June 29, 2022

Will U.S. companies face ESG reporting requirements in the EU?

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Some U.S. companies may well have to report on ESG—even if the SEC takes no action on climate or other ESG disclosure proposals! How’s that? According to this press release from the Council of the European Union, the Council and the European Parliament reached a provisional agreement last week on a corporate sustainability reporting directive (CSRD) that would require more detailed reporting on “sustainability issues such as environmental rights, social rights, human rights and governance factors.” The provisional agreement is subject to approval by the Council and the European Parliament. The press release indicates that the requirements would apply to all large companies and all companies listed on regulated markets, as well as to listed small- to medium-size companies (“taking into account their specific characteristics”). Importantly, for companies outside the EU, “the requirement to provide a sustainability report applies to all companies generating a net turnover of €150 million in the EU and which have at least one subsidiary or branch in the EU. These companies must provide a report on their ESG impacts, namely on environmental, social and governance impacts, as defined in this directive.”

(“‘Net turnover’ means the amounts derived from the sale of products and the provision of services after deducting sales rebates and value added tax and other taxes directly linked to turnover.”)

SideBar

You might recall that the EU employs a “double materiality” standard for sustainability disclosure. This memo to the European Council in connection with the CSRD explains that prior directives “require reporting not only on information ‘to the extent necessary for an understanding of the undertaking’s development, performance, position’, but also on information necessary for an understanding of the impact of the undertaking’s activities on environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters.” The references to the company’s “development, performance, position” are references to financial materiality, as they affect the value of the company. The memo makes clear that climate-related information “should be reported if it is necessary for an understanding of the development, performance and position of the company. This perspective is typically of most interest to investors.” The references to “information necessary for an understanding of the impact of the undertaking’s activities on environmental, social” and other matters is to provide information that is important to citizens, consumers, employees and other stakeholders. The memo indicates that, with double materiality, companies “report both on the impacts of the activities of the undertaking on people and the environment and on how various sustainability matters affect the undertaking. That is referred to as the double-materiality perspective, in which the risks to the undertaking and the impacts of the undertaking each represent one materiality perspective.” The memo indicates that a review of “corporate reporting shows that those two perspectives are often not well understood or applied. It is therefore necessary to clarify that undertakings should consider each materiality perspective in its own right, and should disclose information that is material from both perspectives as well as information that is material from only one perspective.”

The European Financial Reporting Advisory Group (EFRAG) will be responsible for establishing European standards, with the European Commission expected to adopt the first set of standards in 2023, according to Bloomberg. Reporting will be phased in, beginning in 2024 with companies already subject to the non-financial reporting directive, a delay from the original expectation of 2023.

The CSRD will also introduce a requirement for assurance of sustainability reporting. Reports must be certified by an “accredited independent auditor or certifier,” who must “ensure that the sustainability information complies with the certification standards that have been adopted by the EU.” Assurance is also required for non-EU companies, whether by a European auditor or by one established in a third country. Bloomberg reports that countries in the EU will be permitted to accredit independent certification companies to provide assurance for sustainability reports, a move characterized by Bloomberg as “an effort to dilute big audit firms’ market power.”

According to Bloomberg, the European commissioner for financial services said “the sustainability rules would ‘take account of global standards, including the standards currently being developed by the International Sustainability Standards Board.’ The ISSB is developing a separate set of ESG reporting standards, aimed more narrowly at informing financial investors over the risks companies face from climate and other ESG issues.”

Of course, none of these standards is likely to be precisely on all fours with what the SEC has proposed or ultimately adopts on climate disclosure. In this article, Bloomberg reports on commenters urging the SEC to modify its proposal to more closely align with the ISSB so that multinational companies “can meet similar regulations under consideration in Europe and other markets.” One company, Bloomberg reports, asked the SEC to “ease the burden associated with the complexity of the current disclosure framework and to ensure that neither registrants nor investors are faced with a transition from a fragmented proliferation of voluntary standards, frameworks, and metrics to a fragmented proliferation of regulated standards, frameworks, and metrics.”

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