In this chapter of Environment Analyst's Corporate Guide: Accelerating your ESG transition, Nate Kimball, sustainability practice leader, Sara Rowland, ESG advisory services leader, Bradford Conroy, ESG senior professional and Alison Bryant, marketing director at Antea Group explore the upcoming legislative changes relating to ESG.
Governments and regulatory bodies around the world are implementing mandates to address the mounting environmental and social challenges arising from climate change and unjust working conditions. These mandates establish expectations for business performance and disclosures on material environmental, social, and governance (ESG) topics. Recent and upcoming legislative changes, such as the EU Corporate Sustainability Reporting Directive (CSRD), EU Corporate Sustainability Due Diligence Directive (CSDD), German Supply Chain Due Diligence Act (LkSG), and the US Securities and Exchange Commission (SEC) proposed rule to enhance and standardise climate related disclosures, are critical tools in achieving this goal.
Recent legislative reforms reflect a global shift towards greater transparency, accountability and commitment to sustainable business practices, based on the UN guiding principles on business and human rights. These regulations require thorough and standardised disclosures, urging corporations to accurately assess, measure, and communicate their impact on the environment, society, and climate. This not only provides stakeholders with a clearer understanding of each company’s ESG performance but also motivates businesses to take strategic steps toward managing risks associated with their operations.
Moreover, these legislative changes are helping to accelerate the transition towards a net-zero economy by encouraging, and in some cases mandating, companies to set greenhouse gas emissions reduction targets in line with the Paris climate agreement. Legislation can stimulate innovation, reduce costs, foster sustainable growth, and can enhance a company’s reputation. In this way, recent and upcoming legislative changes are not only reshaping the rules of the game but are also driving the collective journey toward a sustainable and resilient global economy.
Lastly, it should not be overlooked that there are other voluntary programmes and frameworks populating the ESG landscape, including the Science Based Targets Initiative (SBTi), Taskforce on Nature-related Financial Disclosures (TNFD), and EU taxonomy for sustainable activities that are intended to help companies approach strategies for, and report on, ESG issues.
Disclaimer: please note that for the most accurate and up-to-date information on the status of legislative requirements, you should refer to the official organisation website or consult with legal counsel specialising in sustainability and ESG matters.
Companies that proactively address their ESG risks will be better positioned to withstand future shocks
Recent and upcoming legislation
In this section, we outline recent and upcoming legislative changes and discuss steps you can take to prepare your business for improved ESG performance.
(i) EU Corporate Sustainability Reporting Directive (CSRD)
Approved by the European Commission in November 2022, the CSRD is a key component of the European Union’s sustainable finance strategy. It replaces the Non-Financial Reporting Directive (NFRD), strengthening and expanding the existing sustainability reporting requirements for EU businesses.
Key features of CSRD include:
- Expanded Scope: Unlike the NFRD, which applied only to large public-interest entities with more than 500 employees, the CSRD will apply to all large companies and all companies listed on regulated markets (except listed micro-enterprises). This means that approximately 50,000 companies will fall under the CSRD requirements, compared to the 11,000 that were subject to the NFRD.
- Reporting standards: The CSRD will require companies to report in line with mandatory EU sustainability reporting standards currently being developed. These standards will cover a wide range of ESG topics.
- Assurance: Similar to financial disclosures, companies’ sustainability information will need to be assured by an external auditor.
- Digital reporting: The reported information will need to be tagged so it can be incorporated into a European Single Access Point (ESAP) which the EU plans to establish.
- Alignment with other sustainability frameworks: The EU will aim to ensure that the reporting standards align with other major global frameworks and standards to the greatest extent.
In summary, the CSRD will require many companies to begin sustainability reporting for the first time or to significantly enhance their current reporting. This may involve additional costs and resources to collect the necessary data, establish reporting procedures, and obtain external assurance. However, by providing a clear and common set of reporting standards, CSRD will enhance the comparability and reliability of sustainability information, which could attract investors and customers interested in ESG performance.
(ii) EU Corporate Sustainability Due Diligence Directive (CSDD)
With a proposal expected in 2023, the CSDD will introduce mandatory due diligence requirements for companies operating in the EU to identify, address and remedy their impacts on the environment and human rights in their operations and across their value chains. This is intended to create a level playing field, reduce risks and uncertainties, and encourage sustainable and responsible corporate behaviour.
Key features of the CSDD include:
- Broad Scope: the CSDD is proposed to apply to all large companies operating in the EU, as well as publicly listed small and medium-sized enterprises (SMEs), and high-risk SMEs.
- Due diligence obligations: the directive requires companies to conduct due diligence to identify, prevent, and mitigate adverse sustainability impacts in their operations and supply chains. This includes potential and actual adverse impacts on human rights and the environment, and good governance.
- Risk-based approach: the due diligence obligations are based on a risk-based approach, meaning that companies are expected to prioritise their actions based on the severity and likelihood of the adverse impacts.
- Transparency and reporting: companies will be required to publish a due diligence statement annually detailing their due diligence strategies, processes and results.
- Remediation and accountability: in the event of harm caused by the company’s activities or those in its supply chain, companies are required to provide for, or cooperate in, remediation through legitimate processes.
- Enforcement and sanctions: the CSDD will be enforced by national authorities, with sanctions for non-compliance.
In summary, CSDD will require companies to implement robust due diligence processes across their operations and supply chains. This will likely require additional resources, especially for companies with complex supply chains or those operating in high-risk sectors or regions. By identifying and addressing sustainability risks, companies can avoid harm to people and the environment, prevent reputational damage, and promote sustainable long-term growth.
(iii) German Supply Chain Due Diligence Act (LkSG)
The German Supply Chain Due Diligence Act, or "Lieferkettengesetz" (LkSG), passed in 2021, is a pioneering law that mandates companies to uphold human rights and environmental standards across their global supply chains.
