EU

The EU has introduced several regulations concerning ESG: the Taxonomy Regulation, the Non-Financial Reporting Directive (NFRD), the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Due Diligence Directive (CSDDD).

The Taxonomy Regulation

The Taxonomy Regulation was published in the Official Journal of the EU on 22 June 2020 and entered into force on 12 July 2020. It can be described as a green classification system that translates the EU’s climate and environmental objectives into criteria for specific economic activities for investment purposes.

The environmental objectives are:

This is supplemented by further delegated acts on:

  • Gas/atoms
  • Assessment criteria for the other four environmental objectives
  • A social taxonomy

In addition, the taxonomy reflects transition efforts by companies – “transition finance”.

The delegated act on the first two environmental objectives will be extended to include activities such as agriculture.

In 2023, in accordance with Article 10(4) of the Disclosures Delegated Act, large non-financial undertakings will need to report activities that are considered as aligned with the EU Climate Delegated Act. Similarly, and in accordance with Article 10(5) of the Disclosures Delegated Act, large financial institutions should disclose their taxonomy-eligible and aligned activities in 2024 for activities related to climate objectives.

Non-Financial Reporting Directive

Under the NFRD (Directive 2014/95/EU), certain large EU public-interest companies must disclose non-financial and diversity information in their annual reports. This information relates to the following ESG areas: environmental protection, social responsibility and treatment of employees, respect for human rights, anti-corruption and anti-bribery, and diversity on company boards.

Large public-interest corporations are defined as companies with more than 500 employees, including listed entities and insurance companies.

According to the EU Taxonomy, companies falling within the scope of the existing NFRD – approximately 11,700 EU companies – are expected to report on the extent to which their activities are sustainable, as specified in the relevant Commission Delegated Act, in alignment with SFDR and existing EU Taxonomy requirements.

This is supplemented by further delegated acts on:

  • Gas/atoms
  • Assessment criteria for the other four environmental objectives
  • A social taxonomy

In addition, the taxonomy reflects transition efforts by companies – “transition finance”.

The delegated act on the first two environmental objectives will be extended to include activities such as agriculture.

In 2023, in accordance with Article 10(4) of the Disclosures Delegated Act, large non-financial undertakings will need to report activities that are considered as aligned with the EU Climate Delegated Act. Similarly, and in accordance with Article 10(5) of the Disclosures Delegated Act, large financial institutions should disclose their taxonomy-eligible and aligned activities in 2024 for activities related to climate objectives.

Non-Financial Reporting Directive

Under the NFRD (Directive 2014/95/EU), certain large EU public-interest companies must disclose non-financial and diversity information in their annual reports. This information relates to the following ESG areas: environmental protection, social responsibility and treatment of employees, respect for human rights, anti-corruption and anti-bribery, and diversity on company boards.

Large public-interest corporations are defined as companies with more than 500 employees, including listed entities and insurance companies.

According to the EU Taxonomy, companies falling within the scope of the existing NFRD – approximately 11,700 EU companies – are expected to report on the extent to which their activities are sustainable, as specified in the relevant Commission Delegated Act, in alignment with SFDR and existing EU Taxonomy requirements.

The Corporate Sustainability Reporting Directive

The CSRD broadens the existing applicable NFRD and looks to address key structural weaknesses in current ESG regulation reporting. The new regulation affects a higher number of large EU-listed entities than the NFRD,including businesses, banks and insurance companies, with approximately 50,000 entities impacted by the CSRD, almost five times as many as the previous NFRD legislation.

Each company within scope is required to report more broadly on sustainability-focused topics, including environmental matters, social responsibility, respect for human rights, anti- corruption measures and board diversity. Entities also need to report on how environmental and social matters influence their development – this is called “double materiality”.

Companies that meet two of the following three conditions must comply with the CSRD:

  • More than €40 million in net turnover
  • Balance sheet total assets are greater than €20 million
  • 250 or more employees

In addition, non-EU companies with a turnover of at least €150 million in the EU over two consecutive years must comply.

The new rules will apply for the first time in financial year 2024 for reports that will be published in 2025. As the CSRD will cover all listed companies in EU-regulated markets (except listed micro-enterprises), affected businesses should start to familiarise themselves with it now. The sooner entities are compliant with the CSRD, the better prepared they will be for 2024.

Sustainable Finance Disclosure Regulation

The SFDR aims to enhance transparency in the sustainable investment market. Its purpose is to prevent misleading environmental claims – also known as “greenwashing” – against investment products and to increase investment into sustainable products to accelerate the transition to a low- carbon economy.

