The ESG “Pillars” for a Sustainability Transition

Introduction

Nowadays, sustainability stands as a prominent topic, widely debated and extensively regulated, undergoing rapid transformation. Financial operators and corporations are paying increasing attention to sustainability – ie, ESG factors and risks according to the EU regulatory framework (see, for example, the definition under Article 2 point (22 and 24) of the Regulation (EU) 2019/2088) – particularly environmental and social factors (such as carbon emissions, employee health, human rights) and good governance practices. This follows the path set by policymakers and lawmakers.

Indeed, the European Union is advancing a deep-rooted, yet still evolving, set of policies and laws related to sustainability. As an example, in the recent years the EU established an ecosystem of regulations on ESG, such as the Sustainable Finance Disclosure Regulation 2019/2088 (SFDR), Regulation 2020/852 (the “Taxonomy Regulation”) and Corporate Sustainability Reporting Directive 2022/2464 (CSRD). In addition, other relevant regulations, such as the Corporate Sustainability Due Diligence Directive (CS3D), the Empowering Consumers Directive (ECD), the Green Claims Directive (GCD) and the ESG Ratings Regulation (the “ESG Ratings”) are about to come.

Within this intricate and ambitious framework, it is undeniable that such regulations now encompass every economic and financial sector, setting new standards for sustainability. This includes ESG data governance, sustainability disclosure, and, above all, sustainable corporate governance. Strategy, business practices, governance structures, fiduciary duties, director’s liabilities, risk management, supplier and value chain relationships, stakeholder engagement, ESG reporting and claims are just a few examples of the multifaceted nature of sustainability in EU legislation.

Sustainable finance

The EU policymaker, within the “Action Plan: Financing Sustainable Growth” (the “Action Plan”) identified the financial sector as the leverage to accomplish the ambitious, concrete goals set by the 2015 Paris Agreement and the UN Sustainable Development Goals. At the core of this process is the intention to transition from non-binding policies (soft law) to mandatory regulations (hard law). In this context, the SFDR introduced specific and harmonised sustainability disclosure requirements for financial market participants and financial advisers operating in the member states, and in less than three years since its entry into force (on 10 March 2021) the landscape of financial products and services in the EU market significantly changed.

Among the innovative features of the SFDR, first of all, there is the emersion of ESG factors related to financial products. Sustainability is no longer a voluntary practice but a mandatory component in pre‐contractual disclosures, as well as in periodic reports for investors. Second, ESG issues must be disclosed from both the “inside-out” and the “outside-in” perspective. The “inside-out” perspective pertains to the consideration of principal ESG adverse impacts and the promotion of environmental and/or social characteristics or objectives (referred to as “light green/Article 8” products and “dark green/Article 9” products). On the contrary, the “outside-in” perspective involves ESG issues that could have negative impacts on the value of the investment, defined as “sustainability risks”.

Sustainability risks, as underlined by the Action Plan, play an important role in the transition towards a sustainable finance and are at the core of a set of Delegated Acts introducing for financial operators due diligence obligations to take into account ESG in the risk management framework. Such regulations, all adopted by the European Commission on 2 August 2021 and nearly identical in their contents, are addressed to alternative investment fund managers, insurance undertakings and distributors, reinsurance undertakings and undertakings for collective investment in transferable securities and investment firms:

• Delegated Regulation (EU) 2021/1255 regarding “the sustainability risks and sustainability factors to be taken into account by Alternative Investment Fund Managers”;
• Delegated Regulation (EU) 2021/1256 regarding “the integration of sustainability risks in the governance of insurance and reinsurance undertakings”;
• Delegated Regulation (EU) 2021/1257 regarding “the integration of sustainability factors, risks and preferences into the product oversight and governance requirements for insurance undertakings and insurance distributors and into the rules on conduct of business and investment advice for insurance-based investment products”;
• Delegated Regulation (EU) 2021/1253 regarding “the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms”; and
• Delegated Directive (EU) 2021/1270 regarding “the sustainability risks and sustainability factors to be taken into account for Undertakings for Collective Investment in Transferable Securities (UCITS)”.

