European Union rules on ESG and directors’ duties

The European Union (EU) has been at the forefront of generating environmental, social, and governance (ESG) legislation and guidance with overarching aims to enhance transparency, traceability and corporate responsibility, including the promotion of sustainable finance and reporting measures which are intended to drive capital allocations to sustainable activities and investments. Many of these developments already, or will in quite short order, impose additional obligations for companies, and in turn additional duties and responsibilities for their respective directors and officers. For financial institutions, these duties and responsibilities also extend to the products and services offered by those institutions.

We set out below some of the current key legislation and guidance and their legislative status (where relevant). The scope and applicability may differ depending upon the size and sector of companies as well as the types of business activities they undertake.  Where legislation remains at the proposal stage, it may be subject to significant changes in scope and substance. 

The overview below is intended as a guide only – this is a rapidly evolving area of law. If you have any specific questions on how these rules might impact your company or directors, or their current status, we recommend speaking to your local CMS expert indicated in the relevant country page in this guide.

The CSRD entered into force on 5 January 2023 and has a phased application beginning from the 2024 financial year, for reporting in 2025. It aims to drive accountability and transparency by modernising and strengthening the rules concerning the social and environmental information which companies need to report. It is expected that, by ensuring that adequate and comparable information on the impact of companies on people and the environment is made available to investors and other stakeholders (including the public and NGOs) they will be better able to assess the potential financial risks and opportunities arising from climate change and other sustainability issues. 

The CSRD significantly expands the remit and scope of the existing Non-Financial Reporting Directive (“NFRD”), which was considered by the EU to be ineffective. Sustainability information to be reported under the CSRD comprises impacts, risks and opportunities relating to environmental, social and human rights and governance factors such as a company's business model and strategy, time-sensitive targets, management board role and expertise, policies, incentive schemes, due diligence processes and principal risks, to the extent such factors are related to sustainability matters. Companies must also provide information on processes they have in place to identify such sustainability information. 

Companies subject to the CSRD must report information according to the European Sustainability Reporting Standards (“ESRS”) contained in a delegated regulation which applied from 1 January 2024. Sector specific standards are expected to apply in the future, but as of June 2024 their adoption has been delayed. Companies will be required to report on a "double materiality" approach: (a) how their business is impacted by sustainability risks and opportunities, and conversely (b) how their activities impact the environment and wider society. 

Companies already subject to the NFRD will be the first class required to report on sustainability matters in their annual reports, followed by other large EU and Non-EU entities, then listed SMEs and finally non-EU undertakings with a significant EU presence.  The progressive implementation of the CSRD and the different categories of companies concerned are specified in the table below: 

The Taxonomy Regulation is a classification framework which is designed to help identify whether activities undertaken by businesses are “environmentally sustainable”. It is considered to be a cornerstone of the EU’s sustainable finance framework, linking companies in scope of CSRD and financial institutions in scope of the Sustainable Finance Disclosure Regulation (“SFDR”) which is outlined further down the page. 

The Taxonomy Regulation is intended to be developed and expanded over time but, as of January 2024, it covers certain economic activities under the following six environmental objectives:  

1. climate change mitigation
2. climate change adaptation
3. sustainable use and protection of maritime resources
4. transition to a circular economy
5. pollution prevention and control
6. protection and restoration of biodiversity and ecosystems.  

With those six objectives in mind, the Taxonomy Regulation sets out the following four overarching conditions which must be met for an economic activity, and therefore an investment into such activity, to qualify as environmentally sustainable:

1. Substantial Contribution – the activity must substantially contribute to at least one of the six environmental objectives;
2. No Significant Harm – the positive contribution of the activity to one of the six objectives must not be to the detriment of any of the other objectives;
3. Minimum Social Safeguards – the activity must comply with minimum social safeguards, such as by conducting business responsibly in line with the OECD Guidelines for Multinational Enterprises, UN Guiding Principles on Business and Human Rights and ILO Principles;
4. Technical Screening Criteria – the activity must comply with any defined technical screening criteria to be established by the European Commission for each environmental objective through delegated and implementing acts. 

While there are no specific directors’ duties or sanctions under the Taxonomy Regulation, companies  in scope of the SFDR and CSRD are  required to provide metric disclosure on their Taxonomy Regulation measured against their capex, opex  and turnover. 

The CBAM is a tool developed by the EU designed to put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries. The aim is to effectively adjust the price paid for the embedded carbon emissions generated in the production of goods imported into the EU against the carbon price of domestic production, to ensure importing activities are harmonised to the EU’s climate objectives. 

The CBAM is currently in a transitional period which commenced on 1 October 2023 (requiring reporting obligations for EU importers), and will apply definitively from 1 January 2026 (requiring EU importers to submit a CBAM declaration and purchase certificates).

