On 12 December 2023, the Parliament adopted Act CVIII of 2023 on the rules of corporate social responsibility and amending other related acts to promote sustainable financing and unified corporate responsibility, taking into account environmental, social and societal aspects.
It has done so in order to objectively assess the activities of a growing number of business entities from a sustainability (ESG – Environmental, Social and Governance) perspective, to support the implementation of the European Green Deal and to ensure that the legislation is in line with the sustainability frameworks, standards and regulations in force in the European Union and with international accounting principles.
The aim of the legislation is to ensure that companies disclose appropriate information (in an accessible way) on the sustainability risks and opportunities they face, their impact on people and the environment, and the status and future direction of corporate social responsibility.
What does all this mean, what will change in 2024, what is the regulation about?
The biggest change is that the current market self-regulation has been replaced by a single set of standards and regulations. The first important milestone was the adoption by the European Commission of the first set of ESRS (European Sustainability Reporting Standards) - 12 standards to be precise - on 31 July 2023. Under the Corporate Sustainability Reporting Directive (CSRD) of the European Parliament and of the Council, the ESRS reporting standards are mandatory for companies required to report under the Directive, ushering in a new era of corporate transparency and accountability.
EU law requires all large companies and all listed companies (except listed micro-enterprises) to disclose information in an appropriate format on the risks arising from social and environmental issues and the impact of their activities on people and the environment. The standard reporting obligation will facilitate objective assessment of companies' sustainability performance.
Another important change is that companies subject to the CSRD will no longer have to disclose ESRS-compliant information in separate sustainability reports, but as part of their annual reports, so the Directive also expects sustainability-related information to be published in a consolidated financial report and audited. The EU Taxonomy Directive, which complements the CSRD, requires the classification of a company's activities according to their sustainability impact, and the disclosure of information on those activities that are considered sustainable.
The ESRS is based on materiality assessment (a concept already familiar from the Global Reporting Initiative – GRI – standard used in previous sustainability reporting), which is a central tool of the CSRD Directive to identify impacts, risks and opportunities and ensure that information on these is published in line with each data set. The ESRS is based on the principle of dual materiality and draws heavily on the GRI: it allows companies to look at sustainability from two angles; firstly, the impact of the company's activities on the environment and society, and secondly, which ESG issues impact on the company's revenue and value. Materiality assessment is a tool for determining the content of a report: which ESRS to apply and exactly what content to report depends on what the company considers material. Of course, it requires detailed justification if certain aspects are not considered material by the company.
After reviewing the European framework, let us examine how this has been transposed into Hungarian law
The Act CVIII of 2023 (the Hungarian ESG Act), already mentioned in the introduction, lays down the essential foundations of the domestic regulation in line with the European normative, some implementation details of which have not yet been adopted. The Act has in fact introduced two ESG institutions: one is regulated by the ESG Act itself, under which a defined group of companies must prepare an ESG report every year, and the other is regulated by Act C of 2000 (Accounting Act), as amended by this Act, under which a defined group of companies must prepare an annual sustainability report.
Companies have previously been able to decide whether to publish a sustainability report at all, and if so, what standard to use (e.g. GRI), and whether to have the document audited or whether it is sufficient to publish it. The publication of an ESG report was therefore a voluntary sign of the company's commitment to environmental, social and corporate responsibility, transparency and ethical conduct.
With the entry into force of the ESG law in Hungary from 1 January 2024, reporting obligations will gradually be introduced for companies of different sizes and turnover, but companies will also have to fulfil a number of new tasks.
The content requirements for the report to be prepared under the CSRD are governed by the EU's ESRS set of standards, as required by the Accounting Act as amended by this content.
Obligated parties are required to establish a risk management system, integrate it into their business processes and then, by 30 June each year, carry out a full risk analysis of not only their own activities but those of the entire supply chain (!) to identify material risks. This requires the appointment of a dedicated risk management expert, the development of an internal responsibility strategy and system, regular risk analyses, the implementation of complaint handling systems and, where appropriate, preventive and corrective actions.
The law assigns a special role to the Supervisory Authority for Regulated Activities (Authority) for example, the obliged company may involve an ESG consultant registered by the Authority in the process of preparing the ESG report. Moreover, the accreditation and registration of ESG software and EGS auditors that may be used under the law is also carried out by the Authority, which also regulates the areas of gambling and tobacco.
In addition, the Authority's President will also set out in a decree the content requirements for the ESG report, for which he will seek the opinion of the so-called National ESG Council, as designated in the legislation. Only the ICT (Information and Communication Technology) system accredited by the Authority may be used for supply chain screening and risk analysis.
The ESG report in Hungarian must be uploaded electronically to the ESG management platform. The law also specifically regulates the role of the ESG verifier, which is not mandatory but can be used on a voluntary basis or on request by partners. The rating methodology must be publicly available.
Although level of the legal fine has not yet been made public, from 2026, companies that do not comply with the reporting requirements may be subject to a finantial penalty. It is also the responsibility of the Authority to impose those fines.
Necessary evil or a new start?
Let's take a new perspective on the obligations for companies, as ESG regulation offers a number of opportunities in the right context. On the one hand, the reporting can be translated into concrete business benefits: new sources of revenue can be identified when assessing risks, operational efficiency can be increased, innovation can be stimulated, negative externalities can be reduced, exposure in resource procurement can be reduced, supplier and customer confidence can be increased.
Well-constructed reporting can make a significant contribution to a company's reputation and legal compliance, and access to more favourable financing in the market, favourable credit ratings will increasingly be linked to corporate transparency and sustainability performance, so it is in the well-understood interest of all business organisations to improve and communicate such results in a transparent manner.
It is also an opportunity for the company to showcase its sustainability efforts, responsibility and commitment more widely. This opportunity brings with it a new challenge: the whole reporting process needs to be based on a corporate strategy that is able to assess business processes and trends well and to identify key indicators.
Good news for all companies that have already prepared GRI-based reports is that EFRAG (European Financial Reporting Advisory Group) and GRI have published a joint statement on the high degree of alignment between the two sets of standards (GRI Standards 2021 and ESRS), with ESRS using many of the same definitions as GRI, for example for materiality analysis, integrating decades of GRI expertise and experience. As a result, the basic concepts and disclosure requirements of ESRS and GRI are very closely aligned, and it is not expected that the introduction of the new standard will unnecessarily increase the reporting burden for companies.
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