How the EU Corporate Sustainability Reporting Directive will affect investment in the US

Impact on businesses outside EU looking to work or sell products and funds within the EU or to EU investors.

Modernizing and strengthening the rules concerning transparency on the sustainability impact of companies is the aim of the EU’s Corporate Sustainability Reporting Directive (CSRD). It requires large companies to disclose information on risks and opportunities related to sustainability issues. And it will seriously affect businesses.

It is expected to impact around 50,000 businesses in the EU alone, which collectively serve 450 million people. And while the remit of the EU doesn’t extend beyond the borders of the bloc’s 27 Member States, the Directive will affect businesses outside the EU if they are looking to work or sell products and funds within the EU or to EU investors.

Research from Refinitiv suggests that this direct effect of the CSRD could affect up to 3,000 US firms. And the indirect impact of this Directive will be even greater than that.

Data leads to better investment decisions

Broadly speaking, the CSRD requires companies in the EU to report on sustainability impacts. This includes “outgoing” impacts, like emissions or pollution, but also “incoming” impacts on their business, like the risk of extreme weather in their value chain. As these impacts can have serious financial consequences, sustainability data is a good indicator of the health and resilience of a company in a changing world.

Has a company adequately mitigated the incoming risks? Under the CSRD, the answer to questions like this will become readily available. Investors can use this to integrate climate risk into their investment decisions. CSRD data will thus help investors make better business risk decisions.

The information disclosed via the CSRD must be made available for everybody. Crucially, a business’s CSRD disclosure will be available to investors and interested parties everywhere, not just in the EU. Americans can just as well leverage the data, and why wouldn’t they?

While it remains early days, and we have yet to see what the impact of the Directive will be over the longer-term, we can already see how US asset managers incorporate the data that becomes available as a result of the CSRD into their investment strategies and use it to make better decisions.

Impact beyond the EU

Beyond the CSRD’s direct impact, we expect the indirect impact of improved availability of sustainability data to radiate to capital markets beyond our own continent. Investors and other stakeholders will get used to the increased transparency of European companies and may also start demanding it from companies outside the EU, including those in the United States.

When businesses within the EU are disclosing better, clearer data, they’ll become easier to invest in than businesses where data is more obscure, leading to an increased flow of capital towards those businesses. This dynamic could create a new form of corporate competition, as businesses move toward greater standards of sustainability and transparency in a bid to attract ESG-compliant investment flows.

We could then begin to see a disparity emerge between those companies that will be CSRD compliant and those that fall under US regulation which does not have a similar level of depth. This will lay down a challenge to US regulators to match the CSRD and ensure American businesses remain competitive in a world of conscientious investment.

White House battle

With ESG having become a front in the battle for the White House next year however, delivering more stringent regulation may prove difficult. Despite this, if CSRD compliant businesses gain a competitive advantage, it may be the case that the regulation is de facto adopted anyway, regardless of the regulatory regime.

This “race to the top” is a form of what is coined as “the Brussels effect”, when EU laws are externalised beyond the EU borders through market mechanisms.

The CSRD will increase transparency of companies’ sustainability data. Investors will use the available data to make better-informed decisions, which we expect to in turn move companies outside the scope of the CSRD to improve their disclosures as well. The knock-on effect we hope will be to bring the world closer to the Paris Agreement goal of keeping global temperature rise below 2°C and it will ensure that businesses, and crucially investors, can more easily support this goal.

Boris van Overbeeke is a consultant, ESG & Sustainability, at global financial services provider at Apex Group.