ESG factors and sustainability risks have also garnered significant attention from both European and national supervisory authorities. For instance, in July 2023, the European Securities and Markets Authority (ESMA) initiated a Common Supervisory Action in collaboration with National Competent Authorities, focusing on sustainability-related disclosures and the integration of sustainability risks by asset managers. Additionally, in July 2023, the European Supervisory Authorities (ESAs) released their “Progress Reports on Greenwashing in the financial sector” as a follow-up to a “Call for evidence on better understanding greenwashing” launched in November 2022. Supervisory authorities interpret and complement the legal framework by addressing practical questions, such as when and how it is possible to use the terms “ESG”, “sustainable” and “impact” in fund names.

To comply with the above-mentioned regulatory framework (in particular, the obligation to measure ESG performances for Article 8 and 9 products according to the Delegated Regulation (EU) 2022/1288 (RTS)), meet the expectation of the Supervisory Authorities and make informed sustainable investments and/or financing decisions, financial operators have to collect reliable and consistent ESG data. Given the pivotal role of ESG ratings in global capital markets, serving as essential tools for investors and companies in shaping their investment strategies, managing risks and meeting disclosure obligations, the EU Commission published on 13 June 2023 a Proposal for a dedicated Regulation “on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities”. At the same time, financial operators may also collect ESG data directly from voluntary or mandatory company sustainability reports, regulated by the Non-Financial Reporting Directive (EU) 2014/95 (NFRD), as recently amended by the CSRD described in the following section. It should be noted that SFDR and CSRD are together supplemented by the Taxonomy Regulation establishing metrics and KPIs to determine whether an economic activity is environmentally sustainable or not. Therefore, recipients of the SFDR and CSRD also have to disclose in their sustainability reports whether their investments or business activities are “taxonomy-aligned” or not.

It should be noted that the sustainable finance pillar is still evolving, continuously adjusting to the complexities of the financial sector and the rules established under the other pillars it interacts with. As an example, on 14 September 2023, in less than three years after the SFDR entry into force, the European Commission launched a public and targeted consultation “on the implementation of the Sustainable Financial Disclosure Regulation (SFDR)”, and on 12 April 2023 the ESAs released a Joint Consultation Paper reviewing the RTS. These consultations aim to simplify and update the SFDR regime, aligning it with the needs emerging from the practical application of its norms and the other ESG regulations such as the CSRD and CS3D.

Sustainable corporate governance and value chain

Sustainable corporate governance is shaped by two directives: the CSRD, which involves transparent and comprehensive disclosure of a company’s sustainability practices and performance, and the CS3D, which aims at assessing and managing impacts on human rights and the environment throughout a company’s value chain. Together, these two directives create a comprehensive framework for sustainable corporate governance, fostering transparency, accountability and responsibility in business activities.

Corporate sustainability reporting

The NFRD introduced for the first time the obligation to disclose non-financial information by public interest entities (such as listed companies, banks, insurance and reinsurance companies) of large size. Nonetheless, the limited number of the NFRD recipients, the vague definition of the information to be disclosed and the lack of common reporting standards rapidly outdated the directive, which has recently been amended by the CSRD.

The CSRD applies to all listed companies and large undertakings (from 2025 onwards, based on the company’s size) and aims at providing better quality ESG information to investors – including asset managers – in order to understand sustainability risks and opportunities related to the investment, and to civil society actors and other stakeholders, to hold undertakings to account for their impacts on people and the environment.

According to the CSRD, major market operators, including financial operators, will be obliged to publicly disclose their sustainability efforts, considering both positive and negative material impacts on stakeholders, as well as material financial risks and opportunities (so-called double materiality). Therefore, ESG factors will have to be properly assessed, and companies will no longer hide behind a smokescreen of marketing communications as they may have done in the past. Sustainability reporting will be an integral part of a corporation’s financial management report and it will have to be made available on the website, exposing the company to public ESG assessments by all stakeholders, along with the control of Supervisory Authorities.

