How European Union ESG Reporting Regulations Affect U.S. Companies
February 09, 2023
By Lourenco Miranda
Middle market companies in the U.S. may not be directly subject to European Union (“EU”) environmental, social and governance (“ESG”) reporting regulations. However, many companies, regardless of size or location, are beginning to adopt ESG reporting practices due to increased investor demand for this type of information and growing awareness of the potential financial benefits of sustainable business practices. Additionally, some U.S.-based companies may have operations in the EU and therefore may be subject to ESG reporting requirements in those countries.
Which EU ESG reporting requirements affect U.S. companies?
In the European Union, there are several regulatory requirements related to ESG reporting. One key regulation is the Non-Financial Reporting Directive (“NFRD”), which applies to large companies and groups headquartered in the EU. The NFRD requires these companies to disclose information on their environmental, social and employee-related matters, as well as information on respect for human rights, anti-corruption and bribery issues in their management report.
Another regulation is the Taxonomy Regulation, which establishes a framework for sustainable activities and defines the economic activities that qualify as environmentally sustainable and the criteria that an economic activity must meet to be considered a sustainable activity. This regulation also requires companies to disclose their contributions to sustainable activities in their annual financial reports.
Finally, the EU's Action Plan on Financing Sustainable Growth, announced in 2018, aims to increase the number of sustainable investments by integrating sustainability considerations into the rules governing financial markets and institutions. This includes a proposal to require companies to disclose information on the impacts of their activities on sustainability factors, such as climate change, in line with international standards.
The Corporate Sustainability Reporting Directive (“CSRD”) is a new EU directive that was adopted in December 2020 and will be effective beginning in 2023. The CSRD aims to improve the quality and comparability of sustainability information provided by large companies and groups by introducing mandatory sustainability reporting.
What is the impact of the CSRD on U.S. companies?
In general, U.S.-based companies that have operations in the EU will be subject to the CSRD if they meet the criteria for large companies and groups outlined in the directive. This means that U.S.-based companies with EU operations will be required to disclose sustainability information in their annual financial reports, including information on environmental, social and employee-related matters, human rights, anti-corruption and bribery, and diversity on boards of directors.
However, U.S.-based companies without EU operations are not directly subject to the CSRD and therefore are not required to comply with the directive. It is worth noting that many U.S.-based companies are already reporting on ESG matters voluntarily, as investors, consumers and other stakeholders are becoming increasingly interested in companies' sustainability performance and many companies are recognizing the potential financial benefits of sustainable business practices.
The CSRD has a specific focus on supply chain management, as it requires companies to disclose information on the impacts of their activities on sustainability factors, such as climate change, human rights, labor conditions and biodiversity, within their entire life cycle, including the supply chain.
U.S.-based companies that are part of the supply chain of EU-based companies that are subject to the new CSRD may be indirectly affected by the directive. If an EU-based company that is subject to the CSRD sources products or services from a U.S.-based company, it will be required to report on the due diligence process it has undertaken to identify, assess and manage the sustainability risks and opportunities of its supply chain, as well as the measures implemented to ensure that its suppliers respect human rights and the environment. This could include information on any incidents or non-compliance with their policies that have occurred.
Therefore, U.S.-based organizations who are part of the supply chain of EU-based companies subject to the CSRD may be indirectly affected by the directive, as they may need to provide information to the EU-based company or even demonstrate compliance with certain sustainability standards. However, it is worth noting that the CSRD does not impose any direct legal obligation on the suppliers themselves to comply with the directive; it is the responsibility of the company reporting to comply with the directive.
What can U.S. companies start doing right now to remain competitive in an increasing global market?
If a U.S.-based company wants to be competitive in the global market, it may benefit from looking into the CSRD and similar sustainability reporting regulations.
However, it's important to note that CSRD is not yet in effect, and it's necessary for the companies to stay informed on any updates and changes on the directive. Furthermore, companies should also keep in mind that there are several different sustainability reporting frameworks and guidelines available, such as the Global Reporting Initiative (“GRI”), the Sustainability Accounting Standards Board (“SASB”), and the Task Force on Climate-Related Financial Disclosures (“TCFD”), among others, and they can choose the one that best suits their needs.
After identifying the most appropriate reporting framework and requirements, the company should conduct a materiality assessment to understand the sustainability matters that are most relevant to their business and their stakeholders and evaluate their company's performance in these areas. Based on the materiality assessment, they should then develop a sustainability strategy that outlines how the company plans to address the most material sustainability issues and improve its performance.
The company should then regularly review and update their sustainability strategy and performance, and work towards continuous improvement.
Reporting on sustainability performance can also help companies to identify risks, opportunities and areas for improvement in their business and make more informed decisions on how to operate in a more sustainable way. This can help companies to achieve cost savings, increase their efficiency and attract and retain employees, customers and suppliers.