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Sustainability
Concerns over impact of new EU reporting rules on M&A
The EU Corporate Sustainability Reporting Directive (CSRD) will impose comprehensive and standardized sustainability reporting responsibilities on firms, adding unprecedented complexity to mergers and acquisitions.
The goal of the new set of regulations encompassed by the EU Corporate Sustainability Reporting Directive (CSRD), to which European companies will have to adhere from 2025, is to provide greater transparency on the environmental and social impacts of businesses to customers, stakeholders, and the public. However, it has implications beyond Europe’s borders for companies engaged in M&A activities.
Take the example of a Hong Kong-based company that is poised to acquire a business in Lille, France. With 300 employees and an annual turnover of about €550m in each of the last three years, the target company presents a lucrative opportunity for strategic acquisition and synergies, and the price is right. But there is a catch: despite not being located within Europe, once the Hong Kong-based company buys the European target it will need to satisfy the CSRD.
Following more stringent reporting but only for the European subsidiary could be awkward for non-EU companies, and potentially create pressure for applying the CSRD’s requirements to acquiring companies’ worldwide activities. So, does this poison the M&A chalice for non-EU companies?
Impact on costs and M&A attractiveness
The introduction of CSRD – along with the standardized reporting requirements set out by the European Sustainability Reporting Standard (ESRS) – will certainly raise operating costs for businesses. The magnitude of the compliance cost is not clear but could vary significantly depending on factors such as the size of the company, current implementation of sustainability reporting practices, the industry in which it operates, and the complexity of its operations.
For companies based outside of the EU, compliance with CSRD could mean four things: (Click slider buttons or swipe to view.)
1. Increased due diligence costs and complexity:
- Non-EU buyers looking to acquire EU companies will need to assess the costs and additional complexity of extending compliance, not only to the EU subsidiary (if it is not a company already), but also to the main entity.
2. Potential for additional liabilities:
- Buyers must consider the risk of inheriting non-compliance issues with the CSRD, which could lead to potential fines or reputational damage at both the subsidiary and entity level. This risk might make non-EU buyers more cautious, potentially slowing down the decision-making process (or leading to renegotiations of terms to account for these additional risks).
3. Integration challenges:
- Post-acquisition, integrating the target into the buyer's broader operations could become more challenging if the buyer is not already compliant with similar sustainability reporting standards. The requirement for the non-EU parent company to comply with the CSRD at the group level means that it may need to overhaul its reporting and sustainability practices, adding complexity and cost to the integration process.
4. Increased operational costs post-acquisition:
- For non-EU buyers, ensuring compliance with the CSRD at the group level could result in increased operational costs. These could include investments in new technologies or systems for sustainability reporting, hiring, or training staff to manage compliance, additional costs associated with the supply chain, and ongoing costs associated with maintaining these higher standards of sustainability reporting.
Higher costs – but greater ESG authenticity
The new rules will have a double-edged impact on the value of EU-based acquisitions. The extra costs will tend to depress the value, but the enhanced environmental, social, and governance (ESG) credentials may make the complying companies more attractive to ESG-sensitive investors.
The impact will not be the same for EU-based and non-EU-based acquirers. European buyers will have to apply the new rules in any case. For non-EU firms, buying an EU-based target will bring new reporting requirements.
In short, the new regulations are likely to lead non-EU companies to re-evaluate the strategic value of acquiring EU companies, considering the costs associated with CSRD compliance. This can impact the perceived value of deals and may lead to a preference for targets not subject to the CSRD.
These challenges may prompt a more cautious approach to M&A activities in the EU, potentially slowing down transactions or leading to more divestitures as companies reassess the implications of compliance for their business operations and strategic objectives.
The outlook is not all negative: due to the extra costs, it is possible that EU-based assets might have a lower valuation, making the region more attractive for bargain hunting in the eyes of non-EU companies. Here, the notion of competitive advantage comes into play. More stringent reporting requirements make the target assets worth less to potential acquirers, but what matters is the relative change. Firms that are particularly adept at navigating ESG reporting may find new opportunities among EU targets.
“The introduction of the CSRD is set to have a profound impact on M&A activities within Europe, presenting both challenges and opportunities for non-EU companies.”
Preparing a CSRD strategy
Given the potential implications of the CSRD for asset values, non-EU companies considering M&A activities in Europe need to strategically adapt to this new regulatory environment if they are to gain a competitive advantage that will help them win relatively low-value assets in EU nations. This may involve:
- Investing in sustainability capabilities: To navigate the complexities of the CSRD and to be proactive, companies may need to invest in developing internal sustainability capabilities or partner with external advisors who can guide them through the compliance process.
- Building sustainability into strategic planning: If a company has a cost-compliance advantage (because some of the structure, processes, and systems are already in place), then integrating sustainability considerations into strategic planning and M&A criteria would allow for the identification of inexpensive assets.
The introduction of the CSRD is set to have a profound impact on M&A activities within Europe, presenting both challenges and opportunities for non-EU companies. While the directive may initially increase complexities, it also gives companies with a sustainability advantage easier access to undervalued assets.
The CSRD is also an example of the ‘Brussels Effect,’ whereby EU regulations tend to influence the regulations of countries around the world. The General Data Protection Regulation (GDPR), which went into effect in 2018, had a direct extra-territorial impact on firms handling European data. Beyond this, it inspired nations around the world to adopt their own privacy rules.
With GDPR, Brussels understood the deepening concern of citizens and moved first. It enacted rules about the handling of citizens’ online data and the protection of privacy. The CSRD, with which Brussels has once again made the first move, may well turn out to be as influential as GDPR, as it addresses rising concerns around the world about ‘greenwashing’ and the reliability of companies’ self-reported ESG credentials.
What is the Corporate Sustainability Reporting Directive?
In force since 2017, the Corporate Sustainability Reporting Directive (CSRD) is a component of the European Green Deal and an extension of the Non-Financial Reporting Directive (NFRD). It will require an estimated 49,000 companies across Europe to adhere to more stringent sustainability reporting standards from 2025, based on their activities in 2024 (that is, now).
The goal is to provide stakeholders, including investors, customers, and the public, with a comprehensive view of a company’s ESG practices. Importantly, the directive extends beyond EU borders, impacting non-EU companies that have significant operations or subsidiaries within the EU, provided they meet certain financial criteria.
The NFRD was an initial step towards requiring companies to include non-financial statements in their annual reports. It applied to large public-interest entities with more than 500 employees, including listed companies, banks, and insurance companies, mandating them to disclose information on their policies, risks, and outcomes regarding environmental protection, social responsibility and treatment of employees, respect for human rights, anti-corruption and bribery, and diversity on company boards.
The CSRD is a significant expansion of the NFRD that broadens the range of companies required to report, laying out reporting requirements in greater detail, and ensuring the reliability of the data firms provide via external auditing requirements. The CSRD will effectively replace the NFRD. The new rules extend the reporting requirements to all large companies and all companies listed on regulated markets (except listed micro-enterprises). This will significantly increase the number of companies that need to comply.
A groundbreaking aspect of the CSRD is the requirement for sustainability information provided by companies to be subject to assurance, enhancing its credibility and reliability. The directive also requires that reports be prepared in a digital format, making it easier to access and analyze the information. It is expected to be phased in over several years from 2024 onwards, depending on the size and type of company.
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