The European Union (EU) has some of the world's most advanced, strict, progressive, and complex corporate and investor sustainability laws and reporting requirements of any economic region. Under the banner of a 'European Green New Deal', Europe is implementing a sweeping set of measures designed to fight climate change, support sustainable innovation, and make Europe the first climate-neutral continent by 2050.
However, as we all know, large economic and regulatory changes also create new compliance obligations for companies and investors, and the EU's embrace of sustainability reporting is no different. As this surge of new sustainability legislation can be challenging to track, we’ve prepared this guide to summarize the major laws, reporting requirements, and what they mean for organizations in 2023.
All of these EU laws and regulations have important implications for companies and investors, particularly the major four, which we'll outline and summarize here:
The EU SFDR requires specific firm-level disclosures from EU asset managers and investment advisers regarding how they address (1) sustainability risks, (2) principal adverse impacts (PAI), and (3) sustainable investment marketing
The EU SFDR directs financial firms, advisors, and providers of financial products on how to transparently and accurately communicate the sustainability risks, attributes, and data underlying investments. The goals are to identify:
SFDR applies to all EU investment management firms and advisors, including asset managers, banks, and insurers. It also includes non-EU firms who target the EU market through the Alternative Investment Fund Managers (AIFM) Directive.
There are specific SFRD rules and requirements based on the type of organization the rules apply to:
SFDR also designates three different financial product categories:
Article 6 products must disclose how sustainability risks are integrated into their investment decisions as well as an assessment of the likely impacts of sustainability risks on their returns.
Article 8 and Article 9 products require more comprehensive reporting on a variety of sustainability and ESG topics, including:
PAIs are defined under EU SFDR as impacts that have "negative, material, or likely to be material effects on sustainability factors that are caused, compounded by, or directly linked to investment decisions and advice performed by the legal entity." The EU defines 64 specific PAIs. 18 are mandatory to report, 46 are voluntary. These PAIs focus on market standard ESG KPIs. Mandatory environmental PAI factors include carbon emissions, fossil fuel exposure, and waste generation. Mandatory social PAI factors include gender diversity and human rights due diligence. Governance PAI factors include protections and ESG governance measures and controls around preventing corruption, bribery or other corporate ethics failings.
The latest SFDR technical standards, released on April 6, 2022, require greater disclosure data from investment entities, including detailed Scope 3 emissions data from assets and portfolio companies.
SFDR disclosures fall in two categories:
Both pre-contractural and period SFDR disclosures must be dated, publicly available, and uploaded to the filer’s website.
SFDR disclosure filings run on calendar years cycles. Each year's data must be shared by filers by June 30th of the following year for a reporting Period. For example, 2022 PAI data, risk, and performance information must be reported by June 30th, 2022. All PAI-related metrics must be calculated at the end of each calendar quarter, then averaged for each annual SFDR report.
The EU CSRD is an EU ESG standard passed by European Union Council on November 28, 2022 designed to make corporate sustainability reporting more common, consistent, and standardized like financial accounting and reporting
The EU Parliament and the European Council officially approved the EU Corporate Sustainability Reporting Directive (CSRD) in November 2022. The CSRD, which goes into law in 2023 and starts to take effect for larger companies in their fiscal year 2024, requires companies to track and report their ESG activities using metrics defined by EFRAG (European Financial Reporting Advisory Group). These EFRAG metrics are known as the European Sustianability Reporting Standards (EU ESRS).
The CSRD will apply to all companies with:
The CSRD makes the EU the first region to mandate corporate sustainability and ESG reporting for thousands of companies (in the coming years). The EU’s belief is the CSRD will improve corporate accountability, reduce divergent sustainability standards, and inspire companies to improve and invest in their sustainability performance to accelerate the transition towards a more sustainable economy.
To comply with CSRD, organization's will need to take the following annual compliance steps, starting in 2024:
Brightest helps hundreds of companies measure EU sustainability reporting KPIs and manage their ESG compliance activities in one unified system
The EU Taxonomy for Sustainable Activities ("EU Taxonomy") is a classification system, establishing a list of environmentally sustainable economic activities. It provides companies, investors, and regulators with appropriate definitions for which economic activities are considered environmentally sustainable
We've already mentioned the EU Taxonomy twice in relation to both EU SFDR and the CSRD. In a sense, the EU Taxonomy is a "unifying framework" within the EU's 2050 Sustainable Action Plan - designed to tie together sustainable financial and corporate investment in a single classification system.
The EU Taxonomy's primary role is to serve as the rule book that determines which economic, business, and investment activities officially count as 'sustainable'.
Under SFDR, when an eligible organization labels or markets a financial product as sustainable, they must disclose the degree to which the underlying investments meet the EU Taxonomy's qualifications. Similarly, when an EU company allocates its capital expenditures (CAPEX), what percentage of the company's investments are in sustainable activities like sustainable manufacturing, building energy efficiency, renewable energy development, or other areas?
