Many US companies face significant and complex sustainability reporting requirements due to the EU’s Corporate Sustainability Reporting Directive, explains Lukas Tunikaitis, Sustainability Specialist, UL Solutions.
Investors in US companies would do well to avoid being lulled into believing that the political and ideological backlash against ESG pushes regulatory timelines back or gives investee firms a break. In fact, investors should pay close attention to whether current and prospective US-based portfolio companies will be subject to complex, stringent ESG reporting requirements in the form of the EU’s Corporate Sustainability Reporting Directive (CSRD). And, importantly, investors should do the work to determine whether those companies are taking the proper steps to prepare.
Larger European companies with significant operations in the EU are, for the most part, already aligned with the majority of CSRD requirements — which build on existing ESG practices and reporting directives — because most of them will have to report 2024 CSRD data in 2025.
Short runway for preparation
The scenario could be clearer for companies outside the EU. But one thing is certain, no company with EU operations or a listing on an EU stock exchange can ignore CSRD; it will affect nearly all those firms to some extent — and for many, it will affect them significantly.
CSRD places a range of new responsibilities on US and other non-EU companies, and investors should do the due diligence to judge whether companies are prepared for the directive — operationally, financially and from a governance, human resources and strategic perspective. If they appear to be lagging, investors may need to do some prompting and/or offer support. At the very least, investors should begin determining the questions to ask companies in their portfolios.
With that backdrop, here’s a sketch of the CSRD landscape for US companies.
US and other non-EU companies that annually generate over €150 million in revenue and significant EU subsidiaries (minimum annual revenue of €40 million) will need to report 2028 data in 2029 at the latest.
But many non-EU companies will have to comply much sooner. Firms based outside the EU that are already subject to previous EU Non-Financial Reporting Directive (NFRD) regulation and have EU-listed securities and more than 500 employees will need to report 2024 CSRD data in 2025. Similar companies with 250-500 employees, revenue over €40 million or balance sheets over €20 million (satisfying any two out of three conditions) will have to report 2025 CSRD data in 2026. And many small- to medium-sized enterprises (SMEs) with EU-listed securities and consolidated revenue between €8-€40 million, a balance sheet of €4-€20 million, and between 50-250 employees (satisfying any two out of three conditions) will need to report 2026 data in 2027 — although SMEs can opt-out until 2029.
While it may seem like non-EU companies have a comfortable runway ahead of them to get ready to report CSRD data, the reality is that many of the requirements are complex and may require strategic shifts, a new level of financial analysis, subsidiary-specific analyses that hasn’t been done before, deep research into supply chains, and a new mindset or perspective when it comes to ESG. In other words, given the task, time is short.
New levels of ESG rigour
Non-EU companies — especially US companies — tend to be less mature in ESG than EU companies, due to looser, or non-existent, national and regional ESG regulations. This means there’s more work to be done to align ESG reporting.
Many US companies are accustomed to only reporting quantitative and qualitative sustainability KPIs in a discrete ESG or sustainability report. Even for non-EU companies, CSRD will require that sustainability data for EU subsidiaries be reported together with the company’s financial data within the company’s annual report. Beyond that, these companies will need to include in their annual reports how ESG KPIs are being integrated into the company’s governance, strategy, risk management approaches, executive remuneration schemes and financial decision-making processes.
Suppose the US company has numerous EU subsidiaries, including in other jurisdictions, that are subject to CSRD. In that case, the company will likely be best placed to report the sustainability data of each subsidiary on a consolidated basis within the annual report.
And CSRD will make non-EU companies report on variables they haven’t focused on before. For instance, many US companies are accustomed to reporting mainly on carbon emissions and their plans for reducing them. Depending on the results of the ESG double materiality assessment, CSRD may also require them to report on their EU operations’ use of resources, waste and the degree to which the company is advancing resource efficiency and the circular economy. Similarly, companies may be required to disclose the working conditions of their own workforce in much greater detail and explain processes used to promote the creation of equal opportunities and fair remuneration. And that, too, must be reported in the context of business strategy, risk management and financial impact.
Further, CSRD encompasses a company’s — or subsidiary’s — whole value chain. The company must gain a deep understanding of, and ultimately report, the number of suppliers it works with, its sustainability policies, and the overall impact these supplier operations have on society and the environment. This value chain requirement entails a time-consuming and sometimes arduous process.
Double materiality and assurance
CSRD also calls on companies to report through the lens of ‘double materiality’. This means a company, or subsidiary, must report both on how sustainability issues affect its business (‘outside in’) and how the company’s activities impact society and the environment (‘inside out’). Double materiality pushes companies to examine and report on how their actions affect the resources and people they rely on to sustain operations. This is a cornerstone of the regulation as it helps discover which ESG topics and KPIs are relevant to each company in the scope of the CSRD.
Another layer of complexity: If a US company believes it cannot comply entirely with CSRD, it must figure out the ramifications. And that is not clear cut, as repercussions will vary depending on what EU jurisdictions the operations are in. Each EU member will eventually have its draft guidelines. For instance, the fines or processes may be different in Germany than in the Netherlands.
Finally, the CSRD data that companies report must be externally audited. This puts the onus on companies to develop and report high-quality data — and build in the time and process for that to be vetted by a CSRD-accepted third party.
The imperative for diligent investors
Given the complexity and breadth of CSRD requirements, investors would benefit from ensuring that company leadership has at least started to work to understand whether its EU subsidiaries will be subject to CSRD requirements. And in the process of doing that, leadership should nail down the timeline that applies to the company or subsidiary.
Next, the company needs to make sure it has a working group or outside experts in place to perform the gap analysis that lays out what the company will need to do that it isn’t already doing to be in a position to align with CSRD. And the company may have to conduct complete gap analyses for several EU subsidiaries and the organisation overall.
It will be helpful for companies — and their investors — to recognise that it will pay off to start right now to build, incrementally, the most needed programmes so that by the time the company is required to report, almost all the variables align with CSRD. Now is the time for US companies with EU-based operations to internalise the notion that ESG must be at the core of their strategy and risk management approach.