US businesses face challenge in meeting European ESG requirements

Michael Watson, James Hay, and Mark Ferguson of Pinsent Masons said large private and listed companies in the US need to urgently consider how new reporting requirements in both the EU and UK, set to take effect next year, might impact their business.

Even those US businesses that have embraced recommendations made by the Taskforce for Climate-related Financial Disclosures (TCFD) and the equivalent Taskforce on Nature-Related Financial Disclosures (TNFD), are readying themselves to comply with proposed new Securities and Exchange Commission (SEC) rules on climate-related disclosures, and which plan to conform to new sustainability disclosure standards finalised earlier this year by the International Sustainability Standards Board (ISSB), will find they face additional obligations in the EU and UK, they said.

Michael Watson, who advises businesses on climate and sustainability issues, said: “It has been clear from our engagement with US businesses that there is awareness of new reporting requirements that have been developed in the EU and UK, but also concern and uncertainty about the extent to which those regulations will impact them – and over what action they will need to take.”

“The first task for US businesses should be to undertake an urgent scoping exercise to determine what part of their business is caught by the mandatory reporting requirements and, if so, to then understand whether they can apply the same compliance programmes across their whole business. This will depend on the size and geographic spread of their business,” he said.

“While the TCFD and subsequently the ISSB have developed global baseline standards in respect of climate and sustainability disclosures respectively, policymakers and regulators have been implementing these standards in legal and regulatory frameworks in different ways around the world. For US businesses, the lack of interoperability across regimes means thought will likely need to be given to adapting their processes for the different requirements we are seeing emerge across jurisdictions,” Watson said.

Public policy expert Mark Ferguson said the EU is introducing the most robust and comprehensive ESG regulatory requirements across any jurisdiction in the world.

“Issues such as the Corporate Sustainability Reporting Directive (CSRD), the Corporate Sustainability Due Diligence Directive, the ISSB standards, the Green Claims Directive and the Taskforce on Nature-Related Financial Disclosures are already requiring both EU and non-EU businesses to factor into their planning how they report on such issues to remain compliant with EU regulatory standards,” Ferguson said.

“The European Commission’s work programme for 2024 indicates further non-legislative developments, including plans for a new 2040 climate target in early 2024 as well as a separate initiative on water resilience. This, and the completion of other ESG files, will all happen ahead of the European Parliament elections in June 2024, which in turn will be followed by a newly appointed Commission later in the year which will bring with it a new legislative agenda,” he said.

Of the raft of EU regulations, the CSRD – which will apply gradually from 2024 but likely impact US businesses in either 2025 or 2026, depending on whether they are already subject to the EU’s Non-Financial Reporting Directive (NFRD) – has particular relevance for US businesses, said sustainable finance adviser James Hay

Hay said: “The CSRD scoping rules dramatically increase the reach of EU sustainability reporting requirements. The previous rules under the NFRD applied only to European companies, but CSRD also introduces reporting for non-EU issuers of securities listed on EU markets and non-EU companies with significant business activities in the EU. As a result of the rules potentially bringing into scope large non-EU issuers, some multinationals are working out how to delist securities from the EU while others are biting the bullet and reporting on a global basis, which represents a very significant reporting burden.”

“Although CSRD introduces a temporary provision for ‘EU consolidated reporting’ whereby companies can report only on their EU-based subsidiaries, the reality is that creating new reporting procedures only in respect of EU activities may not be the easy option it appears at face value,” he said.

“Pushing reporting obligations down to subsidiaries creates a fresh set of practical challenges, as reporting teams would have to re-orient their understanding of the business. Establishing new governance structures at subsidiaries that typically rely on sustainability expertise from head office at short notice, when sustainability reports have to undergo independent limited assurance and there are serious financial penalties expected to be associated with non-compliance, can be impractical. As a result, many companies are taking seriously the prospect of voluntarily opting in early on a global basis to avoid a half-way house implementation in the short-term which would need to get significantly uplifted in future years,” Hay added.

A significant difference between the ISSB sustainability standards that have been developed and the requirements arising under the CSRD is the fact that the latter requires businesses to assess and report risk on a ‘double materiality’ basis – both where it is material to their financial performance as well as with regards their impact on the environment or on people. The approach to materiality under the ISSB standards is focused solely on financial performance.

In the UK, the government has confirmed that it will explore new ISSB standards-based requirements for UK registered companies and limited liability partnerships, while the Financial Conduct Authority (FCA) has separately confirmed that it intends to update its existing rules on climate-related reporting for listed companies – which are based on the TCFD recommendations – to “refer to the UK-endorsed ISSB standards”.

In October, the UK’s Transition Plan Taskforce (TPT) published a new framework that encourages businesses to develop plans on how they will transition to “a low GHG-emissions, climate-resilient economy”, and make a series of disclosures in relation to those plans. The framework is initially voluntary for businesses to adopt, but it is expected to form the basis of legal and regulatory requirements in the UK in due course. 

Watson said: “The prospective introduction in the UK of the TPT’s recommendations, when combined with TCFD/ISSB-based reporting, could actually have some similarity in impact and information provision to the EU double materiality requirements, but not identical.”

Ferguson said US businesses looking to conduct business in Europe, or access European investors, must be mindful of the existing reporting demands and statutory obligations, and put in place effective monitoring systems that can help them to track, engagement with and influence future developments.

“The rapidly growing and evolving legal, policy and regulatory landscape around ESG does present significant challenges to organisations large and small as they seek to ensure compliance while building increased sustainability measures into their business planning,” Ferguson said.

“Regular horizon scanning can inform and underpin a company’s engagement with their key stakeholders and puts them in a position to enjoy more positive relations with political and regulatory contacts. Businesses should also look at how they can prioritise internal resource, allocate budgets, and undertake the annual planning cycle in a holistic way with the maelstrom of ESG regulation in mind. A centralised knowledge repository allows organizations to manage their knowledge assets more efficiently, and creating a shared regulatory baseline of what is required and by when enables legal, compliance and ESG teams to have common reference points and ensure any collective strategic decision making is grounded in an appreciation of both the short and medium-term horizon,” he said.