Should European companies outside of the EU get ready for ESG disclosure?

Updated: Sep 26, 2021

The common goal for corporates from the EU is primarily based on the Paris Agreement effective in 2016, which is consistent with the EU's commitment to being NetZero by 2050, achieving 50% emission reduction by 2030 and limiting global warming within 1.5 degrees Celsius.

With the EU Taxonomy regulation come into the light, the goal is set even clearer in order to maximally mitigate greenwashing, which can break down into 6 detailed goals that each company should self-assessed and disclose on a yearly basis.

  • Goal 1: Climate change mitigation

  • Goal 2: Climate change adaptation

  • Goal 3: Water & Marine Resources

  • Goal 4: Circular Economy Transition

  • Goal 5: Pollution Prevention & Control

  • Goal 6: Biodiversity & Ecosystem Protection

With the goals in mind, we can then move on to how corporates can achieve them. Reporting on sustainability is apparently not the ultimate goal but a way to present the process and actions that companies take to contribute and eventually achieve the goal of the Paris Agreement.

What ESG related regulations are impacted?

For the EU corporates, several ESG related regulations have been made, such as NFRD, EU Taxnomy and SFDR:

NFRD stands for the Non-Financial Reporting Directive. Since 2018, a mandatory ESG disclosure requirement has been put forward by NFRD. Specifically, for large public-interest companies with more than 500 employees, NFRD requires them to disclose ESG data related to the corporate business operations. Up to now, this requirement has covered approximately 6,000 large companies and groups across the EU, including listed companies, banks, insurance companies, and other companies designated by national authorities as public-interest entities.

On top of NFRD, EU Taxonomy regulation comes into effect in 2020, aiming to help companies contributing to the Paris Agreement. At the same time, EU taxonomy not only affects non-financial companies but also works on financial firms. In this way, through EU taxonomy regulation, investments can be assessed according to strict criteria before being labeled as "environmentally sustainable".

Different from NFRD, SFDR, Sustainable Finance Disclosure Regulation applies also to financial firms, aligning to the EU Taxonomy regulations. The three regulations, NFRD, EU Taxonomy, and SFDR, coordinate with each other, and the disclosure requirements are consistent among three of them.

Since now corporates not only need to respond to their stakeholders, such as suppliers, clients, employees, shareholders, where the disclosure is usually included in the CSR (Corporate social responsibility) report, however, with the increasing demand for disclosure by investors, more and more corporates choose to issue ESG (Environmental, Social and Governance) report to include comprehensive non-financial issues valued by the institutional investors. Based on NFDR, public interest companies with more than 500 employees are obliged to report on their non-financial performance, but for some other regions, the bar of minimum employees could be potentially lowered to 200 employees.

The significant timeline you need to know

As mentioned above, NFRD has been made into the effectiveness from 2018 onwards, which is the first time that ESG factors have been systematically included in legal documents. Required disclosure broadly falls into the following categories: Environmental matters, Social and employee aspects, Respect for human rights, Anti-corruption and bribery issues, Diversity on board of directors.

Although EU Taxonomy has been approved in 2020, the details have not yet been fully available. By the end of 2020, the European Commission will codify what is called "delegated Acts", and by 1 June 2021, the European Commission will specify disclosure obligations for financial and non-financial companies. Finally, by the end of 2021, businesses and investors will be required to disclose against Taxonomy.

Supply chain management becomes more important

Except for the reporting requirement, the internal or external motivation varies from company to company, supply chain sustainability management becomes more and more important.

On average, supply chains account for about 41% of a company’s impact. However, the proportion rises to 59% in the case of a company’s adverse environmental impact, according to the study conducted by Scope, which analyzed 1,600 companies in the MSCI World index. In addition, the more complex the supply chain, the more difficult it is for final producers to track the effects of greenhouse gases through raw material suppliers.

The French Compulsory Protection Act (2017) and the Dutch Child Labor Due Diligence Act (2019) are the first laws in Europe that force companies to consider and report on suppliers’ environmental and/or social standards.

Will subsidiaries or branches outside of the EU be impacted?

The short answer is yes. EU companies' global branches, offices, suppliers, partners are also impacted as well as foreign companies who have a presence in the EU that fall under NFRD need to disclose against Taxonomy's new disclosure requirements.

Basically, Taxonomy criteria are relevant for all members of the Paris Agreement. In regards to EU companies that are based in China, China is a member of the Paris Agreement. Chinese President Xi spoke at the United Nations General Assembly in Sept. 2020 that China aims to achieve a peak in carbon dioxide emissions before 2030 and carbon neutrality before 2060. No matter from which side, taxonomy regulation will either directly or indirectly impact on branches in China.

The disclosure requirement may come from European headquarters since the carbon footprint or carbon emission data will need to cover the entire production process including the plants and the manufacturing suppliers from China and Scope 3 emissions that come from transportation will also need to be calculated. Vice versa, Chinese companies that have a presence in the EU that fall under NFRD will have to comply with the disclosure requirement of NFRD and EU taxonomy.

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