The most important ESG regulations are the CSR Directive Implementation Act (CSR-RUG), the Sustainable Finance Disclosure Regulation (SFRD), the EU Taxonomy, the Non-Financial Reporting Directive (NFRD), the Corporate Sustainability Reporting Directive (CSRD), the Whistleblower Protection Act (HinschG) and the Supply Chain Sourcing Obligations Act ( LksG ).
The goal of ESG regulations is to integrate sustainability into corporate business practices, both strategically and operationally, and to continuously improve sustainability performance. It is important for corporate managers to obtain an overview of the current and upcoming ESG regulations. After all, those who succeed in establishing active sustainability management will gain a long-lasting competitive advantage. In the following, we will take a closer look at the most important ESG regulations.
CSR-Directive Implementation Act (CSR-RUG)
One of the most important regulations is the CSR Directive Implementation Act (CSR-RUG). This obliges companies to disclose information on non-financial aspects and thus to prepare a sustainability report.
Five non-financial aspects to report on:
- Environmental concerns
- Employee matters
- Social issues
- Human rights
- Combating corruption and bribery
In addition, disclosures are to be made on the individual aspects that are necessary for an understanding of the course of business, business events and the position of the company, as well as the impact of the activity on the non-financial aspects. The guideline has been effective since the 2017 financial year.
The CSR-RUG is intended to encourage capital market-oriented companies as well as banks and insurance companies throughout Europe to act more responsibly and sustainably. The aim is to create greater transparency regarding environmental and social impacts.
Organizations can decide whether to publish their information as an extension of the group management report in the annual report or separately in a sustainability report, which must be mentioned as a reference in the management report. Subsequently, a follow-up auditor must formally verify whether the non-financial information has been presented in the report. Currently, a substantive audit has not yet been specified.
When preparing the sustainability report, the EU directive refers to using the Global Reporting Initiative (GRI) guideline or the German Sustainability Code (DNK ) as a guide for preparing the report. This framework must then be mentioned in the report and if these have not been used, a corresponding explanation must be given. In addition, the EU Commission has developed a non-binding guideline on methods for mandatory reporting, which provide support for the preparation of the report.
However, not everything has to be reported. Information that a company cannot mention for reasons of competition, for example, does not have to be published. However, this information must be explained ("comply or explain"). If a company does not publish the necessary information and does not provide an explanation, fines of up to €10 million can be imposed. These fines are based on the company's sales and profits.
To whom does it apply and from when?
The CRS-RUG affects capital market-oriented companies, institutions, and insurance companies with more than 500 employees or total assets of more than EUR 20 million or sales of more than EUR 40 million since the 2017 financial year.
The Sustainable Finance Disclosure Regulation (SFRD)
The Sustainable Finance Disclosure Regulation (SFRD) is an ESG regulation that affects financial market participants and financial advisors - i.e. companies that offer and develop financial products. The SFRD requires financial market participants to evaluate financial products according to ESG criteria.
The Disclosure Regulation, which came into force in March 2021, is particularly important for companies that advertise ESG products or describe products as "sustainable investments". Through the SFRD, there are concrete requirements for companies to disclose sustainability information in order to create more transparency regarding sustainability criteria. The regulation thus provides standardized disclosures to enable comparability of different ESG product types. The SFRD additionally promotes that sustainability factors are increasingly included and implemented in decision-making processes.
Based on environmental, social and governance (ESG) criteria, the SFRD aims to help investors make more informed decisions when selecting financial products, and to make financial products more comparable in terms of their sustainability impacts. In this way, valuable insights into the risks and opportunities of individual companies can be gained and changes in sustainability issues can be brought about.
The SFRD also poses challenges for companies that are not active in the financial sector, as investors will increasingly request information that is required for the SFRD. Thus, it will become increasingly important for companies to collect and report sustainability data in a structured manner in order to be attractive to investors.
To whom does the SFRD apply and from when?
Since March 2021, the SFRD primarily affects financial market participants and financial advisors who develop and offer financial products.
