Key European Union ESG Regulations
Sustainable Finance Disclosure Regulation (SFDR) – (EU) 2019/2088
The SFDR requires asset managers and investors to disclose detailed information about how their investment decisions impact ESG issues. Therefore, funds and companies that intend to attract EU capital will need to be transparent about ESG risks and comply with sustainability requirements imposed by EU investors, demanding companies adopt more rigid risk management policies and openly inform their sustainable practices.
Corporate Sustainability Reporting Directive (CSRD) – (EU) 2022/2464
Replacing the Non-financial Reporting Directive (NFRD), the CSRD expands ESG reporting requirements to a wide range of companies (those listed on an EU-regulated market, except for micro-enterprises), including subsidiaries of non-European firms. Companies exporting to the EU will need to provide detailed reports on carbon emissions, social impacts, and corporate governance under the risk of being excluded from the market. The directive aims to prevent greenwashing by ensuring that sustainability claims are verifiable and accurate. The EU is already taking measures to ensure that member states implement the directive, which had its transposition deadline expired on 6 July 2024, showing that the region will not ignore its enforcement.
The GBS establishes requirements for issuing green bonds, financial instruments used to raise funds for projects that have positive environmental benefits. It seeks to ensure the funds are used in sustainable projects. It allows companies to raise capital in the European market, provided they meet the strict environmental criteria imposed. This will require greater transparency in fund allocation and the adoption of verifiably sustainable practices.
This regulation aims to standardize and increase the transparency of ESG performance assessments conducted by rating agencies. Companies will need to ensure that their ESG practices are audited and reported according to European standards if they want to maintain a favorable reputation with European investors.
The Taxonomy Regulation sets criteria for defining an environmentally sustainable activity, representing an important instrument for combating greenwashing while holding companies accountable for their sustainability claims and ensuring they align with measurable, legally defined standards.
According to the regulation, business activity must contribute to at least one of the six environmental objectives listed in its text: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems. However, while contributing to these objectives, companies must observe the “do no significant harm” principle, ensuring that environmental benefits in one area do not come at the cost of damage in another.
The European Climate Law aims to achieve carbon neutrality by 2050, directly impacting international supply chains. Businesses exporting to the EU must adapt their operations to meet carbon footprint requirements, including reducing greenhouse gas emissions across their activities, even if they extend to other jurisdictions.
The law reinforces existing EU policies, and as a result, companies in high-emission sectors may need to implement more transparent reporting systems, invest in cleaner technologies, and adopt sustainable land-use practices to maintain access to the European market. If they cannot comply with the imposed requirement, they might face increased costs, trade restrictions, and reputational risks, making carbon reduction strategies an important factor for long-term business viability.
European Union Deforestation Regulation (EUDR) – (EU) 2023/1115
The EUDR prohibits products from deforested areas from entering the European market after December 2020, whether legally or illegally deforested, and requires compliance with due diligence procedures. Developing countries, and most recently, the United States, have expressed concerns regarding implementing this regulation. It is difficult to assess the negative impacts on non-EU national economies fully, as they will vary depending on the commodity.
Corporate Sustainability Due Diligence Directive (CSDDD) – (EU) 2024/1760
The CSDDD establishes strict obligations for companies––large EU limited liability companies and partnerships with at least 1000 employees and at least EUR 450 million turnover worldwide and large non-EU companies that have EUR 450 million turnover in the EU––to identify, prevent, mitigate, and, when necessary, remedy the negative impacts of their activities on human rights and the environment throughout the value chain. This directive holds companies accountable for their direct operations, supply chains, and trading partners, including raw material suppliers in third countries.
For companies exporting to the EU, the CSDDD requires a thorough review of business practices and those of their suppliers. Compliance involves conducting detailed audits and implementing due diligence policies to ensure no violations of human rights, such as child labor or forced labor, nor environmental impacts, such as illegal deforestation or pollution, in line with the criteria set by the European regulation.
However, recent political shifts in France and Germany threaten the stability of sustainability regulations in the EU. France has proposed a postponement of the CSDDD and a two-year delay in implementing the CSRD, arguing that such regulations undermine competitiveness. Germany is facing political challenges that could weaken its own due diligence laws. Nonetheless, many companies still recognize the benefits of sustainability regulations.
Meanwhile, in the United States, despite President Trump's measures that are not environmentally oriented, investor pressure and market forces continue to drive sustainable business practices. Many companies remain committed to integrating sustainability into their strategies.
Challenges and Opportunities for Corporations
The EU ESG legal framework has grown in recent years, and, considering the key regulations discussed, they represent both challenges and opportunities for companies within and outside the EU. This context attests to the relevance of its understanding and compliance by the actors interested in entering the European market or maintaining its current trade relations.
Adapting to these standards is costly due to the need to invest in technology and organizational structure, especially considering traceability obligations. According to the EU legal framework, companies unable to comply with these regulations may face obstacles in accessing the European market including reputational risks, loss of competitiveness, and even commercial sanctions.
On the other hand, companies capable of adapting to the new legal requirements not only promote responsible conduct, protect the environment, respect human rights, and foster ethical governance but also may gain preferential access to the European market. In addition to this benefit in the EU context, compliance with the ESG criteria also strengthens companies' reputation worldwide, which could attract new investments.
