Environmental, social and governance | UK Regulatory Outlook January 2023
Published on 27th Jan 2023
EU Corporate Sustainability Reporting Directive | Deforestation – free supply chains regulation | Approval of final text of corporate sustainability due diligence directive in 2023
EU Corporate Sustainability Reporting Directive
As mentioned in our previous Regulatory Outlook, the Corporate Sustainability Reporting Directive (CSRD) was adopted by the European Parliament and Council at the end of last year. Since then, the final version of the directive has been published in the Official Journal and entered into force on 5 January 2023.
The CSRD looks to extend existing requirements under the Non-Financial Reporting Directive 2014/95/EU (NFRD). The NFRD currently obligates financial market participants to disclose non-financial and diversity information (which is aligned with and benchmarked against the six environmental sustainability objectives outlined in the EU Taxonomy Regulation).
The application of the CSRD will take place in four stages:
- EU "public interest" company – reporting due from 2025 for financial years starting on or after 1 January 2024.
- EU large company – reporting due from 2026 for financial years starting on or after 1 January 2025.
- EU small or medium-sized company – reporting due from 2027 for financial years starting on or after 1 January 2026.
- Non-EU company – reporting due from 2029 for financial years starting on or after 1 January 2028.
The first set of EU sustainability reporting standards, which will underpin the reporting, were adopted in November 2022.
The obligation arises if an organisation is:
- An EU "public interest" company with more than 500 employees.
- An EU large company with a €20m balance sheet total, a €40m net turnover and/or an average of 250 employees during a financial year.
- An EU small or medium-sized company listed on a regulated market (except for listed micro undertakings) with a €4m balance sheet total, a €8m net turnover and/or an average of 50 employees during a financial year.
- A non-EU company with €150m net turnover generated in the EU (for each of the last two consecutive years) and the company has at least one subsidiary/branch in the EU.
For more details on whether your business will fall within the scope of this directive and your obligations, please see our Insight.
Deforestation – free supply chains regulation
The European Parliament and Council of EU reached a provisional political agreement on a regulation on deforestation-free supply chains at the end of last year. It will require companies to issue due diligence statements regarding goods placed on, or exported from, the EU market.
Operators and traders will have to prove that products placed on the market are deforestation-free (meaning that they were produced on land that was not subject to deforestation after 31 December 2020) as well as to verifying compliance with legislation in relation to human rights and the rights of indigenous people.
According to the agreed text, while no country or commodity as such will be banned, companies will not be allowed to sell their products in the EU without this due diligence statement. This regulation will not apply to products that were already placed on the market before the date it comes into force (date to be confirmed).
The products covered by the legislation include palm oil, cattle, soy, coffee, cocoa, timber and rubber, as well as those products derived from these commodities, such as leather, chocolate and furniture. They have also included rubber, charcoal, printed paper products and a number of palm oil derivatives. A list of the products that fall within the scope can be found in Annex I.
Penalties for non-compliance with the regulation will be set at the maximum of 4% of the total annual turnover in the EU of the infringing operator or trader.
The earliest date for coming into force is in June 2024. The EU will need to formally adopt the new regulation before it can enter into force. Once in force, obligated entities will have 18 months to implement the new rules.
Even though this regulation will not come into force for at least 18 months, businesses should start thinking about communicating with your supply chains to understand the source of your products that fall under the scope of this regulation.
The UK is taking a similar approach. The Department for Environment, Food and Rural Affairs (Defra) recently confirmed that there will be due diligence requirements introduced under the Environment Act 2021 (see Part 2 to Schedule 17) for forest-risk commodities. Secondary legislation will be introduced to set out the details of the illegal deforestation provisions and the due diligence system that companies will have to follow. At time of writing, there has not been any mention of exactly when these regulations may come into force, but it could occur in 2023.
Approval of final text of corporate sustainability due diligence directive in 2023
On 1 December, the European Council adopted its negotiating position ("general approach") on the corporate sustainability due diligence directive (CSDD).
As detailed in an earlier Regulatory Outlook, under the CSDD qualifying companies will have a duty to undertake due diligence to identify actual and potential adverse impacts of their activities on human rights and the environment. Potential impacts will need to be prevented or mitigated and actual impacts will need to be minimised or stopped. These include child labour and the exploitation of workers and the environment, irrespective of whether the activities occur in the company’s own operations, their subsidiaries or in their value chain.
Practically businesses will need to:
- Integrate due diligence into policies.
- Identify actual or potential adverse human rights and environmental impacts .
- Prevent or mitigate potential impacts.
- End or minimise actual adverse impacts.
- Establish and maintain a complaints procedure (which allows interested parties with legitimate concerns to submit complaints of actual or potential human rights or environmental impacts).
- Monitor the effectiveness of these measures and policies.
- Publicly communicate on due diligence efforts.
- Directors will need to take into account the sustainability consequences of their decisions.
The new rules will apply to:
- An EU limited liability company with 500+ employees and €150m in net worldwide turnover (Group 1);
- An EU limited liability company with 250+ employees and €40m in net worldwide turnover which operate in defined high impact sectors (which includes the following relevant sectors: food product manufacturing and trading agricultural raw materials/wood/food/beverages) (Group 2). Group 2 companies will have two more years to adapt to the directive before the legal effects come into force; and
- A non-EU company active in the EU, which has a turnover generated in the EU that meets the Group 1 or Group 2 thresholds. A direct link with and activity in the EU for the purpose of being caught is established by the generation of turnover by the company in the EU.
The general approach reached on 1 December completes the negotiating position agreed by the Council and the proposals still needs to be negotiated with the European Parliament, which is expected to adopt its position in March 2023.
Once adopted, Member States will have two years to transpose the directive into national law, meaning the earliest that the obligations under the CSDD will apply is from 2025.
FCA announces its plans to develop Code of Conduct for ESG data and ratings providers
In November 2022, the Financial Conduct Authority (FCA) announced the formation of a working group to develop a Code of Conduct for ESG data and ratings providers.
While the FCA does not currently regulate ESG data and ratings providers, in order to support greater transparency and trust in the market for ESG data and ratings services, it has previously supported the extension of its regulatory perimeter in this way. While the government considers this, and to maintain momentum, the FCA has worked to convene, support and encourage industry participants to develop and follow a voluntary Code of Conduct. The group, which will aim to meet for the first time later this year, will want to ensure that the code is internationally consistent, by taking into account not only recommendations of the International Organization of Securities Commissions (IOSCO) but also developments in jurisdictions such as Japan and the EU. This will help encourage the development of consistent global standards. A code could also continue to apply for ESG data and ratings providers that fall outside the scope of potential future regulation.
Please see our recent Insight on this topic for more details.
The Taskforce on Nature-related Financial Disclosures
The Taskforce on Nature-Related Financial Disclosures (TNFD) is an international initiative that builds on a model developed by the Taskforce on Climate-Related Financial Disclosures (TCFD). It seeks to provide a framework for how organisations can address environmental risks and opportunities.
The TNFD was launched on 4 June 2022 and is expected to publish a list of recommendations to support businesses in disclosing the nature-related risks and opportunities relating to their governance, strategy and risk management processes (as well as any metrics or targets used by the business to assess nature-related considerations). The final list of recommendations is expected to be published in September 2023.
The expectation is that the recommendations of the TNFD will be implemented to complement the existing TCFD framework and will initially target large financial institutions and corporate entities on a voluntary basis.
However, if the TNFD recommendations are given equal regulatory weight as the TCFD, we anticipate that the recommendations will become mandatory for businesses on a phased basis in coming years.
For more information about the impact of biodiversity on business, read our Insight.