ESG regulatory pressure: how to navigate the increasing EU regulations?

With the new set of EU sustainability reporting standards, companies falling into scope should act now to be compliant with the reporting timeline.

With the introduction of the Green Deal, the EU has set its intentions to increase transparency around sustainability reporting in both the corporate and financial sector. This aim has been translated into new regulations, namely the Corporate Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR). Through those, alongside the EU Taxonomy Regulation and the EU Corporate Sustainability Due Diligence Directive (currently still in the proposal stage), the EU hopes to redirect capital flows towards a more sustainable economy and increase the importance of sustainability risks in decision-making. This article will provide the main information companies need to know about the regulations and how to navigate through them in a time of increasing public and investor pressure. 

Deep dive into the regulations

CSRD

The CSRD amends the previous applicable Non-Financial Reporting Directive (NFRD) with the aim of having more companies falling into its scope (around 50,000 in total versus 11,000 currently affected – not taking into account the SMEs that will be affected in a few years’ time), thus reporting on sustainability information in a consistent and comparable way. The directive will apply to all companies listed on EU-regulated markets, except micro-enterprises, as well as large companies meeting two of the following criteria:

• A net turnover of > €40 million
• A balance sheet total of > €20 million
• > 250 employees on average over the financial year

These criteria apply as well to non-EU companies listed on EU-regulated markets. Regarding other non-EU companies, those with substantial activities within the EU (i.e. with a net turnover > €150 million in the EU at the consolidated level) and which have at least one subsidiary or branch with a net turnover > €40 million) in the EU are required to draft a sustainability report.

The expected timeline varies depending on whether companies already fall into the scope of the NFRD. If they do, they are expected to publish reports in 2025 on the financial year 2024, whereas if they do not previously fall into scope, this timeline is extended by one year. Listed SMEs have two years extra to comply with the CSRD.

SFDR

The SFDR introduces mandatory ESG disclosure requirements for asset managers and other financial market participants to achieve more transparency around sustainability risks and impacts. It is closely linked to the EU Taxonomy through the Regulatory Technical Standards (RTS) which describe how to disclose mandatory information from the SFDR, and it is aligned to the EU Taxonomy classification system.

The requirements of the SFDR on asset managers and other financial market participants are defined at both company and product level and should be disclosed through channels such as the company’s website, periodic reports, and pre-contractual documents. Therefore, this constitutes a strategic aspect for companies as these requirements will be integrated throughout various stages of product development.

As the SFDR is constantly evolving, it brings new challenges to companies. Indeed, level 1 RTS is already into force whereas level 2 RTS will be mandatory from January 2023.
 

EU Corporate Sustainability Due Diligence Directive

The EU Corporate Sustainability Due Diligence Directive requires companies to identify and act on adverse environmental and human rights impacts across their own organization and their entire supply chain. The proposed directive applies to the following companies:

• EU companies with > 500 employees and > €150 million global net turnover
• EU companies operating in high-impact sectors with more than 250 employees and a global net turnover > €40 million
• Non-EU companies that are active in the EU and generate turnover in the EU exceeding the threshold mentioned above

Companies are expected to monitor and optimize their performance in relation to issues such as child labor, exploitation of workers, safe and healthy working conditions, biodiversity loss and pollution, by conducting specific due diligence activities. This directive will be adopted in 2024 and be applicable in 2026 and 2028 depending on the company type.
 

Conclusion

The EU has made it clear through its increasing regulatory requirements that sustainability should be at the forefront of a business strategy. This evolving regulatory landscape, together with shifting stakeholder expectations and pressure from investors, means that companies need to tackle these requirements in the right way. Concepts such as ’double materiality‘, with both ’impact materiality‘ and ’financial materiality‘ can help companies prepare for an efficient implementation.  

EY has developed tools to help companies identify and gather ESG KPIs, manage ESG risks, set up policies, and agree on targets for material topics. Moreover, under the CSRD, companies are required to have a statutory auditor such as an independent assurance services provider to provide limited (and in the future even reasonable) assurance on the company’s reports.