Indeed, as for the SFDR, the main outcome of the CSRD is not the disclosure obligations that it introduces, but rather the identification of what is needed for a “sustainable corporate governance”. In particular, sustainable corporate governance represents a comprehensive cluster encompassing all activities related to ESG, including ESG data governance, ESG marketing and communication and all the governance processes, controls and procedures to monitor, manage and oversee sustainability impacts, risks and opportunities in alignment with the company’s ESG strategy and business model. A detailed framework for sustainable corporate governance can be found in the European Sustainability Reporting Standards (ESRS), which set forth EU standards and the specific content to be disclosed in sustainability reporting.

As a consequence, viewing sustainability as a significant aspect of a company strategy, rather than mere compliance, represents a forward-looking approach to creating long-term value for both the company’s shareholders and stakeholders and preventing risks and liabilities.

Corporate sustainability due diligence

The CS3D will further expand the sustainable corporate governance legal framework and the existing sectorial ESG due diligence obligations (as Regulation (EU) No 995/2010 laying down the obligations of operators who place timber and timber products on the market; and Regulation (EU) 2017/821 laying down supply chain due diligence obligations for Union importers of tin, tantalum and tungsten, their ores, and gold originating from conflict-affected and high-risk areas) by introducing general requirements to assess, prevent, mitigate or remediate the value chain adverse impacts of all large companies. While the CS3D is currently in draft and under negotiation among the EU Commission, Parliament and the Council, many market operators are already aligning themselves with these obligations, being aware of how due diligence practices benefit companies by mitigating reputational risks and damages and by proactively preparing for future compliance.

The due diligence duties introduced by the CS3D refer to both actual and potential negative impacts on human rights and the environment arising from the company operations, those of their subsidiaries and those of operators in their value chain with which the company has business relationships. Therefore, the due diligence procedures promoted by the CS3D become integral with the CSRD sustainability reporting which requires disclosure of the material impacts, risks and opportunities of a company’s value chain.

However, unlike the CSRD, the CS3D, along with the due diligence obligations, will also introduce responsibilities for companies and executives, which may give rise to the company’s civil and administrative liability for damages upon failure to comply with the directive. As a consequence, CS3D will significantly affect large companies’ internal processes and business relationships to prevent and manage such adverse impacts. For instance, first, companies will have to enter into contracts exclusively with partners and suppliers who have adequate policies and procedures concerning ESG matters, by conducting ESG assessments or due diligences on the value chain. Second, companies will have to periodically verify the ESG performance and compliance with the company ethical code and ESG policies of these partners and suppliers. Last, they will have to implement grievance mechanisms and stakeholder engagement to directly receive information from all the value chain stakeholders on possible risks of negative impacts.

In light of the above, even though the CS3D will apply to a limited number of direct recipients, it will have a “leverage effect” – as envisioned by the European Commission in recital 20 of the CS3D proposal – indirectly expanding the due diligence obligations to all operators in the value chain. Indeed, CS3D recipients are expected to impose similar due diligence obligations on their partners and suppliers, mainly through contractual clauses, in order to comply with the directive. Note that the CS3D will not allow companies to terminate contracts with the partner and supplier causing adverse impacts, except as a last resort. Instead, they will have to assist them in addressing, mitigating and ceasing these impacts.

Aware of the relevance of contractual leverage, the European Commission will adopt a guidance about voluntary model contract clauses to provide support to companies. At the same time, an independent working group of European legal experts is developing a set of model clauses (European Model Clauses) to align international supply chain contracts with the goals of the CS3D, built on the UN Guiding Principles and the OECD Guidelines for Multinational Enterprises.

Green claims and consumer protection

The European Commission recently introduced another important piece of legislation for promoting the ESG transition. The ECD, actually under negotiation between the EU Commission, Parliament and the Council, amending the Unfair Commercial Practices Directive 2005/29/EC, will introduce new “unfair commercial practices” related to sustainability matters, to avoid misleading information in business-to-consumer relationships. This norm aims at empowering consumers to actively contribute to the green transition by having clear information about the sustainability of a product, a service or a business.