The EU Taxonomy helps companies and investors align their activities with which ones either fit or don't fit the EU taxonomy's macroeconomic categories:
The EU Taxonomy Regulation sets mandatory requirements around EU taxonomy disclosure. Practically, large FMPs who meet SFDR disclosure criteria and large corporate filers who fall under the CSRD both need to disclose to what extent their activities meet the criteria set out in the EU Taxonomy. FMPs (like asset managers) will have to disclose to what extent the activities that their financial products fund meet the EU Taxonomy criteria. Companies will disclose the extent to which they invest, for example, CAPEX, in Taxonomy-aligned actions and categories. Disclosure on green revenue and green expenditure is designed to provide the EU market with information on:
In this sense, an FMPs EU SFDR reporting becomes linked to its EU Taxonomy reporting, while a company's CSRD reporting aligns with its Taxonomy disclosures.
The Corporate Sustainability Due Diligence Directive (CSDDD) is an EU directive on corporate sustainability due diligence designed to foster sustainable and responsible corporate behaviour throughout global value chains
To promote full economic transformation towards sustainability, EU policymakers are also looking beyond corporate operations and financial sector investment to a third frontier: supply chains. Supply chains often represent 60-90% of a company's environmental impacts and carbon emissions, which makes supply chain sustainability and due diligence critical aspects of the region's overall sustainable transition plan. Human rights protections for workers are also in scope as well, and all supply chain workers must have access to safe and healthy work conditions.
Currently, Germany has already passed its own national Supply Chain Due Diligence Act, known in German as Lieferkettensorgfaltspflichtengesetz (LkSG). LkSG goes into effect on January 1, 2023 for organizations with over 3,000 employees currently doing business in Germany. Other EU countries like the Netherlands have also proposed similar laws.
Following this lead, the EU is aiming to introduce broader standards and improvement around corporate sustainability due diligence duty designed to address negative human rights and environmental impacts in supply chains.
The new, proposed due diligence rules will apply to the following companies and sectors:
Small and medium enterprises (SMEs) are not directly impacted by the disclosure and reporting requirements this proposal, however many of these companies are suppliers within larger corporate supply chains of companies who do meet supply chain due diligence reporting criteria.
This proposal applies to the company's direct operations, subsidiaries, and their value chains (direct and indirect established business relationships).
In order to comply with the corporate due diligence duty, companies need to:
National administrative authorities appointed by EU Member States will be responsible for supervising these new rules and may impose fines in case of non-compliance. In addition, victims will have the opportunity to take legal action for damages that could have been avoided with appropriate due diligence measures.
The aim of the proposal is to ensure that the EU private and public sectors fully respect the region's international commitments to protecting human rights and fostering sustainable development in international trade.
The proposal is expected to be presented to the European Parliament and the Council for approval in the near future. Once adopted, EU Member States will have two years to transpose the directive into national law.
As you can tell from the length of this article alone, there are a lot of major new EU sustainability laws going into effect in 2023, 2024, and future years. In fairness, it can feel very complex and daunting. However, from a positive perspective:
For organizations in the early stages of their sustainability reporting journey, we have a few general recommendations, additional reading, and suggested next steps:
Materiality assessment - The principle of Materiality is embedded in most of these new EU legislations, particularly the concept of double materiality. Materiality essentially asks and attempts to answer a fundamental question: what are the most important (re: material) ESG and sustainability risks and considerations for a business or investment? If your organization hasn't already done so, a materiality assessment can help determine what your top sustainability goals, targets, risks, and priorities should be in relation to regulatory and investor sustainability reporting. In turn, this can help clarify where to focus, what to prioritize, and what aspects of pending or forthcoming EU sustainability legislation matter most to you.
Understand the laws in depth - A full, in-depth breakdown of each law is outside the scope of this piece, but it is critical that, if your organization meets EU sustainability disclosure and/or due diligence criteria, you work with your leadership, directors, legal counsel, auditors, and other stakeholders to learn your organization's specific timeline and obligations under each law.
Sustainability data systems and process - While this might go without saying, in order to report your organization's sustainability and ESG performance, you need to know what it is - with a high degree of accuracy. Your materiality process can help guide you toward the main sustainability themes you may need to focus on and collect data around. Is employee travel a big source of your organization's carbon footprint? Facilities? Manufacturing sites? Where does that data exist today, and how will you access or collect it? Many organizations start their sustainability reporting with relatively simple spreadsheets, surveys, and documents, but things can get complex fast - particularly for larger companies. If you're an organization with a medium-to-large or complex environmental footprint, you likely need dedicated sustainability reporting and data management software, like the kind we design here at Brightest to help organizations stay ESG compliant. Ongoing report archiving, version control, and governance are also important to think about, since you'll be reporting under ESRS every year.
Further reading - Our free guides to sustainability measurement, sustainability reporting, and ESG reporting provide additional, detailed guidance and insights on how to measure and report your sustainability performance. Or, if you're ready to up-level your sustainability reporting and data maturity to meet ESRS requirements, please contact us for a free assement or demo of Brightest's intelligent, award-winning ESG platform.