During the transitional period, the CBAM applies to imports from countries outside the EU into the EU of certain goods whose production is carbon intensive and at most significant risk of carbon leakage such as cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. 

The CBAM requires EU importers of in-scope goods to report greenhouse gas emissions (both direct and indirect) which are embedded within their imports. Relevant importers need to be registered with the CBAM Transitional Registry, access to which is requested through the National Competent Authority of the importer’s Member State. 

On 23 February 2022, the European Commission proposed the CSDDD to “foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance”. 

On 24 May 2024, the Council of the European Union approved a heavily revised version of the CSDDD. 

In this respect, the CSDDD will apply to:

• EU companies with more than 1000 employees and a net worldwide turnover of more than EUR 450 million;
• EU ultimate parent companies of groups that reach these thresholds; and
• Non-EU companies that generate net turnover of more than EUR 450 million in the EU (regardless of the number of their employees). 

There are also thresholds for companies that enterinto franchising or licensing agreements in the EU with independent third-party companies in return for royalties (in specific circumstances). In this sense, the CSDDD will apply to companies having more than 1,000 employees with global net turnover of more than EUR 80 million and which generate more than EUR 22.5 million through loyalties from franchising or licensing agreements with an independent third-party. The same requirements will apply to non-EU companies but without the employee threshold. 

Specific exemptions apply for (a) ultimate parent companies that are non-operational (b) companies that cease to meet the applicable criteria for each of the last two relevant financial years and (c) alternative investment funds and UCITS. 

The text does not include different thresholds or other provisions that apply to companies operating in high-risk sectors.  

The CSDDD will establish a corporate due diligence duty upon in-scope companies and will require the implementation of processes that willenable companies to identify, bring to an end, prevent, mitigate and account for negative human rights and environmental impacts in an in-scope company’s own activities as well as those of its subsidiaries and wider supply chains to ensure that operators along an in-scope company’s entire supply chain operate in a sustainable manner. 

While there are no specific provisions on directors’ duties in the CSDDD, companies (and consequently their directors) willstill need to consider how to integrate the due diligence obligations under the CSDDD into a company’s own policies and risk management systems in such a way that the effectiveness of such processes can be readily monitored. 

Member States are expected to supervise companies’ compliance with their due diligence obligations and are empowered to impose fines upon companies that default on their obligations. The maximum limit of financial penalties will be not less than 5% of the net worldwide turnover of the company in the financial year preceding the fining decision. 

The CSDDD will be enforced with a phased approach based on company size and turnover, grouped as follows:

• From 2027 (3-years following the CSDDD coming into force)for companies with more than 5000 employees and €1,500 million turnover;
• From 2028 (4 years following the CSDDD coming into force) for companies with more than 3000 employees and €900 million turnover; and
•  From 2029 (5 years following the CSDDD coming into force) for companies with more than 1000 employees and €450 million turnover and for companies that have entered into franchising or licensing agreements with more than €80 million turnover in the EU and €22.5 million in royalties . 

EU Member States have two years from the date of implementation to transpose the Directive into national law and must also establish supervisory authorities and take appropriate measures for the implementation of the requirements of the CSDDD. 

SFDR was one of the first pillars of the EU’s drive to reorient capital to more sustainable investment. Unlike the other legislation explained in this chapter, SFDR does not have general corporate application but instead applies to certain financial institutions and the investment products those institutions make available.

SFDR initially came into force in 2021, with the aim of improving the transparency and comparability of certain investment products.  It requires financial market participants (“FMP”s) – such as asset managers, investment advisers and pension funds – to disclose detailed information at both an entity and product level. 

There are many obligations under SFDR applying at both an entity level and product level. These include public disclosures in relation to an FMP’s approach to the integration of sustainability risks in the investment decision making process and how the entity takes into account principal adverse indicators, as well as the likely impact of sustainability risks on their financial products. 

For financial products (including investment funds made available in the EU, and therefore bringing into scope any non-EU domiciled funds marketed to EU investors), detailed compulsory disclosures must be provided in respect of products which either promote environmental and/or social characteristics or which have sustainable investment as their objective. These disclosures include pre-contractual, periodic and website disclosures on the sustainable elements of the fund, with the requirement for detailed qualitative and quantitative information. 

The EU Level 2 requirements of SFDR came fully into force as at 1 January 2023. However, SFDR is currently subject to a thorough consultation intended to consider whether the directive has met its aims. There have been many issues with the application of SFDR since 2021, including its use as a labelling rather than transparency regime; its subjectivity (and therefore lack of comparability); whether it is fit for purpose across public markets (do retail investors understand?) and private markets (do institutional investors need or want the mandatory information?).

While SFDR was a groundbreaking piece of legislation which led the way for CSRD and other initiatives outside of the EU, it is now (as of June 2024) in a period of uncertainty which is likely to continue for a significant period of time.