Caught between EU and UK ESG laws? What every business needs to know

The case for reporting on Environment, Social and Governance (ESG) is settled. While the political winds may be blowing against an over-emphasis on certain aspects of the ESG agenda, it is very clear that the way companies approach the combination of the three factors provides investors and stakeholders with a good view of how a business manages its risks.

It is accepted that systematic and transparent reporting provides the discipline to measure, manage and make incremental improvements.

Systematic and transparent reporting provides the discipline to measure, manage and make incremental improvements

However, the level of the reporting requirements has not yet been fully settled. In this article, we are examining the implications for UK-based businesses around the ongoing debate about the right level of reporting, and the differences between the UK and EU regulatory approaches to ESG reporting.

Similar target audiences

The UK regulations require all companies listed on the London Stock Exchange to report on their ESG activities, as well as UK-based businesses listed on regulated markets in the European Economic Area and the US. The regulations also apply to UK-incorporated companies and Limited Liability Partnerships that meet at least two of:

• More than 250 employees
• Annual turnover greater than £36 million (€42 million)
• Balance sheet total exceeding £18 million (€21 million)

The EU’s approach follows a similar pattern. Again, the regulations cover listed business and unlisted business for a certain size. Like the UK, that means more than 250 employees. But the financials are slightly different: over €50 million revenue or a balance sheet of over €25 million.

In addition, companies with €150 million or more in net turnover generated within the EU for two consecutive years are subject to the EU’s regulations.

That is where any similarities end.

UK’s international approach

The UK is taking a more general approach, aligning with global standards, in particular the requirements set out by International Sustainability Standards Board (ISSB), with the objective of compatibility with other countries. Much of the focus is on financial materiality of ESG factors, which reflects the ISSB investor focus.

In addition, financial firms providing sustainable investment products in the UK must adhere to the Sustainability Disclosure Requirements (SDR), which are designed to increase transparency and reduce greenwashing.

It also uses the Task Force on Climate-related Financial Disclosures (TCFD), the global initiative established by the Financial Stability Board to develop a standardised framework for companies to disclose climate-related financial opportunities and risks.

The third pillar is the UK’s Streamlined Energy and Carbon Reporting (SECR), which requires businesses to disclose their energy consumption and the resulting greenhouse gas emissions

Finally, the UK is developing its own Green Taxonomy, with the aim of supporting market participants to make sustainable investment decisions, and the specific market and regulatory use cases which facilitate this. It is still in the consultation phase.

The EU is seeking to lead

The EU, however, has developed its own specific, prescriptive and detailed reporting requirements that are more stringent than the UK’s and for many companies, the current default international reporting guidelines.

The Corporate Sustainability Reporting Directive (CSRD) mandates specific reporting requirements across the E, S and G areas, as stipulated in the European Sustainability Reporting Standards (ESRS). It includes a requirement for a double materiality, with companies asked to report on their impact on environment and society in addition to the financial impact that ESG factors have on the company (inside-out and outside-in).

And EU ESG reports are required to have third-party assurance.

The EU has also progressed its green taxonomy, based on six principles that go far beyond economic impact:

1. Climate change mitigation
2. Climate change adaptation
3. Sustainable use and protection of water and marine resources
4. Transition to a circular economy
5. Pollution prevention and control
6. Protection and restoration of biodiversity and ecosystems

Implications for businesses

As a first step, companies covered by the regulations must understand exactly what is required of them, both in terms of the big picture and the detail, and decide on their reporting strategy.

There is, of course, a cost attached to compliance. Most businesses have an ESG team as well as using external consultants to help them ensure they are on track and to help prepare their reports. The financial materiality assessment shows whether the measures are cost negative, positive or neutral.

There are also significant costs attached to not complying. For the EU, that could mean fines of millions of Euros, exclusions from public procurement contracts and even restrictions to bank loans. In the UK, non-compliance can mean fines of up to 4% of a business’ global turnover, up to £20 million, and even two years in prison for company directors.

More broadly, not complying can mean loss of business opportunities as buyers keep an eye on their own Scope 3 requirements.

For most companies, the best way to meet UK and EU ESG reporting requirements is to integrate sustainability considerations into strategic decision-making, meeting the general requirements and intentions of both regimes. This should drive continuous improvement, as well as providing transparent information to all stakeholders.

For most companies, the best way to meet UK and EU ESG reporting requirements is to integrate sustainability into strategic decision-making.