This article discusses what ESG is, and what European regulation means for businesses, how businesses can and must become more sustainable within the three ESG pillars, and how ESG reporting can contribute to your company’s image and business strategy.
In a world where companies are increasingly held responsible for their impact on society and the environment, sustainable and responsible business practice is no longer a luxury. It is a necessity and can also yield commercial benefits.
Implementing ESG criteria gives companies a framework to both reduce their ecological footprint and increase social responsibility. But what is actually mandatory now, and what isn’t?
Legal status of ESG and the Corporate Sustainability Reporting Directive (CSRD)
First of all, ESG is not official legislation, but a set of voluntary principles and guidelines that companies can use to assess and integrate sustainability and social responsibility into their processes. It is therefore not a legally binding standard. The European CSRD (Corporate Sustainability Reporting Directive) regulation, on the other hand, does use this ESG framework as the basis for mandatory sustainability reporting.
Who is subject to CSRD reporting obligations?
With the introduction of the CSRD, larger companies are required, from 1 January 2024, to report extensive and standardized information on their environmental, social, and governance performance based on the ESG framework.
A company falls under the CSRD obligations if it meets at least two of the following three conditions:
- 250 employees or more on average per year;
- Revenue of €50 million or more per year;
- €25 million on the balance sheet.
Consequences of the CSRD for SMEs
The CSRD indirectly affects SMEs, especially if they work for large companies as clients. But also if they are a supplier to companies that in turn work for those large companies. These large client companies face increased transparency requirements and have a CSRD reporting obligation. This means these clients ask their suppliers, including your company, to provide insight into their sustainability impact, so they too can meet their reporting obligations under the CSRD.
Increasingly, they impose compliance statements or chain clauses on their suppliers, with which suppliers declare that they meet certain sustainability aspects.
Listed SMEs will also fall under the CSRD
CSRD legislation will also apply to listed SMEs from 1 January 2026. These are clients/companies with fewer than 250 employees and an annual turnover of at most €50 million or an annual balance sheet total of at most €43 million. In addition, the shares of these companies are traded on the regulated stock exchange.
From 1 January 2026, these clients will also be required to report on their sustainability efforts, albeit to a lesser extent than large companies. They may use the adapted European sustainability reporting standards called the “Listed SME standards (LSME).” These standards are less extensive and complex than the standards that apply to large companies, called the ESRS (European Sustainability Reporting Standards).
Large clients/companies may only request information from you as an SME up to the LSME limit. This makes the LSME standard useful for SMEs too, even though they are not subject to the reporting obligation. This way, companies can better anticipate possible questions from large companies that do fall under the CSRD (Corporate Sustainability Reporting Directive).
What does ESG literally mean?
ESG stands for Environmental, Social, and Governance. Together they form the three main pillars with which companies can measure and improve their social responsibility and sustainability. Implementing an ESG business strategy is not only a way to meet the growing demand for corporate social responsibility (CSR), but also a way to remain economically successful amid the major issues and challenges of our time. Clients, too, are increasingly asking for sustainable solutions. Companies that comply with ESG criteria can obtain certifications such as ISO 14001, making them more attractive to clients. By scoring high on the ESG ladder, your company gets into the spotlight and can gain a competitive advantage. But how does your company score high on the ESG ladder?
First element: Environment
The environmental aspect of ESG is about companies reducing their impact on the environment through sustainable business operations and products. Think, for example, of certain products that contain harmful substances and can affect indoor air quality and the environment. By choosing organic and biodegradable alternatives, companies can reduce the use of harmful substances.
Companies can also focus on more efficient waste management and recycling of materials. For example, it is possible to work with suppliers on reusable packaging or refillable products. Reducing energy consumption can also contribute to a more sustainable image, for example by using electric vehicles for transport or energy-efficient equipment. Through these efforts, companies not only contribute to a cleaner environment but also meet the requirements of customers and companies that place great value on sustainability.
Second element: Social, Wellbeing and Safety
The “S” in ESG stands for social responsibility, which is essential for companies that are highly dependent on their employees. Think of safe and healthy working conditions and job satisfaction. Companies can, for example, invest in ergonomic aids to ease physical work and thereby reduce the risk of injury.
