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Commentary

The Jury is Out

Luma Saqqaf, CEO of Ajyal Sustainability Consulting, considers whether the world’s foremost sustainability accelerator is shooting itself in the foot.

For many years, the world has been keenly eying the EU’s Corporate Sustainability Reporting Directive (CSRD). From an observer’s perspective, it has been fascinating to watch the development of a body of law supporting countries’ sustainability and net zero commitments, and enabling a clearer path to a green economy as outlined in the EU Green Deal. This includes the CSRD as a key tool to mobilise sustainable finance by requiring corporates to disclose various sustainability related aspects.

The implications are clear for companies within the EU’s 27 member states. But perhaps they are less obvious when we think about companies globally – because the CSRD will capture within its scope a significant number of non-EU companies.

According to recent research from financial data firm Refinitiv, reported in the Wall Street Journal, the CSRD will eventually require more than 10,000 foreign companies to significantly step up their sustainability reporting if they want to do business in the EU.

The EU’s CSRD disclosures, labelled in EY research as a “game changer”, include many requirements that do not currently apply internationally. These include how sustainability considerations are integrated into businesses; how material ESG impacts, risks and opportunities are identified using a ‘double materiality’ definition; and various environmental, social and human rights and governance disclosures. 

On a conceptual level, these are brilliant measures. But on a practical level, is the EU shooting itself in the foot? 

Comply or avoid?

There’s no question the EU is going further than any other jurisdiction globally in full advancement of its green and sustainability agenda. But when you start looking at the practicalities, there are potential consequences as the gap widens between what the EU is doing and what the rest of the world is doing. The question becomes to what extent these rules may make companies try to avoid them.

Some will not be able to. Amfori, a global trade association with 2,400 members from more than 40 countries, has even suggested EU legislation could be a matter of survival for Asian supply companies.

But will others, for example companies that are only caught by the CSRD due to listing securities, be attracted to other markets with less stringent requirements? Or perhaps US companies which have substantial activity in the EU but now have to substantially up their reporting at a time when anti-ESG legislation in the US is on the rise.

Could this lead to the emergence of separate sustainability markets as foreign companies consider taking their business elsewhere? There is such a chasm opening between the EU and the rest of the world in terms of sustainability reporting that it could be the beginning of more fragmentation of the markets and more de-globalisation – a movement which has already started.

Last year we saw the Inflation Reduction Act (IRA) passed by US President Joe Biden. In an attempt to expand the clean energy and green tech sectors, the act will provide hundreds of billions of dollars in tax breaks and subsidies for the benefit of companies which are set up in the US. It’s in this climate that companies are already considering if it’s cheaper to operate in the US. Unless these companies see the benefit of following the EU’s sustainability reporting rules, and the extra compliance costs make sense, this could well lead to more fragmentation if more companies are asking: “Is this worth it?”

Conflicting currents

After the sustainability agenda has suffered setbacks over the past year as a result of largely unforeseen geopolitical events – Russia’s war causing countries’ priorities to shift amid energy and food security issues – the EU acting as an accelerator, demanding more from companies, can only be welcomed. After all, much of the onus is on companies to work very fast to avoid climate disaster. This is the EU’s attitude in how it is positioning itself to the rest of the world.

However, there are conflicting currents. While on the one hand, regulators like the EU need to move quickly and with a sense of urgency, on the other there will be resistance from companies outside the bloc because of the immense practicalities they will have to adapt to. Resistance will also come from EU companies which have expressed concern over the speed of requirements versus quality of disclosures and achieving the transparency required by these rules. So, has the EU gone too far for its own good? The jury is out.

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