The EU’s directives on Environmental, Social and Governance (ESG) reporting and due diligence in recent years are significant and wide-ranging. Their transposition by EU member states reflects both challenges and opportunities for companies that fall under their scope. In this article, Mario Levin examines the evolution of ESG regulation in the EU and asks what this could mean for the construction sector in Spain, one whose social and environmental impacts go far beyond Europe.
Over the last decade, the EU has published several prominent directives with the aim of setting clear ESG reporting frameworks for businesses in specific sectors. Its Corporate Sustainability Reporting Directive (CSRD) is the trailblazing policy, which aims to achieve more unified, complete and transparent sustainability reporting across all sectors. EU member states will need to transpose this directive, which the European Parliament voted to adopt in November 2022, by the deadline of 6th July 2024. Many of the 50,000 companies that stand to be directly affected by the CSRD will need to re-evaluate the way they carry out their operations globally.
In addition to a broader scope, the CSRD will also require companies to conduct third party verification of reported sustainability data, ensuring they adhere to binding sustainability reporting standards."
The CSRD replaces the Non-Financial Reporting Directive (NFRD), and in doing so, brings tens of thousands more companies in scope of EU sustainability reporting requirements. Most fundamentally, the CSRD widens and deepens companies’ reporting requirements – obliging them to report on Environmental, Social and Governance metrics, alongside their financial reporting. This means companies need to show that they are gathering data on, and acting upon, such varied issues as modern slavery or anti-corruption. Reporting must also now cover targets, risk and opportunity management and forward planning.
In addition to a broader scope, the CSRD will also require companies to conduct third party verification of reported sustainability data, ensuring they adhere to binding sustainability reporting standards. Ultimately, claims must be backed by sound data. If this data is to be robust and reflect business operations, companies need to act now to start gathering it, rather than waiting for their company to fall into scope of the CSRD. Materiality will need to be assessed and KPIs and metrics developed and honed over time.
The CSRD timeframe
From 1st January 2024, the first companies must comply with the CSRD. These large businesses with more than 500 employees, who were already in scope of the NFRD, must submit their first reporting in 2025. Over the subsequent four years, all large and listed European companies will be brought into scope, along with EU subsidiaries of non-EU parent companies which generate an annual net turnover of EUR 150 million in Europe. Some of the small and medium-sized businesses will be able to opt out until 2028, but they will still ultimately have to comply with the CSRD.
Complementing the reporting framework established by the CSRD, the Corporate Sustainability Due Diligence Directive (CSDDD) is working its way through the EU’s legislative process. Intended to be finalised by the end of 2023, followed by a two-year period to transpose into national laws and a phased implementation period over subsequent years, the CSDDD will establish a European framework for a responsible and sustainable approach to global value chains. Ultimately, this will introduce a mandatory due diligence requirement for companies to measure, report and mitigate the environmental and social impacts of not just their own operations, but also those of their subsidiaries and others within their supply chains.
Both the CSRD and CSDDD need to be transposed into national laws by EU member countries. Whilst the directives are very descriptive in terms of their guidance to member states, there is room for discretion in implementation. The CSRD, for example, requires a statutory auditor to express an opinion on the sustainability reporting – members states can determine their own requirements for the quality, independence and oversight of these auditors.
Companies captured by the CSDDD
The CSDDD does not capture as many companies directly in scope as the CSRD, although its impact will be felt to a wider value chain. The CSDDD will apply to EU companies either with more than 500 employees and an annual global turnover of more than EUR 150 million or those with 250 employees, an annual global turnover of EUR 40 million and where at least half of this was generated in a high-impact sector, such as mining, agriculture and construction. The directive will also apply to non-EU companies that fit the same criteria, but with these turnover thresholds applied to figures generated from within the EU instead. Many smaller companies both in the EU and overseas will ultimately be forced into de facto compliance with higher ESG standards simply because they fall into the value chain of one of these larger companies that is directly in scope.
Spotlight on the Spanish construction sector
Spain’s experience of ESG directives began when it transposed the NFRD in November 2017, requiring companies to report a wide range of non-financial metrics, including their due diligence procedures and the detection and assessment of ESG risks. Spain is now similarly progressing with the CSRD. Its proposed draft legislation was approved by the Spanish Council of Ministers (Consejo de Ministros), the main collective decision-making body of the Spanish Government, in May, although still remains subject to change.
Both the CSRD and the CSDDD have the potential to be particularly transformative in Spain – where a high proportion of companies operate in sectors and regions either considered to be ‘high impact’ for the CSDDD, or have the potential for severe negative impacts on the environment and society. This is on top of extensive supply chains that often extend to North Africa and Latin America.