In particular, the ECD proposal introduces as unfair commercial practices:

• “displaying a sustainability label which is not based on a certification scheme or not established by public authorities”;
• “making a generic environmental claim for which the trader is not able to demonstrate recognised excellent environmental performance relevant to the claim”;
• “making an environmental claim about the entire product when it actually concerns only a certain aspect of the product” and
• according to the European Parliament amendments to the proposal, also the following:
1. “claiming, based on carbon offsetting, that a product has a neutral, reduced, compensated or positive greenhouse gas emissions’ impact on the environment”; and
2. “making an environmental claim which cannot be substantiated in accordance with legal requirements”.

Along with the list of unfair commercial practices, the ECD proposal also provides definitions for environmental claims, sustainability labels, and certification schemes. These definitions serve as the basis for establishing minimum transparency and credibility conditions for these practices to be considered “fair” in commercial contexts.

Given the growing attention to environmental factors, the European Commission decided to introduce a dedicated regulation, the GCD, as a complement to the ECD. The GCD aims to establish a comprehensive set of requirements for explicit environmental claims and environmental labels. For instance, the GCD mandates that explicit environmental claims:

• must specify whether they pertain to the entire product, a part of it, or specific aspects;
• must demonstrate that they do not merely comply with legal requirements; and
• must rely on widely recognised scientific evidence, accurate information, and relevant international standards.

It is evident that these types of information are a decisive factor influencing consumer choices. Just as in the financial and corporate sectors, companies will have to provide accurate ESG data and information in business-to-consumer commercial practices in order to avoid being charged with unfair commercial practices by consumers and competitors. This information should be based on solid and scientific-based methodology to adequately substantiate claims. Once again, data governance is one of the cornerstones upon which the ESG regulations are based or focused (ie, the ESG Ratings).

Conclusions

The ESG legal framework and forthcoming regulations are reshaping the EU market, promoting sustainability in both financial and non-financial products and services, and imposing stringent obligations on all market operators. Companies, including third-country firms operating within the EU market or participating in an EU company’s value chain, will not only need to comply with ESG regulations but also understand how they may affect the business in order to mitigate risks and capitalise on opportunities.

In such a scenario, lawyers and ESG advisers can serve as catalysts in shaping their clients’ trajectories – companies, investors, and a broader spectrum of market operators – within the new regulatory framework to build an ESG legal and organisational infrastructure capable of addressing sustainability-related issues. Such infrastructure, if aligned with the EU regulations, will enable companies to:

• monitor the consistency of the company’s activities with its ESG strategy;
• periodically verify directors’ duties and prevent directors’ liability on ESG matters;
• identify, address and manage ESG-related risks, impacts and opportunities throughout the value chain; and
• ensure the transparency, compliance and responsibility of the company’s activities.

As for the future, questions arise regarding whether the EU pillars will prove robust enough to withstand the pressures of global change. For now, these pillars are the solid foundation upon which the EU is constructing its path towards sustainable transformation.

How EU Laws Affect Foreign Companies and Value Chains

The European Union is leading the way in establishing a structured set of interconnected binding rules to promote sustainable development inside and outside its market, meeting its commitments under the UN 2030 agenda (SDGs) and the Paris Agreement (2015). In only a few years, the EU identified, through the Action Plan Financing Sustainable Growth (2018), the European Green Deal (2019) and the Renewed Sustainable Finance Strategy (2021), its objectives and strategy for the transition towards a sustainable economy. This set of policies heavily relies on the key role of private financial and market operators, leveraged through significant public resources and regulatory initiatives.

In this respect, the EU set also a specific regulatory framework on sustainability, adopting (to mention the most relevant and recent initiatives):

• Regulation 2019/2088 on Sustainable Finance Disclosure (SFDR);
• Regulation 2020/852 on the “Green Taxonomy”;
• Directive 2022/2464 on Corporate Sustainability Reporting (CSRD); and
• the European Sustainability Reporting Standards (ESRS).