Another important aspect is promoting diversity and inclusion in personnel policy. Companies can develop policies to support employees from different backgrounds and promote equal opportunities. Offering fair wages and secondary employment benefits such as pension and healthcare also plays a role in social sustainability. Strengthening the workplace culture not only leads to satisfied employees but can also help retain good talent in a labor market where staff turnover is a common problem.
Third element: Governance, Transparent and Ethical Business Practices
Good governance within ESG is about setting up strong, ethical, and transparent corporate structures. It is the pillar that ensures good leadership, compliance with laws and regulations, and fairness in decision-making. This applies to all companies, especially sectors that work with a diverse workforce (e.g. self-employed contractors) and maintain strong customer relationships; here, governance plays a crucial role in safeguarding integrity and sustainability. Good contract structure and documentation is essential in this regard. Contracts with customers should also mention compliance with the General Data Protection Regulation (GDPR), the Working Conditions Act (Arbowet), the Chain Liability Act (WKA), and the Foreign Nationals Employment Act (WAV), and of course these should also be complied with in practice. In the contractual documentation for your staff, this is reflected in fair and transparent employment conditions, both primary and secondary, and correct application of any collective labor agreement (CAO). But also think of topics such as complaints procedures regarding undesirable behavior and reporting procedures for integrity violations and wrongdoing under the Whistleblowers Protection Act (Wbk). Appointing an internal or external confidential advisor is also no longer a superfluous luxury, as organizations can use this to give substance to the duty of care under Article 7:658 of the Dutch Civil Code and the Working Conditions Act. By having a good governance structure, companies can strengthen the trust of their customers and employees and better manage risks.
SMEs and contractually mandated reporting
Reporting on sustainability is not mandatory for non-listed SMEs, but due to supply chain dynamics and contractual arrangements, this will almost become necessary anyway. It is expected that large and listed SMEs subject to CSRD legislation will, within a foreseeable period, revise their contracts with suppliers and customers and impose obligations on them. They will prefer partners who can provide reliable and verifiable sustainability data, so that their own reporting runs smoothly.
Reporting obligations are also relevant when obtaining financing
But the impact reaches further than that. Banks and investors, for example, must also account, under the EU legislation applicable to them, for how they deploy their capital flows towards a sustainable economy. If you want to obtain financing from a bank soon, you can expect the bank to also ask non-financial questions. Think, for example, of the working conditions and (equal) pay of your own and hired staff.
Voluntarily choosing an SME VSME report is very smart
Although a sustainability report is not mandatory for non-listed SMEs, for the reasons mentioned above you can choose to voluntarily report on sustainability. This also lets you stay in control by reporting according to the VSME standards, preventing a flood of questionnaires, meetings, and interviews from these parties. With a clear report containing the requested data, you provide transparency and factual information about your sustainability efforts.
To provide good guidance for such reporting, a new reporting standard is now being developed specifically for SMEs: the VSME (Voluntary Sustainability Reporting Standard for non-listed SMEs). This standard follows the ESRS structure but is much more compact. This more proportionate standard will also serve as a starting point for requests from companies subject to the CSRD, in order to prevent arbitrariness. The size of the company determines the level of detail on environmental (E), social (S), and governance (G) issues you can report on. The final VSME standard will be published in early 2025. This will then become the European voluntary standard for sustainability reporting for SMEs and micro-enterprises.
The VSME enables you to provide the right information to large customers and suppliers in a structured way. This gives clear insight into your sustainable development efforts and shows how your initiatives make a positive contribution to society.
How can The Legal Company help you with ESG and CSRD questions?
The team of business lawyers at The Legal Company has years of experience with legal issues and sustainable business practices. Among other things, we offer legal advice and support with:
- Helping answer ESG questions regarding compliance statements and chain clauses imposed by clients;
- Advising on the legal requirements of ESG reporting and obtaining certifications;
- Drafting socially responsible employment conditions for your staff (both primary and secondary), as part of the ESG strategy;
- Bringing your contracts with customers and staff into line with applicable laws, regulations, and ESG criteria;
- Drafting codes of conduct and complaints procedures regarding undesirable behavior;
- Drafting whistleblower policies and internal reporting procedures to comply with the Wbk.
Contact The Legal Company’s business lawyers today at info@thelegalcompany.nl or by phone at 020-3450152 and discover how we can legally support your business toward a sustainable future!
