ESG due diligence: current regulatory framework and a look to the future
Category: Corporate law
For years, due diligence has played a key role in mergers and acquisitions. Before a purchase agreement is concluded, the company set to purchase or be purchased is usually meticulously analysed in terms of its economic, legal, tax and financial circumstances. Given that sustainability has recently also gained significance for companies in today’s society, the role of environmental, social and governance (ESG) due diligence has also increased considerably. ESG due diligence looks into whether a company is acting in accordance with sustainability regulations.
The EU Action Plan on Financing Sustainable Growth and the European Green Deal have introduced several regulations. These plans were drawn up in response to the Paris Climate Agreement. In this blog entry, I will be exploring the current European sustainability schemes for listed companies and possible future developments.
Non-Financial Reporting Directive
The Non-Financial Reporting Directive (NFRD) was established in 2014 and has been in force since 2018. Pursuant to the NFRD, public-interest entities with more than 500 employees must provide so-called non-financial information in their annual accounts or annual report. Many listed companies fall within the scope of this directive. Non-financial information is divided into three categories:
- Information on the business model
- Information on environmental, social and employee matters, respect for human rights, and anti-corruption and bribery matters, and
- Information on non-financial key performance indicators (such as how future-proof the undertaking’s performance is).
To help gain a better picture of the minimum requirements of the NFRD, the European Commission has issued additional non-binding guidelines.
Sustainable Finance Disclosure Regulation
The Sustainable Finance Disclosure Regulation (SFDR) came into effect on 10 March 2021. Financial market participants and financial advisers fall within the compass of the SFDR, which means that it basically applies to all asset managers.
The SFDR aims to implement a harmonised framework for the provision of information on sustainability aspects of financial products with an investment component. The SFDR contains a transparency obligation that requires financial market participants to publish information on their website regarding how sustainability risks are integrated into their investment processes. The aim is to protect investors so that they can make informed investment decisions.
Taxonomy Regulation
The Taxonomy Regulation, which was published on 22 June 2020, partly entered into force on 1 January 2022. The rest of the regulation is slated to take effect on 1 January 2023. The Taxonomy Regulation establishes a framework of criteria for assessing whether or not economic activities are environmentally sustainable and lays down a classification system to indicate the environmental sustainability of an investment. An environmentally sustainable investment:
- Must make a substantial contribution to at least one of the six environmental goals set out in the regulation
- Must not seriously infringe on any other environmental goal, and
- Is conducted in accordance with the minimum requirements on social standards, such as labour and human rights.
First and foremost, the Taxonomy Regulation applies to all measures taken by Member States or the EU concerning financial products or corporate bonds marketed as environmentally sustainable investments. Moreover, the regulation applies to financial market participants providing financial products. For the rest, the scope of the Taxonomy Regulation ties in with that of the NFRD.
Corporate Sustainability Reporting Directive
In April 2021 the proposed Corporate Sustainability Reporting Directive (CSRD) was adopted, and many companies will be affected from 2024/25. The aim of the CSRD is to achieve harmonisation at a European level in the field of regulations on sustainability reporting. In terms of content, it is a proposal to amend the NFRD. This means the scope of the CSRD is considerably broader than that of the NFRD and also includes extensive reporting requirements.
The CSRD applies to all companies listed within the EU, as well as all companies complying with two of the three size criteria based on accounting law, i.e. having more than 250 employees, and a turnover of more than EUR 40 million or a balance sheet exceeding EUR 20 million.
In terms of reporting requirements, companies must use what is known as “double materiality” as a starting point. This means that the reporting obligation is divided into two. Not only must companies report on how sustainability factors affect their business, but also on the impact of their corporate activities on society and the environment.
SFDR Regulatory Technical Standards
The disclosure obligations in the Taxonomy Regulation and the SFDR are further elaborated in the Regulatory Technical Standards (SFDR RTS). The SFDR RTS aim to establish a single rulebook for sustainability reporting by providing an explanation of the obligations generally formulated in the aforementioned regulations. The SFDR RTS is expected to enter into force on 1 January 2023.
Blenheim advises companies
In 2022, companies are required to deal with an extensive regulatory framework for ESG due diligence, which is only expected to continue growing. This is why it is vital to take these regulations into account when performing due diligence.
Should you have any questions about the information provided above, please do not hesitate to get in touch with Blenheim’s Corporate Team. Our lawyers are highly experienced in advising companies on mergers and acquisitions.