The EU taxonomy
With the EU taxonomy, the EU has created a classification system for ecologically "sustainable" or "green" economic activities. The taxonomy now creates clear rules and framework conditions for the term "sustainability" as to when a company is operating in a sustainable or environmentally friendly manner. The EU taxonomy sets binding standards for sustainable economic activity and thus creates the prerequisites for standardized sustainability reports with specified key figures. The taxonomy defines which economic activities may be considered sustainable investments and requires organizations to be transparent about their own business activities.
The aim of the EU taxonomy is to create uniform sustainable reporting requirements for companies and to make information on the sustainability of activities comparable. In this way, investors can use clear criteria to recognize whether a company is operating sustainably or not.
The focus is on the following six environmental goals:
- Climate protection
- Adaptation to climate change
- Sustainable use and application of water and marine resources
- Transition to the circular economy
- Pollution prevention or control
- Protection and restoration of biodiversity and ecosystems
In order to be considered sustainable according to the EU Taxonomy Regulation, a company must ...
- Contribute to at least one of the environmental goals listed in the taxonomy (Substantial Contribution).
- Do not violate any of the other taxonomy objectives (Do not cause significant harm)
- and comply with specified minimum standards (minimum safeguards).
The following areas of the EU taxonomy-compliant share must be disclosed by a company for sustainable financial management:
- Proportion of sales from activities that meet the criteria of the taxonomy (sales revenue)
- The operating expenses (OpEx)
- Capital expenditures (Capex)
To whom does the EU taxonomy apply and from when?
The EU taxonomy applies to companies that offer financial products in the EU and also large companies with more than 500 employees that fall under the NFRD. In the future, companies with more than 250 employees and a balance sheet total of more than EUR 20 million or sales of more than EUR 40 million will also be subject to the reporting obligation, irrespective of their capital market orientation. The EU taxonomy has already been applied for the first two environmental targets, climate change mitigation and adaptation, since January 2022. Corresponding legal acts are still expected by the end of 2022 for the four other environmental targets.
The Non-Financial Reporting Directive (NFRD)
The Non-Financial Reporting Directive (NFRD), as a guideline on non-financial reporting, legally defines important principles for sustainability reporting by large companies.
The EU directive requires large listed companies as well as banks and insurance companies to add sustainability disclosures to their existing management reports. The reporting is intended to give investors and consumers, as well as other stakeholders, the opportunity to learn more about material non-financial aspects such as the company's operations. However, analyses by the EU Commission showed that a large number of stakeholders would like to see the reporting requirements and content extended to other categories of companies. In addition, the EU Commission proposes to extend the scope of the directive to listed SMEs, as only around 11,000 companies are currently affected by the NFRD. Therefore, a planned renewal of the CSR directive is to take place through the CSRD, which is to expand the scope of application and define a more comprehensive reporting standard for sustainability in companies.
To whom does the NFRD apply and from when?
The NFRD applies to large companies with more than 500 employees and was implemented in the EU in 2017.
The Corporate Sustainability Reporting Directive (CSRD)
The Corporate Sustainability Reporting Directive (CSRD) will be the largest European reform of so-called non-financial reporting. The CSRD will replace the existing Non-financial Reporting Directive (NFRD). Thus, for the first time, a uniform framework for the reporting of non-financial data will be defined by the European Commission.
The aim of the CSRD is to create transparency and consistency with regard to sustainability information along the financial value chain. By expanding the reporting requirements and content, the aim is to gradually create equality between financial and sustainable, non-financial key performance indicators. The CSRD will include more than 140 sustainability indicators (KPIs) that a company must collect and disclose. In addition, the CSRD stipulates that key performance indicators must be included in the company's management report and must be certified by an auditor with at least a limited assurance opinion.
Even non-reporting SMEs that have a business relationship with a reporting company, such as customers, partners and suppliers, can be indirectly affected by the CSRD. This is because reporting companies must provide information about their suppliers and vendors along the entire supply chain. Thus, a scenario is conceivable in which companies affected by the CSRD will in turn require their business partners to disclose certain sustainability information in order to maintain the business relationship. Companies that do not comply with this request could run the risk of slipping down the priority list. This effect, whereby large companies that are subject to certain transparency obligations also pass on these standards within the value chain, is quite intentional on the part of the legislation and is referred to as the trickle-down effect.