Looking forward, there are a number of proposed laws already drafted and at an advanced stage of negotiation, as the proposals for Directives on Corporate Sustainability Due Diligence (CS3D), Empowering Consumers (ECD), Green Claims (GCD) and for a Regulation on ESG ratings. From this set of laws, the pillars on which the European transition rests clearly emerge: a sustainable finance, a sustainable corporate governance and value chain, as well as consumer protection from greenwashing and unfair commercial practices based on misleading sustainability claims and labels. For an overview of the ESG regulatory framework and its pillars, see the article “EU law: the ESG ‘pillars’ for a sustainability transition”.

A comprehensive view of the subject of sustainability and the complexity of the global market and value chains require an analysis of how global trade relations are impacted by the intricate EU regulatory framework on sustainability. In this sense, one of the key aspects of this legal framework to examine is its extraterritoriality effect (“Extraterritoriality”), as these rules also apply, to a certain extent, to non-EU companies. The scope of this article is to illustrate how, through Extraterritoriality, the EU legal framework on sustainability affects any foreign company – directly or indirectly, independently from the sector and size – having a business relationship within the EU market.

Extraterritoriality for sustainable finance

The SFDR, adopted in 2019 and entered into force in 2021, represents the heart of the sustainable finance pillar, being a key tool to readdress capital flows – through a regulatory financial leverage – towards more sustainable investments. In brief, this regulation introduced for financial operators extensive disclosure requirements on aspects related to ESG, as the integration of sustainability risks into investment decision, the promotion of social and environmental characteristics and/or the pursuing of sustainable objectives.

This legislation has been innovative, especially because it binds the financial sector as a whole (Article 1), from “financial market participants” to “financial advisers”, impacting on the activities of alternative investment fund managers (AIFMs), investment firms, insurance undertakings, credit institutions, etc. The scope of the SFDR is further expanded through its Extraterritoriality, which spreads the operational impacts far beyond EU borders.

Indeed, after initial uncertainty on several aspects of the regulation, on 26 July 2021, the European Commission published a set of questions and answers on SFDR in response to a number of issues of interpretation which had been raised by the three European Supervisory Authorities (ESAs), notably the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). Through this Q&A, the European Commission clarified, in particular, the scope of the regulation recipients, specifying that the SFDR also applies to non-EU AIFMs marketing an ESG fund in the EU under a National Private Placement Regime (NPPR) – the system under which a non-EU AIFM can gain access to end-investors in individual EU member states on the basis of national laws.

Moreover, should non-EU AIFMs be subject to SFDR rules, even if only for a particular fund marketed in the EU, one can expect an expansion of SFDR impacts to other managed funds as well, regardless of where they are marketed. Indeed, the attention of the market (especially end-investors) to sustainability issues is steadily increasing, not only in the EU but also globally, driven by policy and regulatory frameworks of foreign jurisdictions increasingly inspired by the above-mentioned EU initiatives. In this sense, the SFDR might be taken as the golden standard for the development of sound investment strategies and marketing communications around sustainability even for funds not directly marketed in the EU. More generally, foreign financial operators should increasingly look to the SFDR as a model for enhancing the ESG profiles of their financial services, to gain competitive advantages and avoid unwanted loss of market share.

Extraterritoriality for a sustainable corporate governance and value chain

The Extraterritoriality is also a significant aspect of the CSRD and the draft CS3D, which form the foundation of the sustainable corporate governance and value chain EU pillar. This assumes the implementation of an ESG legal and organisational infrastructure aimed at addressing, managing and governing sustainability-related issues (sustainability impacts, risks and opportunities), in alignment with the company’s strategy and business model, to prevent and exclude any liability of the company (and its board) with respect to the governance of ESG issues.

Corporate sustainability reporting

In a nutshell, under the CSRD, significant market players, including financial institutions, will be required to publicly disclose how they approach and govern key sustainability aspects, considering both positive and negative material impacts on stakeholders, as well as material financial risks and opportunities that descend from sustainability (referred to as “double materiality”). Sustainability reporting will be integrated into the company’s financial management report and readily accessible on the company’s website.