The SFDR mandates that investment products be categorised into three distinct groups based on their degree of sustainability and related features. Additionally, financial market participants that are now subject to these regulations are required to comply with specific disclosure obligations.

The SFDR requirements are linked with those under the EU Taxonomy by including environmentally sustainable economic activities as defined by the Taxonomy Regulation in the definition of “sustainable investments” in the SFDR.

The SFDR came into effect in March 2021. Since then, financial market participants and financial advisers have been expected to disclose:

  • Sustainability risks policy
  • Integration of sustainability risks into investment decisions and investment advice
  • Principal adverse impacts (PAI) of investment decisions on sustainability factors at entity level (or an explanation of no consideration of PAI at entity level)
  • Consistency of remuneration policies with the integration of sustainability risk

Financial market participants and financial advisers have until the end of June 2023 to disclose mandatory and additional PAI indicators in their PAI statement (covering the calendar year 2022).

Corporate Sustainability Due Diligence Directive

The CSDDD is an EU proposal that will require companies to exercise reasonable due diligence in their own business and in their “value chains” to prevent or minimise human rights or certain environmental risks, and to end human rights or certain environmental violations.

The draft proposal was approved by the EU Parliament on 1 June 2023. Following the vote, negotiations with EU member states will begin, focusing primarily on disagreements around the scope of the new rules and the timeline for their implementation. Depending on the results, it is quite possible that the due diligence obligations could apply as soon as 2025.

Which EU Regulations Should Most Corporations Be Considering?

Compared with the current NFRD, under the CSRD, there will be a near fivefold increase in companies affected – from approximately 11,700 to 50,000. This is how the CSRD breaks down in terms of who will comply and when:

Large European public interest entities already subject to NFRD – The CSRD regulation will apply from 1 January 2024, with reports due in 2025. Large companies not already subject to the NFRD – The CSRD regulation will apply from 1 January 2025, with reports due in 2026. Smaller organisations – The CSRD regulation will apply from 1 January 2026, with reports due in 2027.

Under the CSRD, the management report must disclose both actual and potential impacts related to a company’s operations, as well as across its value chain, including products, services, business relationships and supply chains. It needs to discuss any management or supervisory boards the company utilises regarding matters of sustainability, and it needs to be wrapped up in a forward-looking, time-bound manner and provide progress on achieving environmental targets. There is also an obligation for “double materiality” meaning the company’s sustainable activities and any sustainability activities affecting the company need to be reported. Reports need to be freely available.

Upcoming Related Legislation

Further legislative changes are anticipated in relation to EU Green Bonds, MiFID II, EU Eco Label and Art. 449a CRR.

Competent Authorities

EU Member States must ensure that the relevant competent regulatory authorities monitor the compliance of market participants, and that they have the necessary supervisory and investigatory powers to exercise their functions under the regulations.

  Australia

  • Legislation: Prudential Practice Guidance on Climate Change and Financial Risks CPG229 November 2021
  • Regulatory body: Australian Prudential Regulation Authority

  Brazil

  • Legislation: Management and Disclosure of Social, Environmental and Climate Risks 2021
  • Regulatory body: Central Bank of Brazil (BCB)
  • Legislation: Circular 666 of 06/27/2022 on providing for the requirements for sustainability, to be observed by companies, insurance companies, open supplementary pensions (EACPCs) capitalisation companies and local reinsurers (in force on 1 August 2022)
  • Regulatory body: Superintendence of Private Insurance (SUSEP)

 Canada

  • In development: ESG-related Investment Disclosure for Funds guidance CSA Staff Notice 81-334 2022
  • In development: Climate-related Disclosures for Listed Issuers 2021
  • Regulatory body: Canadian Securities Administrators (CSA)

  Hong Kong

  • In development: Green and Sustainable Finance Strategy (Climate-related Disclosures)
  • Regulatory body: Hong Kong Securities and Future Commission (SFC), Hong Kong Monetary Authority (HKMA)
  • In development: Enhancement of Climate-related Disclosures under the Environmental, Social and Governance Framework – consultation paper April 2023
  • Regulatory body: Hong Kong Exchange (HKEX)

Japan

  • Legislation: Revisions of Corporate Governance Code 2021
  • Regulatory body: Financial Services Agency (FSA) and Tokyo Stock Exchange (TSE)
  • In development: Mandatory TCFD reporting for prime segment listed companies
  • Regulatory body: Japan Financial Services Agency (FSA)

Singapore

  • Legislation: Environmental Risk Management for Asset Managers, Banks and Insurers 2020
  • Regulatory body: Monetary Authority of Singapore (MAS)

 China

  • Legislation: ESG-related Amendments to the Disclosure Rules Applicable to Listed Companies
  • Regulatory body: China Securities Regulatory Commission 2021
  • Legislation: Guidance for Enterprise ESG Disclosure (effective from 1 June 2022)
  • Organisation: CERDS

  Germany

  • Legislation: New Supply Chain Due Diligence Act

The act requires large companies to observe social and environmental standards across their supply chains.

