Upcoming legal requirements to integrate ESG risks into diligent risk management

The days when ESG (environmental, social and corporate governance) could be dismissed as an occasionally effective marketing ploy are long gone. Legally binding regulatory requirements are in the making. But how should companies deal with them? Wait until they are legally binding? Prompt implementation of ESG criteria into risk management can prevent the need for painful cuts and unstructured, time-driven change processes. It will also help companies avoid potential cases of corporate governance liability.

"In view of the Business Judgement Rule, a company's management may already be obliged to initiate a suitable change process, depending on the company's purpose."

The European Union's 2018 Action Plan: Financing Sustainable Growth (the "Action Plan") has for the first time shed light on regulatory measures in the area of so-called "non-financial information", of which ESG criteria form a significant part. It mandates compulsory disclosure of ESG criteria for certain companies or makes ESG criteria a mandatory component of investment advice. While the Action Plan was and still is legally unenforceable, the political agreement reached by the Council and the European Parliament in mid-2022 regarding the Corporate Sustainability Reporting Directive ("CSRD") means that the consideration of ESG criteria is close to becoming legally binding. However, the CSRD must only be seen as a first step in this context. Regulatory pressure at the European level is therefore increasing.

For companies that will most likely be subject to this regulation a careful risk management process can only take place if the ESG criteria are considered. In view of the Business Judgement Rule, a company's management may already be obliged to initiate a suitable change process, depending on an overall consideration of all relevant circumstances.

ESG criteria must be integrated into the risk management guidelines. In this regard, a proactive approach can also result in a sustainable first-mover advantage. To exclude any basis for potential corporate governance liability, ESG criteria, like risk management in general, should not only be applied when problems arise. They have to be analysed in a timely manner and on a regular basis, and appropriate controls should be established.

If a company has not yet dealt with ESG criteria, it's crunch time – not only to preserve assets, but also to actively face the upcoming regulation and eliminate any potential risk of corporate governance liability.

author: Leonhard Telsnig