The application of the CSRD will commence with the 2025 sustainability reporting for EU public interest companies and will gradually become mandatory in the following years, encompassing large companies and SME-listed companies. However, EU undertakings falling within the scope of the directive are required to include in their sustainability reporting material information regarding “upstream and downstream value chain”, which clearly expands, from the very first directive’s application, the impacts of the CSRD beyond EU borders, also to third country companies.

In this sense, it is fundamental to comprehend the extension of the concept of value chain. The ESRS – the standards upon which the disclosure under the CSRD shall be based – gives a definition of value chain, which is meant to include actors upstream and downstream from the undertaking. Actors upstream from the undertaking (eg, suppliers) provide products or services that are used in the development of the undertaking’s products or services. Entities downstream from the undertaking (eg, distributors, customers) receive products or services from the undertaking.

At the same time, the CSRD provides that, in case of difficulties in collecting ESG data of the value chain – including those of foreign companies – undertakings, for the first three years, can limit the disclosure to explaining the efforts made to collect such data, the reasons for failure to collect them and actions taken to ensure collection in future.

Regardless of such exemption, it is clear that the extensive definition of value chain must alert foreign companies, of all sectors and size, which will increasingly be (and in some cases already are) under significant pressure from EU companies whose value chain they are part of. Indeed, EU companies more often protect themselves against possible risks and liabilities through specific ESG clauses in their contracts, by providing obligations, warranties, responsibilities and penalties with respect to, for example, the accuracy and veracity of the ESG data transmitted by such foreign companies.

Finally, the CSRD also provides for direct Extraterritoriality, in that foreign companies with branches or subsidiaries established in the EU will have to publish the group sustainability reporting with reference to the financial year 2028 onwards. Such companies will be required to publish the group sustainability report if:

• the group on, a consolidated basis, generated a net turnover of more than EUR150 million in the EU in each of the last two consecutive financial years; and
• the subsidiary is a listed company or a large company; or
• the branch generated more than EUR40 million in turnover in the EU in the preceding financial year.

In particular, under Article 40a of the CSRD, such sustainability report would need to cover, inter alia, how the group’s strategy has been implemented with regard to sustainability matters. The disclosure shall include:

• how the business model and strategy are in line with the Paris Agreement and the objective of achieving climate neutrality;
• how the group’s business model and strategy take account of the interests of the group’s stakeholders;
• a description of the role of the administrative, management and supervisory bodies with regard to sustainability matters; and
• the due diligence process implemented by the group with regard to sustainability matters, including the principal actual or potential adverse impacts connected with the group’s own operations and with its value chain and business relationships. 

The EU Commission was originally expected to adopt a delegated act to provide for dedicated sustainability reporting standards for non-EU companies by 30 June 2024, while, through a recent proposal, it has adjusted the deadline to 30 June 2026. At the same time, it will be accepted that the sustainability reporting may be drawn up in accordance with sustainability standards equivalent to the ESRS. For the preparation of the sustainability reporting, the subsidiary or the branch shall request the third country parent to provide them with all information necessary to fulfil their obligations.

In conclusion, following especially the indirect Extraterritoriality of the CSRD, non-EU companies should immediately consider the scope and effects of this directive, securing themselves not only contractually, but also adapting their internal procedures, organisational model and governance, building a “sustainable corporate governance” as a safeguard to meet the demands (or avert any claim) made by their EU partners. In this sense, a key aspect will be the implementation of solid stakeholder engagement procedures that, as clarified in the ESRS, are central to the undertaking’s ongoing due diligence process and sustainability materiality assessment.

Corporate sustainability due diligence

As general context, the CS3D draft is set to broaden the existing EU sector-specific ESG due diligence requirements that already affect certain enterprises (eg, those involved in mining or timber trade). More specifically, the CS3D will make mandatory identifying, preventing, mitigating or bringing to an end adverse impacts throughout the value chains, providing for the liability of the company and its directors in case of failure to comply with such obligations. The tight connection between the CS3D and the CSRD is another key feature to consider: the due diligence processes under the former will form part of the strategy of any company approaching and dealing with the sustainability reporting obligations under the CSRD.