Companies must monitor their own operations and their direct suppliers worldwide and act if any violations are found.

The act came into effect on 1 January 2023, and its coverage will be broadened in 2024 by reducing the employee threshold from 3,000 to 1,000. Companies that fail to comply or submit the required documentation risk facing fines and sanctions, including fines of up to 2% of their annual turnover for larger companies, exclusion from public contracts for up to three years, and damage to reputation and trust.

  UK

In the UK, the Financial Conduct Authority (FCA) requires a disclosure regime for ESG matters under the Task Force on Climate-related Financial Disclosures (TCFD). If a company is considered a “premium listed company, asset manager or

FCA-regulated pension provider,” among others, the business is required to make a statement on annual financial reports.

  • In development: Sustainability Disclosure Requirements (SDR) and Investment Labels
  • Policy statement: Diversity and inclusion on company boards and executive management PS22/3 2022
  • In development: Climate-related disclosure rules
  • Regulatory body: Financial Conduct Authority

  US

The US Securities and Exchange Commission (SEC) announced the creation of a climate and ESG task force. Initiatives are to be developed “to proactively identify ESG- related misconduct”. Initially, the task force will focus on material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.

  • In development: Climate Disclosures for Public Companies
  • Regulatory body: Securities and Exchange Commission
  • In development: Climate-related Financial Risks and Insurers
  • Regulatory body: US Federal Insurance Office (FIO)
  • In development: California – Climate Corporate Accountability Act (CCAA)
  • Regulatory body: California Secretary of State Office
  • In development: New York – Fashion Sustainability and Social Accountability Act (FSSAA)
  • Regulatory body: New York State Department of Law

  UAE

The Dubai Financial Service Authority (DFSA) Task Force on Sustainable Finance (TFSF) issued a publication in November 2022 on “Climate and Environmental Risk Management”, contributing to the global debate on how best to address and mitigate the physical and transition risks stemming from climate change, as well as broader environmental risks in the UAE.

The TFSF aims to drive forward discussions regarding sustainable finance in the Dubai International Finance Centre (DIFC) with the goal of supporting the consistent application and adoption of global regulatory standards for sustainable finance in the DIFC.

  Switzerland

  • Legislation: Articles 964a-964c CO – transparency in non- financial matters
  • Legislation: Articles 964j-964l CO – due diligence and transparency in relation to minerals and metals from conflict zones and child labour, which has been further detailed in an Ordinance (the ODiTr)
  • In development: Guideline on Sustainability Reporting 2022
  • Regulatory body: Federal Audit Oversight Authority (FAOA)

Global Standards

Currently, there are various sustainability disclosure standards and frameworks to be discussed:

  • International Sustainability Standards Board (ISSB) is an increasingly central point of reference for supervisors and financial institutions. The draft is currently under

consultation and for climate disclosures, it largely replicates TCFD.

  • Sustainability Accounting Standards Board (SASB) is a framework for reporting environment and social information via the mainstream corporate report.

What Are We Doing to Assist Our Clients in This Area?

The reporting obligations arising from the Taxonomy, NFRD, CSRD and SFDR are significant and we can assist clients in fulfilling these.

In particular, the CSRD’s scope is much broader given the breadth and relative sizes of many US, UK and non-EU entities with significant operations in various EU jurisdictions or listed on an EU-regulated market. As a result, the CSRD may lead to a marked increase in additional substantive disclosures (and increased costs), including multiple subsidiary-level reporting obligations, and the associated risks of divergent reporting.

With the CSRD’s adoption, the SEC’s proposed expanded climate change requirements in the US, and the UK government and relevant agencies rolling out mandatory TCFD-aligned climate disclosure requirements while also pushing for enhanced non-climate-related disclosures, it will be important for US and UK companies with significant EU operations to start compiling and developing standards and procedures to confirm the accuracy of sustainability disclosures and reporting.