In Spain, the real estate and construction sector is responsible for more than 17 percent of the country's GDP and attracts some of the highest rates of FDI. One of the CSRD’s most significant expected impacts on the construction sector in Spain, and elsewhere, will be the requirement for companies to assess environmental and social materiality of their operations. This means that any financial metrics reported by a company will need to be contextualised and linked to its wider ESG policy and strategy.
The incorporation of environmental materiality into periodical reporting is no less than a game-changer for the whole sector, as companies will now need to counterbalance financial performance with the consideration of metrics such as GHG emissions."
According to data from the World Green Building Council, nearly 40% of global greenhouse gas (GHG) emissions come from buildings, of which 11% are from materials and construction. In Spain, the real estate and construction sector is responsible for more than 17 percent of the country’s GDP and attracts some of the highest rates of FDI.
The incorporation of environmental materiality into periodical reporting is no less than a game-changer for the whole sector, as companies will now need to counterbalance financial performance with the consideration of metrics such as GHG emissions. In terms of social materiality, companies will need to disclose not only internal metrics such as diversity, inclusion and employee safety, but also external factors such as the impact of their operations on surrounding communities. Both directives will plant this concept of double materiality at the heart of Spain’s construction sector and its global value chains. The CSDDD will take these requirements even further by compelling companies to report how ESG weaknesses or violations are being monitored and mitigated. Notably, the directives also embody opportunities for the sector’s ‘top performers’ who will now be able to attract investors who prioritise ESG performance.
Spanish construction in Latin America
Spain’s six largest construction companies between them closed the first half of 2022 with a total project portfolio of EUR 205 billion. Construction in Latin America accounts for 20-40 percent of their portfolios.
The impact of the Spanish construction industry on both the environment and local communities in Latin America has long been a concern for regulators, NGOs and eventually investors. Among the most concerning environmental impacts, partly contributed to by the construction industry, are the deforestation of the Amazons and subsequent soil erosion, as well as water pollution and water scarcity. When it regards to the ‘S’ in ESG, many construction companies in Latin America have historically found themselves tangled in legal disputes with indigenous local communities, particularly in relation to the use of local resources, land and water.
While the road ahead remains long until ESG legislation in Spain is comprehensive and compelling, it is expected that the new EU directives will have a significant contribution to the safeguarding of both the environment and society. Given the significant involvement of the Spanish construction sector in Latin America, these upcoming changes could reflect a significant turning point in how these companies are assessing, reporting and mitigating their impact in the region and globally.
The Dique Canal, Colombia: the transformative potential of the CSRD and CSDDD
The Dique Canal is an artificial 118 kilometre-long canal connecting Cartagena, an important port city on the Caribbean coast, to the Magdalena River in northern Colombia. The canal has been unusable for years as a result of challenging environmental conditions such as sea level change and weak soils, as well as social factors including resistance from local communities who were affected by the works. The last major attempt at restoration in the 1980s actually resulted in poorer outcomes, with water contamination and organised criminal groups taking control of parts of the canal, resulting in years of human rights abuses.
Following government intervention and a controversial tender process, in June 2023 Colombia’s National Infrastructure Agency signed an agreement with SACYR, one of Spain’s largest construction companies, to begin the reconstruction of the canal in a huge infrastructure project covering 435,000 hectares. SACYR will hold this concession until 2037 and it marks the company’s first project that is wholly linked to social and environmental sustainability, to ensure that local communities and ecosystems are protected.
As a Spanish company, SACYR will have to comply with the CSRD and CSDDD right from the early days of the Dique Canal project. While the connection between human rights in Colombia and the introduction of legislation in the EU may not seem immediately obvious, there are in fact very real implications. For the first time, and following a history of ESG problems, this massive infrastructure project will come under serious environmental, social and human rights scrutiny. SACYR will be obliged to inspect, report and monitor the impact of its operations at the Dique Canal, as well as those of its supply chain for this critical project, to ensure that local communities, and the surrounding environment, are not adversely impacted by the construction.
The story of the Dique canal illustrates well the interconnectivity of corporates, society and the environment. The repeated failures of construction projects in the Dique Canal have historically had an extensive effect on the lives of millions of people who were impacted either directly, as a result of the floods caused by the canal, or indirectly, by the degradation of the ecosystems or the insurgence of paramilitary groups. While the connection between human rights of communities in South America and the introduction of EU regulations may not seem very obvious, the latter reflect an important step towards the recognition of the impact some companies have on their environments, particularly in high risk sectors such as construction. If it proceeds as planned, the Spanish transpositions of the recent EU ESG regulations will come into effect in the early stages of the company’s 15 years concession. Accordingly, SACYR will therefore become the first company attempting to restore the Dique Canal that would also be obliged to inspect, report and monitor every impact its operations will have on the environment and society.
ESG Watch is S-RM’s round-up of the latest regulatory and policy updates relating to ESG from around the globe. Read the July 2023 edition now.
