Approximately 3,000 U.S. companies must comply with new EU rules, and many are not prepared. Here’s what they should know.

By Harry Etra, Managing Director, North America ESG at Morrow Sodali

Many U.S. companies with substantial business in Europe are not prepared for new sustainability disclosure regulations. We are at an inflection point for companies to understand their exposure to upcoming regulations and take concrete action.

The EU Corporate Sustainability Reporting Directive (CSRD) takes effect next year and should be top of mind. About 50,000 companies globally will be affected, compared to just 11,000 affected by the directive’s predecessor, the Non-Financial Reporting Directive (NFRD). There will be phasing in of some requirements, and longer timelines for smaller companies. Still, while large multinational firms with dedicated sustainability departments are likely better positioned for compliance, smaller firms in scope of the CSRD should not delay.

Below are three important aspects of the CSRD for companies to know.

Value Chain Emissions in the Spotlight

Many U.S. companies have been disclosing only scope 1 and 2 emissions, or none at all. That will no longer suffice for many firms with business in Europe. The CSRD mandates reporting of scope 3 greenhouse gas (GHG) emissions, also known as value chain emissions. For many businesses, scope 3 represents more than 70 percent of their total carbon footprint. Companies cannot always control these emissions, such as how their employees commute or products are used downstream.

The disclosure requirements are challenging, but achievable. Companies will need to compile data from various parts of their operations and supply chain to comply with the new rules. Data advisory support can help ensure bullet-proof data, while carbon accounting platforms can serve as the single source of truth for companies’ reporting. Accurate and comprehensive GHG inventories not only serve as effective tools for compliance and disclosure, but also unveil opportunities for operational cost reductions and overall efficiency.

Unlocking Priorities: How Double Materiality Enhances Due Diligence

European regulators have prioritized double materiality to hold companies accountable for their impacts outside the balance sheet. Such impacts can be material, the rule argues, and thus should be disclosed. U.S. companies affected by the CSRD must complete a double materiality assessment, which considers not only what is material to the company, but also how the company impacts the environment and society.

Think of conducting a double materiality assessment as hitting the reset button on short- and long-term priorities to address key risks and opportunities. The mandate offers an opportunity for companies to weigh the significance of various sustainability issues to their business. From climate change to supply chain risks to shifting demographics, different issues may impact financial performance, long-term sustainability, or reputation to varying extents.

Keep in mind that double materiality assessments will be subject to audit and verification, so careful documentation of all processes and preparation for third-party assurance is imperative.

Enhanced Oversight and Data Management

The Sarbanes-Oxley Act, a congressional response to corporate abuses, upended corporate governance and financial practices in 2002. The Act’s financial data disclosure requirements were difficult and expensive for companies to implement, but ultimately led to greater efficiency and transparency for investors. Now, sustainability reporting is undergoing a similar transformation. The CSRD is a new frontier for sustainability regulation that raises the stakes for sustainability reporting.

ESG reporting – in particular CSRD-aligned disclosure – inherently requires data and information from many different departments. Companies cannot create robust scope 1, 2, and 3 emissions inventories without understanding where data sits, whether within finance, operations, or HR. As such, clear oversight structures and processes around data collection will be crucial. Companies must also prepare for eventual assurance requirements and should consider identifying and implementing new systems and controls for ESG-related data to ensure auditability and reliability.

For U.S. companies that want to stay competitive in Europe, the transformation of their ESG reporting begins now. Conducting scope 3 emissions inventories and double materiality assessments can be time- and labor-intensive. However, insights gained from these preparations can be used to strengthen risk management practices, better inform capital allocation and budgeting decisions, and build stronger business cases for implementing and investing in sustainability initiatives. U.S. companies in scope of the CSRD should take this opportunity to consider the value creation potential for their stakeholders beyond compliance.

About the author:

Harry Etra is Managing Director, North America ESG at Morrow Sodali. Etra’s experience is in advising public and private companies on their sustainability and environmental, social and governance (ESG) strategies.