Key features of LkSG include:
- Scope of application: Beginning in 2023, the LkSG applies to companies headquartered in Germany with 3,000 or more employees. In 2024, it will extend to those with 1,000 or more employees.
- Due diligence requirements: Companies are obligated to conduct risk analyses to identify and prevent potential human rights and environmental risks within their operations and direct supply chains.
- Grievance mechanism: Companies must establish a process for handling complaints about potential or actual adverse impacts.
- Transparency and reporting: Businesses are required to produce an annual report documenting their due diligence measures.
- Liability: Companies may be held legally liable for damages caused by their direct suppliers if the company did not fulfil its due diligence obligations.
- Penalties for non-compliance: Failure to comply can lead to fines, the scale of which is contingent on the company’s size. Repeated infringements may result in exclusion from public procurement contracts for up to three years.
In summary, LkSG necessitates the implementation of extensive due diligence processes, potentially requiring significant investment in new systems and resources, particularly for those with complex, multinational supply chains. However, compliance with the law can help businesses identify and mitigate risks while also creating a competitive edge as stakeholders increasingly value transparent and responsible global trade practices.
(iv) US Securities and Exchange Commission (SEC) proposed rule to enhance and standardise climate-related disclosures
The SEC’s proposed rule is a proposed regulation intended to enhance and standardise the disclosure of climaterelated risks and opportunities by companies. The agency is motivated by a growing consensus that climate change poses significant risks and opportunities that can impact a company’s financial performance and thus should be disclosed to investors. The SEC published a draft rule in March 2022, and a final rule is expected to be released later in 2023.
Key features of the proposed SEC climate disclosure rule include:
- Climate-related impact disclosure: Companies are required to disclose the direct impacts of extreme weather if material to specific line items within their consolidated financial disclosures.
- Greenhouse gas (ghg) emissions: Companies will be required to report Scope 1, 2, and material categories of Scope 3 emissions. Further, larger companies will be required to obtain external assurance for their Scope 1 and 2 emissions disclosures.
- Climate-related risks: Companies will be required to release qualitative assessments of climate-related risks relevant to their operations and financial performance.
- Scenario analysis, targets and transition plans: If companies have established climate-related targets, conducted scenario analysis, or developed low-carbon transition plans, they will be required to disclose details of these and other climate-related activities underway.
In summary, the proposed SEC rule, when finalised, will necessitate the development of systems for measuring and reporting ghg emissions, and for assessing the risks and opportunities associated with climate change. This could require considerable resources, particularly for businesses that have not previously engaged in such activities. However, greater transparency around climate-related risks and opportunities can help businesses identify areas of improvement, potentially driving innovation and resilience.
By disclosing their ESG risks, companies can pinpoint areas for improvement, develop strategies to mitigate these risks and appeal to ESG-conscious investors
How to prepare
Preparing for legislative changes, such as those outlined above, requires careful planning and execution. Here are some steps that businesses can take to get ready:
- Understand the regulations: Companies should thoroughly familiarise themselves with the new legislation, their obligations under them, and how they apply to their business. Engaging with legal, sustainability and financial experts can assist in interpreting the requirements.
- Evaluate existing practices: Companies should conduct a thorough evaluation of their current sustainability reporting, due diligence, supply chain management and climate risk disclosure practices. This would help identify any gaps in alignment with the new requirements.
- Update or formulate policies: Based on the evaluation, companies should update existing policies or formulate new ones to comply with the directives. This could involve introducing new procedures for sustainability reporting, climate-related risk disclosure, human rights due diligence and supply chain management.
- Train and build capacity: Employee training is crucial to ensure all levels of the company understand and can implement the new policies. This could involve training programmes, workshops, or the creation of new resources or guidelines.
- Strengthen data management: These new regulations necessitate the collection, management, and reporting of extensive data on sustainability performance, supply chains and climate risk. Companies may need to bolster their data management systems or invest in new software to handle this efficiently.
- Engage suppliers: Under the CSDD, LkSG, and proposed SEC rule, companies have a greater responsibility to report activities across their supply and value chains. Engaging with suppliers to ensure they meet these standards is a crucial step.
- Prepare for auditing: The CSRD and proposed SEC rule require external assurance or audits of companies’ sustainability and climate risk reports. Preparations should include understanding auditor requirements and ensuring all necessary documentation is in place.
- Communicate with stakeholders: Companies should communicate their changes and improvements in response to these new regulations to stakeholders. This communication should detail the new requirements, the company’s compliance efforts, and any advancements in sustainability performance or practices.
Though preparing for these new legislative requirements may demand significant time and resources, it can also yield substantial benefits. Companies compliant with these directives will be well equipped to manage sustainability and climate risks, enhance their sustainability performance, attract investments, and uphold the trust and support of stakeholders.
It’s important to keep in mind that these recent and emerging legislative developments are not just about risk management; they’re also an opportunity. The EU CSRD, EU CSDD, German Supply Chain Due Diligence Act, and proposed US SEC climate disclosure rule are all intended to promote ESG performance by businesses. By disclosing their ESG risks, companies can pinpoint areas for improvement, develop strategies to mitigate these risks and appeal to ESG-conscious investors. Companies that proactively address their ESG-related risks will be better positioned to withstand future shocks, meet investor expectations, enhance reputation, attract and retain customers, and contribute to a more sustainable and resilient global economy.
This chapter of Environment Analyst's Corporate Guide: Accelerating your ESG transition was kindly authored by Nate Kimball, sustainability practice leader; Sara Rowland, ESG advisory services leader; Bradford Conroy, ESG senior professional and Alison Bryant, marketing director — at Antea Group (www.anteagroup.com)