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EU lawmakers are fighting hard to apply ESG requirements to foreign firms operating in the EU. The European Parliament announced on 23 March 2022 that it is considering a proposal for full compliance with EU ESG laws among foreign companies. For one, this will remove any chance of competitive advantage by companies operating below acceptable levels of ESG standards. On another level, it will be one of the few precedents of ESG legislation with cross-jurisdiction implications, a step towards unifying international ESG cooperation.
The proposed legislation is especially important to US companies, who were hoping for an exemption orchestrated by the US Chamber of Commerce to the EU. It’s not just US companies, though. Some 28,000 foreign subsidiaries operating in Europe are subject to EU’s ESG rules, if the proposed passes through parliament.
The European operations of big brands such as McDonald’s and Starbucks would have to provide the same sustainability-related disclosures as required for European firms. The move comes as part of the EU’s Corporate Sustainability Reporting Directive (CSRD) - a package of sustainability-related disclosures that aim to enhance transparency and corporate responsibility.
If the same ESG rules were imposed, all EU disclosure laws that are in force would likely apply. This would include the requirements of the Non-Financial Reporting Directive (NFDR) or its successor, CSRD, and cross-referenced standards such as the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, EU Taxonomy, Sustainable Finance Disclosure Regulation (SFDR) for financial market players, and potentially other new legislation currently in the pipeline at the regulatory level such as the Corporate Sustainability Due Diligence Act. With so many reporting legislations, it can get disorienting for foreign companies who have not had to report on these criteria before.
The CSRD is one of several new EU legislations related to non-financial reporting with an emphasis on sustainability and ESG matters. The CSRD will kick in from 2024 onwards and companies that fall within its scope are also required to report according to the EU Taxonomy classification system for green activities and the TCFD recommendations for climate-related information. Companies should pay attention to the principle of double materiality, where impacts of the business on people and the environment are as important as ESG impacts on the business.
The CSRD requires alignment with the EU Taxonomy and its six environmental objectives: climate change mitigation, climate change adaptation, water and marine resources, circular economy, pollution, and biodiversity and ecosystems. Taxonomy-eligible companies whose business activities fall within any of the objectives are required to report on their alignment with the Taxonomy.
Financial market players will be responsible for reporting according to SFDR requirements which looks at the ESG impact of investments and the sustainability of financial products. The UK is the only member state of the EU that mandates TCFD recommendations currently, so foreign firms in the EU in general may not be subject to that yet.
First and foremost is a critical need to understand disclosure requirements and take control of data both from internal and third-party sources. Companies should waste no time developing robust measurement and footprinting capabilities that can establish a reliable baseline and monitor targets and KPIs. Methodologies like Life Cycle Assessments (LCA) calculate the environmental footprint of a product from the start to the end of its lifecycle. At the same time, focus on social impacts and corporate governance should not be neglected and these require a different approach to measurement and monitoring.
Regardless of the outcome of the proposal, foreign operations in the EU should be prepared to receive more requests for ESG information from external parties and increasingly strict compliance standards.