Osborne Clarke | EU’s Drive for Sustainability Puts Third Countries in Scope of New Reporting Obligations

The European Union (EU) and its Member States have underwritten both the United Nations Framework Convention on Climate Change (UNFCCC) Paris Agreement on Climate Change and the UN 2030 Agenda for Sustainable Development.

The EU has consequently set itself the ambitious target to reduce its CO2 emissions by at least 55% by 2030 compared to 1990 levels, and to achieve climate neutrality by 2050. To achieve these targets, the government of the EU, the European Commission, has proposed the EU Green Deal and the “Fit for 55”-package, a set of legislation in different policy fields to translate the abstract targets to concrete measures and obligations.

As part of achieving the aforementioned targets and sustainability objectives, the European Commission has adopted a Sustainable Finance Action Plan in 2018 (COM(2018) 97 final), aiming to:

• reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth;
• manage financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and
• foster transparency and long-termism in financial and economic activity.

Sustainable finance

Sustainable finance refers to the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions.

Environmental considerations might include climate change mitigation and adaptation, as well as the environment more broadly, for instance the preservation of biodiversity, pollution prevention and the circular economy.

Social considerations could refer to issues of inequality, inclusiveness, labour relations, investment in people and their skills and communities, as well as human rights issues.

The governance of public and private institutions – including management structures, employee relations and executive remuneration – plays a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process.

EU ESG legislation

The EU ESG legislation consists of:

• the Sustainable Finance Disclosure Regulation or SFDR, reorienting capital flows towards sustainable investments by increasing transparency by financial market participants and advisers on sustainability risks;
• the Corporate Sustainability Reporting Directive or CSRD, imposing mandatory ESG reporting (based on external audits) to all large companies and small and medium-sized enterprises (SMEs) listed on regulated markets;
• the Corporate Sustainability Due Diligence Directive or CSDDD, establishing a corporate due diligence duty for companies to identify, bring to an end, prevent, mitigate and account for negative ESG impacts in their own operations and value chains. Directors of EU companies will also be required to set up and oversee the implementation of the due diligence process and integrate due diligence into the corporate strategy; and
• the Taxonomy Regulation, establishing a harmonised taxonomy to classify financial products as sustainable or not (addressing also “greenwashing” concerns);

These pieces of legislation are not only relevant for EU companies, but also for third country companies, including companies based in the United States. The penalties for non-compliance vary from Member State to Member State, but can be a combination of (administrative) fines and criminal sanctions.

Corporate Sustainability Reporting Directive

The most prominent obligations stem from the Corporate Sustainability Reporting Directive. Notably, third-country undertakings which, at their group level, generated a net turnover of more than €150 million in the EU for each of the last two consecutive financial years, and which have a subsidiary undertaking in the EU, or a branch which generated a net turnover of more than €40 million in the preceding financial year, are also subject to the sustainability reporting requirements of the CSRD from the 2028 financial year onwards.

The CSRD requires reporting of forward-looking, retrospective, qualitative and quantitative information necessary to understand an undertaking’s impacts on sustainability matters and, from the opposite lens, the information necessary to understand how sustainability matters affect an undertaking’s development, performance, and position (that is, “double materiality” reporting).

It is particularly important to note that CSRD reporting covers the organization at a consolidated level, not just at the EU-based subsidiary or branch level. This means that US companies with significant turnover in the EU will need to publish sustainability information that covers their entire operations, including its non-EU operations.

Corporate Sustainability Due Diligence Directive

Although still going through the legislative process, it seems that the Corporate Sustainability Due Diligence Directive will also impose obligations towards US companies.

To determine whether or not a non-EU company is in scope, a similar net turnover threshold would be used (€150 million, from which at least €40 million was generated in the EU). To calculate this threshold, the turnover as generated by third-party companies with whom the company and/or its subsidiaries has entered into a vertical agreement in the EU in return for royalties, would also be taken into account. For certain sectors, an additional threshold based on the number of employees might be used.

Small and medium-sized enterprises, including micro-enterprises, would not be in scope, but may be affected as contractors or subcontractors to companies in scope. However, companies that have an SME business partner would be required to support them to comply with the due diligence measures.

SFDR

With regard to the Sustainable Finance Disclosure Regulation, non-EU entities will only be affected indirectly either through their EU subsidiaries, through the provision of in-scope services in the EU, or through general market pressure.

Carbon Border Adjustment Mechanism

Finally, the EU’s climate legislation will also indirectly apply to some non-EU value chains through the Carbon Border Adjustment Mechanism (or CBAM), which aims to prevent “carbon leakage” by imposing a carbon adjustment price for selected imported products not subject to the carbon price deriving from the EU Emissions Trading System.

For more information, please contact Osborne Clarke’s ESG team.

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