This definition sets the boundaries for companies to assess their connection with Impacts, Risks, and Opportunities (IROs) through both direct and indirect business relationships within their upstream and downstream value chains. Understanding what constitutes a "business relationship" is therefore pivotal in this context. 

As defined in Annex 2 of the delegated act, business relationships are not limited to direct contractual relationships, they also include indirect business relationships beyond the first tier, and shareholding positions in joint ventures or investments. This means, as an example, that a manufacturing company should not stop at its Tier 1 suppliers to look at IROs in the value chain, but rather at all relevant actors (both from direct and indirect relationships).

Where Should Companies Focus in their Value Chain to Identify Material Impacts, Risks, and Opportunities? 

Considering both direct and indirect business relationships broadens the scope of the assessment and may complicate the identification of the IROs in the value chain. However, it is important to note that the reported information does not need to include every actor of the value chain but only those where material IROs are likely to arise. 

To help identify those, The European Financial Reporting Advisory Group (EFRAG) recommends looking at: 

• Actors in the value chain associated with “hot spots”, exposing the likelihood of actual and potential impacts.
• Actors in the value chain where the business model of the reporting entity shows key dependencies in terms of products or services (therefore generating risks and opportunities for the company).

What Does it Mean to be Connected with an Impact?

While risks and opportunities in the value chain may be identified through the financial effect on the reporting entity and its business model, material impacts in the upstream or downstream value chain can be more challenging to identify, particularly their connection to the undertaking. Indeed, as previously stated, the CRSD requires the identification of material impacts connected with the undertaking through its direct and indirect business relationships in the upstream and downstream value chain. 

EFRAG specifies that a reporting entity can be connected with an impact in different ways: 

• Impacts directly caused by the company’s own operations, products, or services. These are impacts related to the company’s own operations and are usually easier to identify during the Double Materiality Assessment (DMA).
• Impacts to which the undertaking has “contributed to”. These are impacts not directly and solely caused by the reporting entity’s operations, products, and services, but in conjunction with a third party. 
• Impacts directly linked to the company’s operations, products, and services, but caused by a business relationship. These impacts, occurring within the upstream or downstream value chain, stem from business relationships and must be identified by the reporting entity, as they are intrinsically linked to its core activities through these connections.

It is therefore key to understand the nature of the relationship of the undertaking with impacts along the value chain and focus on those where the undertaking is expected to have severe negative impacts. 

Implications for CSRD Reporting

IROs identified in the upstream and downstream value chain during the Double Materiality Assessment are then subject to reporting. Topical standards mandate that companies disclose their policies, actions, and targets (PATs) related to material impacts, risks, and opportunities. 

This means that where a policy, action, or target addresses all or some value chain IROs, that should be disclosed. An example could be a target set for the reporting entity’s suppliers to use a certain percentage of recycled materials, following the identification of an impact in the upstream value chain related to resource use or circular economy (ESRS E5). 

Regarding quantitative information in the ESRS, it mostly relates to the company’s own operations and in most cases will not require information from value chain actors. However, there are a few exceptions such as Scope 3 GHG emissions. In addition, while only a limited number of metrics require value chain data inclusion under topical standards, companies are obliged to provide additional entity-specific disclosures, including metrics, if a material IRO in the value chain is not adequately addressed by existing ESRS requirements.

Read more about Scope 3 GHG emissions in our article dedicated to carbon accounting.

The Notion of Reasonable Effort to Collect Value Chain Data

For the Double Materiality Assessment and value chain data inclusion as mandated by metrics, reporting entities have the option to directly gather information from their value chain, employ estimates or proxies, or use a mix of both methods. Establishing a dependable data collection system involving value chain partners is a gradual process. Initially, sector data or comparable sources might serve as a solid foundation until more specific value chain data can be developed. 

Entities should only collect value chain information to an extent deemed a reasonable effort. When primary data is not available, they should rely on reasonable and supportable information obtainable without undue effort or cost. The definition of 'reasonable effort' and 'undue cost or effort' is contingent upon the resources and processes an entity has in place for value chain data collection. Entities must weigh the challenge of acquiring direct data against the potential diminished quality of information from not pursuing such data, ensuring a balanced approach to value chain information gathering and reporting.

Transitional Measures 

The ESRS provide transitional provisions allowing companies a three-year period to adapt to the new reporting requirements regarding their value chains. Companies are still required to include the value chain in their DMAs for the identification and assessment of IROs. However, data collection from value chain actors may be limited during this period. These optional provisions offer time to gather necessary value chain information, encouraging steps like stakeholder engagement, infrastructural preparations, contractual updates, and enhanced value chain understanding. 

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

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