ESG regulatory trends: the likely impact of the EU’s extensive ESG laws on Australian businesses

The proliferation of EU-based environmental, social and governance (ESG) regulation will impact Australian businesses that are exposed to EU markets through their operations, supply and value chains.

Impacts include heightened standards for responsible business conduct, including human rights and environmental due diligence, ‘ecodesign’ product standards and the imposition of carbon tariffs.

The EU’s Corporate Sustainability Due Diligence Directive

Now law, the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) imposes human rights and environmental due diligence duties on organisations with at least euro 450 million turnover in the EU, whether or not domiciled in the EU. Like the EU’s General Data Protection Regulation which shaped data protection practices globally, the CSDDD is anticipated to influence enterprise-wide human rights and environmental due diligence practices worldwide. While some Australian entities will be directly in scope, those doing business with in-scope entities will face a range of contractual requirements by which in-scope entities will seek to ensure that their supply and value chains adopt the standard of business conduct provided for in the CSDDD.

The EUs Deforestation Regulation

The EUs Deforestation Regulation requires exporters of cattle, cocoa, coffee, oil palm, rubber, soya and wood to the EU, or prescribed products made from those commodities, to fulfil human rights and environmental due diligence obligations. Those businesses exporting named commodities and prescribed derivative products will face trade barriers unless they conduct risk assessments to establish that those commodities and products were not produced on deforested land.

Because the EU’s definition of deforestation is far more stringent than Australia’s, Australian businesses should take steps to understand how they may be impacted by the EU’s Deforestation Regulation as they seek to access the EU market. Helpfully, Australia’s Department of Agriculture, Fisheries and Forestry has issued guidance that identifies potential implications for Australia’s production forests and beef exports.

Carbon-border adjustment mechanisms

Carbon-border adjustment mechanisms (CBAM) are being proposed by many of Australia’s major trading partners, including the EU, Canada, China, Japan, the US and UK. CBAM’s are designed to address ‘carbon leakage’ which occurs when the production costs of goods made in one jurisdiction increase because of higher emissions regulation as compared with the same good made in a jurisdiction with laxer emissions standards and therefore lower production costs.

The EU is the first to introduce a CBAM to price the embodied carbon emissions of certain imported goods to equalise the carbon costs of carbon intensive goods produced outside the EU with those produced within the EU. It is being phased in through to 2026, commencing with cement, iron, steel, aluminium, fertilisers, electricity and hydrogen. From 2026, EU importers of goods covered by the CBAM must declare the embodied emissions of those imports and surrender certificates to the value of those emissions each year. The Australian Government’s Carbon Leakage Review (Review) is exploring the feasibility of an Australian CBAM, which if implemented would affect businesses that rely on the importation of carbon-intensive products. The Review is expected to release a final report later this year.

Ultimately, Australian exporters of emissions intensive goods will be incentivised to reduce the emissions generated through production processes in order to retain EU generated revenue streams. Conversely, should Australia introduce its own CBAM, Australian importers of emissions intensive goods may face higher costs and be incentivised to source their goods from less emissions-intensive suppliers. Australian businesses should review the terms of their procurement and supply agreements to ensure flexibility in addressing the economic impact of any CBAMs.

Ecodesign product standards

Designed to improve the circularity, energy performance and other environmental sustainability aspects of products placed on EU markets, the EU’s Ecodesign for Sustainable Products Regulation (ESPR) replaces existing EU ecodesign regulations and establishes a framework for the setting of information and performance requirements (known as ‘ecodesign requirements’). Almost all categories of physical goods will have to comply with these requirements to be placed on the EU market or put into service.

Delegated Acts will be progressively introduced to stipulate requirements for durability, reliability, reusability, upgradability, reparability, presence of substances that inhibit circularity, energy and resource efficiency and carbon and environmental footprint, with priority given to certain products (e.g. textiles, iron and steel, chemicals). The ESPR also requires a new Digital Product Passport to enable consumers and businesses to make more sustainable product choices and assist enforcement agencies’ compliance activities.

Australian exporters wishing to retain EU generated revenue streams will have to comply with the ESPR’s ecodesign requirements. To understand the intended effect of the ESPR, Australian exporters should look to the impact of the EU’s 2022 law that required phone and tablet manufacturers to produce devices compatible with a USB Type-C charging point. As a result, Apple was required to change its charging port for iPhones and other devices to retain its EU generated revenue streams. Australian exporters should watch for publication of any performance standards and understand how and when they will apply.

Corporate Sustainability Reporting Directive

The Corporate Sustainability Reporting Directive (CSRD) will require in-scope Australian entities to report on a ‘double materiality’ basis, which includes the financial impact of sustainability issues on the business (financial materiality) and the impact of the business on sustainability areas including climate, biodiversity, human capital and human rights (impact materiality).

The double materiality approach adopted by the EU, together with the granularity of data required to be reported across multiple sustainability topics, will be unfamiliar to many Australian businesses. Australian in-scope entities should not only understand their reporting obligations, but also how the mandatory disclosures are likely to be received by Australian investors, shareholders, stakeholders and activists and any reputational and legal risks under Australian law arising from those disclosures.

Australian entities that will need to report include:

1. Australian entities listed in EU markets (excluding ‘micro undertakings’).[1]
   
   
2. Australian entities with consolidated EU net turnover of over €150 million in each of the last two years with at least either:
   
   
   • a subsidiary that is either (i) a large undertaking (see below) or (ii) listed on an EU market (excluding ‘micro undertakings’); or
     
     
   • a branch (as defined by EU member states, and is a business that is not legally separate from its foreign parent) with EU net turnover of €40 million.
     
     
3. EU subsidiaries of Australian entities that are either (i) listed in EU markets (excluding ‘micro undertakings’) or (ii) exceed two of the following three criteria of ‘large undertakings’– balance sheet of €25 million and/or net turnover of €50 million and/or 250 employees.

Key takeaway

Whether directly or indirectly in scope of the EU’s raft of sustainability regulations, Australian businesses dependent on supplying to or trading in EU markets should assess their readiness by understanding the scope of uplift required to existing practices.

Preparing early may provide a competitive advantage, allowing Australian businesses to remain attractive as suppliers and business partners. Conversely, delay will mean limited time within which to design new or adapt existing processes to meet the new standards which may ultimately expose the business to potential loss of EU generated revenue streams.

^{[1] Micro-undertakings do not exceed the limits of at least two of the three following criteria: (a) balance sheet total: EUR 450 000; (b) net turnover: EUR 900 000; (c) average number of employees during the financial year: 10.}