Regulation watch: dealing with the EU corporate reporting sustainability directive

One of the imminent regulatory changes that large corporations need to prepare for is the EU Corporate Reporting Sustainability Directive (CRSD).

While the CSRD mainly targets EU-based entities, it will also impact non-EU companies with subsidiaries or operations within the EU.

The directive came into force in 2023, and by 2028, non-EU parent companies with annual EU revenues of at least EUR 150 million in the last two years and an EU-based subsidiary must report on sustainability, diversity, corruption, and other related factors.

The impact on businesses

The European Commission formally adopted the European Sustainability Reporting Standards (ESRS) on July 31, 2023, as part of the CSRD.

The ESRS includes general requirements, disclosures, and 10 environmental, social, and governance (ESG) standards.

Companies must assess and disclose their impact on topics such as climate change, pollution, water resources, biodiversity, and worker and consumer rights.

Companies’ ESG targets must align with ESRS’s minimum disclosure requirements, including specific metrics, timeframes, and reporting practices.

The concept of ‘double materiality’ requires companies to consider both the value creation for their business and the broader impact on the economy, environment, and communities when determining what to report.

“Businesses must also factor in the potential brand and reputational risks of not meeting these requirements, as the penalties could extend beyond formal sanctions.”

Disclosure is mandatory if a company deems certain information to be material.

Notably, the climate change standard (ESRS E1) has a comply-or-explain provision, where companies must explain if they choose not to report on this topic.

James Bosley, head of climate strategy, carbon insurance, and parametric solutions at Gallagher, explains that it is important that companies evaluate the financial implications of meeting these new obligations.

He says: “The level of detail expected in reporting and the repercussions of non-compliance still need to be clarified.

“Businesses must also factor in the potential brand and reputational risks of not meeting these requirements, as the penalties could extend beyond formal sanctions.”

Litigation concerns

With increased regulation comes the increased risk of breaking the rules.

Recent research from Gallagher found that nearly two-thirds (62%) of senior leaders at large UK businesses are concerned that their ESG targets put them at risk of litigation.

When ranking their concerns for their businesses, should they miss their ESG targets, nearly a quarter (24%) said investor withdrawal, more than one in five (21%) said litigation, and 14% said shareholder activism.

“Without a codified set of rules to follow, companies and their directors are left to their own devices and best endeavours, which creates a lot of uncertainty.”

According to Steve Bear, executive director for financial risks at Gallagher, increased regulation is a double-edged sword for Directors’ & Officers’ (D&O) insurers.

He explained: “On the one hand, it’s easy to assume that more regulation means more D&O claims, but without a codified set of rules to follow, companies and their directors are left to their own devices and best endeavours, which creates a lot of uncertainty.”

“Directors also need guidance when it comes to new regulation and how to avoid falling foul of it. We have already seen claims from activist groups, for example, because green credential claims made on company websites prove to be wide of the mark, and this only serves to reinforce the concerns revealed in our research.”

What next

The dynamic regulatory landscape often brings uncertainty, and businesses must develop strategies to cope effectively.

Embracing a proactive approach to regulatory changes is crucial. This includes staying informed about pending legislation, engaging with industry associations and legal experts, and assessing the potential impact on the organisation’s risk profile.

“Conducting a comprehensive assessment of D&O insurance coverage is essential to ensure adequate protection”

A critical aspect of managing regulatory risks is evaluating the volume of potential claims resulting from directors failing to ensure compliance with new legislation.

Steve Bear emphasises the importance of directors and officers understanding the implications of regulatory changes on their responsibilities and the potential consequences of non-compliance.

He concludes: “Conducting a comprehensive assessment of D&O insurance coverage is essential to ensure adequate protection against potential claims and associated legal costs.”