Underlining the Extraterritoriality of the CS3D, the European Commission itself envisioned in recital 20 of its proposal a “leverage effect” of the directive, expecting it to affect companies beyond its primary recipients and the EU borders. Indeed, its due diligence requirements would encompass both actual and potential negative effects on human rights and the environment resulting from a company’s operations, those of their subsidiaries, and any entities in their value chain with whom the company has business relationships.

Accordingly, it is clear that, as in the case of the CSRD, foreign companies participating in the value chain of EU companies subject to the CS3D are affected by and should align with this directive. In this regard, it should be noted that the above-mentioned interventions to implement a “sustainable corporate governance” might be useful for this alignment. Since these interventions would significantly impact internal procedures, the organisational model and the relationship with the entire value chain, as well as the governance of the company, undertakings should begin their alignment with the CS3D (despite it still being under negotiation), given that these interventions are a function of conforming with the CSRD (already in force).

As a conclusive remark on both the CSRD and CS3D, it is clear that their transparency and due diligence requirements expose any company (including foreign companies) to scrutiny by stakeholders and, in particular, supervisory authorities, with potential risks (as reputational and litigation risks), but also opportunities (in terms of market attractiveness, access to credit, etc). In this sense, sustainability under the CSRD and the CS3D should be approached as an integral component of a company’s strategy, rather than just a matter of compliance, aiming not only at creating safeguards to mitigate related risks, but also at pursuing long-term value for both the company’s shareholders and other stakeholders.

Extraterritoriality for consumer protection from greenwashing

In the overall vision of the European Commission, the transition to a sustainable economy also passes through the finalisation of three regulatory initiatives, currently under negotiation, that aim at ensuring that consumers are empowered to make better-informed choices and play an active role in such transition, directly tackling “greenwashing” and “socialwashing” practices and communications of companies: the proposal for the directives ECD and GCD, as well as the proposal for a Regulation on ESG ratings.

These proposals aim at imposing strict requirements in order for companies to make lawful sustainability claims. Notably, the ECD will introduce, inter alia, the unfair commercial practice of displaying a sustainability label which is not based on a certification scheme, while the GCD will require a high degree of compliance for environmental claims and environmental labels.

The ECD and the GCD are meant to directly impact on third-country companies providing certification schemes or making sustainability claims in the EU, in order to ensure internal market integrity and fair competition. Furthermore, the GCD also establishes a specific obligation for third-country environmental labelling schemes, which shall be assessed by national authorities and validated only if they demonstrate added value in terms of their environmental ambition and their coverage of environmental impacts, of product category group or sector.

Consequently, under the ECD and the GCD, it will be critical for market operators, including third-country companies, to substantiate – on a scientific-based methodology – the consistency of their sustainability claims and labels to not be charged with “unfair commercial practices”.

Thus, it will be fundamental, for both EU and non-EU companies, to implement a “sustainable corporate governance” that also encompasses procedures and internal organisation for an efficient – and strategic – governance of ESG data, marketing and communication, capable of preventing and excluding risks (first and foremost, reputational and litigation risks), as well as creating long-term value for shareholders and stakeholders in general.

Conclusions

The Extraterritoriality of the EU regulatory framework on sustainability not only directly affects third-country large companies (direct recipients of many of these regulatory initiatives), but also – and most importantly – any company in the value chain of EU companies and with business relations with the EU market.

Notwithstanding their jurisdiction and size, third-country companies should encompass the pillars that underpin the ESG regulatory framework and aim for an alignment that passes, first and foremost, through the implementation of a “sustainable corporate governance”, based on, for example:

• specific procedures (for reporting to the board, ESG due diligence, stakeholder engagement, grievance mechanisms, etc);
• the review of contracts through the whole value chain; and
• the governance of ESG data, marketing and communications.

Interventions should already be aiming to implement regulatory initiatives that are in the (advanced) negotiation phase (as commented on).

For foreign companies, this is a strategic choice aimed not only at remaining competitive, but also at ensuring the conditions exist for remaining in the EU market.