This article is sponsored by Cority.
In recent years, environmental, social and governance (ESG) reporting for companies has moved from a “nice-to-have” to an integral part of corporate strategy. An increasing awareness of the need to address the material environmental and social risks and opportunities against a backdrop of strong governance is driving increased reporting. Meanwhile, stakeholder pressure to measure and manage ESG performance is mounting, further supported by regulatory tailwinds.
Increased regulations around the world is requiring companies to disclose information regarding the extra-financial aspects of their business to interested stakeholders. Thus, being proactive in monitoring current and emerging ESG regulations to ensure compliance and remain competitive has become a business imperative.
Staying on top of all of these changes can be difficult. To help you better understand the latest on the ESG regulatory landscape — primarily in Europe and the United States — here is some guidance for companies on how they can effectively navigate and prepare for these complex and fast-evolving requirements.
ESG regulations in Europe
Until 2018, and the adoption of the European Union (EU) Action Plan on Sustainable Finance, every EU country had varying degrees of regulatory pressure for sustainability disclosure and action. Application of the Non-Financial Reporting Directive (NFRD) varied country to country, which caused a great deal of confusion when it came to reporting obligations.
The Corporate Sustainability Reporting Directive (CSRD) is the latest EU Regulation regarding ESG and extra-financial reporting. It is a step up from the Non-Financial Reporting Directive (NFRD), significantly expanding the number of companies captured as well as the scope of required disclosure.
CSRD requires mandatory reporting and holds companies accountable for ESG actions and policies, encouraging a push for sustainable corporate behavior. The new legislation works in harmony with GRI Standards and expands on the current EU Green Taxonomy, requiring disclosure on topics including human rights, environmental impacts and climate change. Notably, CSRD requires companies to report using the concept of “double materiality,” whereby disclosures should not only include how ESG issues affect a company’s businesses, but also describe the businesses’ impact on a range of sustainability matters.
Companies must first carry out a double materiality assessment to identify material topics they should report on. EU Sustainability Reporting Standards (ESRS) outline the mandatory concepts and principles with which companies reporting under CSRD must align their sustainability statements. ESRS also provides a set of quantitative and qualitative indicators to report on for each topic. The goal is to provide investors, civil society organizations, consumers and other stakeholders with more comprehensive and comparable sustainability information to evaluate companies’ sustainability performance as part of the European Green Deal.
Starting in 2024, the CSRD will apply only to EU-incorporated companies. But for financial years starting on or after Jan. 1, 2028, non-EU companies must report if they have a significant presence in the EU (defined by minimum EU revenue and asset thresholds) and they must report on a global, whole-group basis. As a result, many multinationals based outside the EU will need to start reporting under the detailed EU rules in 2029 and consider how to ensure compliance, as well as what EU compliance may mean for the corporation’s obligations in other jurisdictions.
To add to this complexity, prior to the adoption of the CSRD, the U.K. amended its extra-financial reporting requirements for U.K.-incorporated companies, requiring certain U.K. companies to report in line with guidelines established by the Taskforce for Climate-related Financial Disclosures (TCFD) of the International Financial Stability Board (IFSB).
ESG regulations in the US
Since the U.S. Securities and Exchange Commission (SEC) proposal in March 2022, public companies have been anticipating reporting their carbon emissions and reductions progress alongside their financial results. While some new reports required by the SEC may not be due until 2024 and beyond, many companies aren’t waiting to get started. Many investors are already asking for climate data and transition plans.
U.S.-listed companies with a significant presence in the EU will need to consider the interplay between the EU reporting requirements and liability provisions under U.S. securities laws. According to an article in The Wall Street Journal, more than 50,000 EU-based companies and approximately 10,400 non-EU enterprises will be subject to CSRD compliance. Nearly one in three of those non-EU companies (31 percent) are based in the U.S. — so mandatory ESG reporting also soon will be a reality for these companies.
A global movement
ESG regulation is certainly not exclusive to Europe and the U.S. In recent years, there has been a significant global movement as governments and international agencies are demanding more transparency and more climate action. There has been a surge in new regulations in countries including Australia, Canada, Chile, Colombia, India and Singapore. In addition to this, according to the Sustainable Stock Exchange Initiative, 34 global stock exchanges have mandatory ESG listing requirements. This has increased awareness on a variety of ESG topics: from climate awareness to diversity, equity, and inclusion (DE&I) standards to executive compensation. And it won’t stop there.
How companies can navigate the regulatory landscape
More than ever, companies are under pressure to address their approach to ESG, not only to meet regulatory demands, but also to avoid reputational harm due to noncompliance. Below are five key steps to prepare for and navigate the complex and fast-evolving regulatory landscape.
1. Confirm your reporting obligations
Companies must have a clear understanding of the jurisdictions in which they operate, and the regulations they fall under. This includes product compliance obligations for the markets in which companies sell their products. ESG standards, regulation and reporting and complexity of operational impacts vary dramatically across geo-regions, industries and company size — so confirming your company’s specific obligations is a crucial starting point.
2. Assess your readiness for reporting
To get started, companies first need to perform a gap analysis to understand their level of maturity for reporting. This should include an inventory of all their current data collection and reporting processes. Readiness can then be determined when analysed against applicable regulations and best practices. Different areas of the business may well already be collecting data and KPIs that could feed into your future reporting. Data coverage and quality are key metrics to consider when identifying opportunities for improvement
3. Look outside of your own operations
You likely will need to look outside of your own operations, and into your value chain, to assess ESG exposure. While a company itself might be out of scope for certain regulations, you might find that customers, suppliers or investments are covered by certain regulations. With carbon emissions, even if a company has a handle on its own emissions, its total carbon footprint might be heavily affected by others in the supply chain or in its investment portfolio (Scope 3 emissions), and that may affect regulatory obligations. A further example is under ESRS where workers in the value chain may need to be considered.
4. Build a cross-functional team
Historically, sustainability and ESG teams may have worked separately from risk management and regulatory compliance departments. Poor communication between these teams and competing priorities may have caused challenges. Now these teams must collaborate to create a more holistic sustainability strategy. Members of the cross-functional team need to have sufficient seniority and access to information across business units and geographies. This transparency helps the team collectively examine and manage the entire scope of ESG-related risks and opportunities.
5. Future-proof your reporting
Considering that the global regulatory landscape is complex and constantly evolving, companies need to be agile, with established and well-thought-out plans for how they can apply best practices from one regulation or framework to another. Implementing processes and tools into your ESG strategy that will grow with your requirements as they evolve is essential to ensure your plan supports your long-terms goals. Keeping up to date with voluntary standards is the best way to plan for future regulation. Even if these requirements are not mandatory today, addressing them will help to differentiate your company, meet stakeholder expectations, and stay ahead of regulations should they be written into law in the future.