The fact that the EU wants to direct capital flows predominantly into sustainable economic activities in the future will further strengthen this effect. Thus, SMEs will also be confronted with the disclosure of sustainability indicators sooner rather than later in the areas of financing and insurance. A timely examination of the CSRD is therefore also recommended for companies that are not directly affected.
To whom does the CSRD apply and from when?
The CSRD affects all companies with more than 250 employees and/or net sales of more than €40 million and/or a balance sheet number of more than €20 million. The CSRD is to be adopted by October 31, 2022 at the latest. A draft is currently available for voting.
Whistleblower Protection Act (HinschG)
Another ESG regulation that affects companies on the path to sustainability is the Whistleblower Protection Act (HinschG). The HinschG, also known as the EU Whistleblower Directive, protects natural persons within a company who report violations of European and national law within the company as part of their professional activities. The prerequisite for this is that the violations must be punishable by law or a fine and endanger health or life. Whistleblowers can thus draw attention to violations such as corruption or tax evasion. The relevant whistleblowers will be protected by law from negative consequences within the company.
In order to be able to better record indications within the company, the procedure for issuing reports must be made possible orally or in writing and, if desired, also in person. Two equally valid reporting channels should be created: internal and external. An internal reporting system within the company can be an electronic whistleblower system or an employee from the compliance department. An external reporting system is set up at the Federal Office of Justice (BfJ). In this case, the whistleblower is free to decide whether to submit the reports or tips via the internal or external reporting office.
To whom does the HinschG apply and from when?
Companies with at least 50 employees are affected by the ESG Act. The German government has passed a corresponding bill and the law could be passed in the fall and thus probably come into force at the beginning of 2023.
Supply chain due diligence act (LksG)
In addition to the CSRD and EU Taxonomy, the EU has launched the Supply Chain Sourcing Obligations Act (LksG) to set requirements for responsible supply chain management for certain companies for the first time within the ESG regulations.
For the first time, the LksG regulates corporate responsibility for human rights compliance in supply chains. The ESG Act provides companies with clear and reasonable legal regulations for fulfilling human due diligence obligations and avoiding human rights violations. The LksG contains an exhaustive catalog of eleven internationally recognized human rights conventions from which behavioral requirements or prohibitions for corporate action can be derived. These include the prohibition of child labor, slavery, forced labor, the disregard of occupational health and safety, the withholding of an appropriate wage, the disregard of the right to form trade unions or employee representatives, the denial of access to food and water, and the unlawful deprivation of land and livelihood. These rules are monitored by the Federal Office of Economic and External Affairs (BAFA), which is equipped with appropriate enforcement instruments.
If companies fail to comply with the obligations, fines of up to 8 million euros or 2 percent of global annual sales can be imposed. However, this only applies to companies with annual sales of more than 400 million euros. In addition, companies that are imposed such fines can be excluded from the award of public contracts.
To whom does the LksG apply and from when?
From January 01, 2023, the ESG Act will apply to companies based in Germany with at least 3,000 employees or companies with a branch in Germany also with at least 3,000 employees. From January 01, 2024, companies with at least 1,000 employees will be affected by the LksG.
Conclusion
Understanding and keeping track of ESG regulations is an elementary part of strategically steering one's own company in the direction of sustainability. From different perspectives, each set of regulations makes a decisive contribution to moving different areas in a company toward more sustainable business practices.
If ESG regulations as well as customer requirements are taken into account from the outset of the sustainability transformation, risks can be circumvented from the outset and competitive advantages can be created for the entire company.
In the third part of the blog series Sustainability between customer wishes and strategic anchoring, customer wishes and strategic alignment within the ESG spectrum are examined in more detail. Both are important factors that need to be taken into account in order to master the sustainability transformation and stay in the market. Corporate executives need to prepare for these issues in order to implement sustainability management strategically and successfully within the company, while minimizing risk to the company as a whole.
Notice: The information shown above is only a summary of selected ESG regulatory topics and data. The information is non-binding and there is no claim to completeness. Please note that information may be changed at short notice and without prior notice. Adjustments and extensions may be made at any time.
