Connecting the pipes: ESG regulations in China and the EU
CNBW member PwC
Article by 3 PwC experts
Jing Yu (one of CNBW's Young Leaders Speakers)
Felix Bohmann
Kevin Young
Connecting the pipes: ESG regulations in China and the EU
The European Union has been proactive in creating mandatory frameworks for reporting environmental, social and governance (ESG) issues. In China, companies face less mandatory but more voluntary disclosure requirements. If they are to reduce reporting risks on a global level, German companies active in China and vice versa must understand the different ESG requirements that apply in both locations.
How did ESG regulations develop in Europe and China?
Companies in Germany follow European Union (EU) and German regulations. The EU has taken significant strides in developing comprehensive ESG disclosure through a two-pronged approach: the Non-Financial Reporting Directive (NFRD) and the newly introduced Corporate Sustainability Reporting Directive (CSRD) which extends the scope of the NFRD. The NFRD, in force since 2016, mandates that large public-interest companies with more than 500 employees must disclose information relevant to ESG topics. These topics encompass environmental impact, social issues, human rights, anti-corruption efforts and board diversity.
The CSRD, which became effective on January 5, 2023, marks a revolutionary expansion of the EU’s ESG disclosure landscape. Not only does the directive apply to large companies, its reach has been extended to include listed small and medium-sized enterprises (SMEs). The CSRD seeks to modernize and reinforce the reporting rules, ensuring that stakeholders – ranging from investors and civil society organizations to consumers – gain insight into a company’s impact on both society and the environment. It aligns with the European Green Deal, a policy initiative aimed at fostering sustainability across the continent. Unlike traditional regulations that prescribe specific actions for companies, the CSRD aims to enhance transparency by fostering the reporting of sustainability activities.
One of the CSRD’s key features is the utilization of European Sustainability Reporting Standards (ESRS), crafted by the independent European Financial Reporting Advisory Group (EFRAG). These standards reflect EU policies while contributing to international standardization efforts. They are poised to facilitate comparisons among companies, creating transparency for all stakeholders while also streamlining reporting costs in the long run.
Lack of comprehensive ESG legislation in China
The development of China’s ESG reporting can be divided into three stages: understanding ESG and advocating for voluntary disclosure (before 2008), combining mandatory disclosure and voluntary disclosure (2008–2016) and further enhancing disclosure mechanisms (2016 to the present). China’s journey into ESG reporting began with the issuance of the Guiding Opinions on Building a Green Finance System in 2016, which laid the foundation for mandatory environmental disclosure by companies listed on the Hong Kong Exchange (HKEX). Subsequent legislation further shaped reporting requirements. However, while some level of ESG disclosure is mandatory for public companies, bond issuers and major polluters, the specifics vary, and comprehensive legislation encompassing all companies is still absent.
Despite this, the appetite for voluntary ESG reporting is growing as stakeholders, including investors and consumers, demand greater transparency. China’s ambitious carbon targets – which aim to achieve peak emissions by 2030 and carbon neutrality by 2060 – are adding impetus to this trend. It is important for companies operating in China to familiarize themselves with existing policies, regulations and standards, while being prepared for potential future shifts.
Trend towards voluntary reporting
China’s mandatory ESG reporting primarily targets companies in polluting sectors, as well as specific public firms. The positive trajectory of voluntary ESG reporting cannot be ignored, however. Driven by investors and stakeholders prioritizing environmental and social responsibility, more companies are willingly disclosing their ESG performance. In 2021, 63.8% of central state-owned enterprises and 49.9% of the state-owned enterprises released ESG reports, as did 23.5% of private enterprises.
Effective as of June 1, 2022, the China Enterprise Reform and Development Research Association, a think tank backed by the China State Council, issued the first official guidance for ESG disclosures for state-owned and private enterprises across all industries. The guidance standardizes reporting methodologies and requires companies to disclose their impact on the environment and society.
Where the EU focuses on mandatory reporting across a broad spectrum of sectors, China’s approach is stratified. China’s existing regulations encompass major polluters, bond-issuing companies, and public firms and their subsidiaries. The degree of mandatory disclosure varies, with heavy emphasis on environmental infractions.
China’s approach highlights its commitment to addressing pollution and enhancing transparency in specific industries. In contrast, the EU endeavors to create a holistic ESG reporting ecosystem applicable across diverse sectors. China’s mandatory reporting is augmented by the trend towards voluntary ESG disclosure, signifying a burgeoning awareness of corporate social and environmental responsibilities.
How to connect the pipes between Chinese and EU regulations?
While companies with operations in China and Germany are undoubtedly making strides towards sustainability, there are still certain challenges they must surmount if they want to establish a seamless sustainability framework.
For example, Chinese companies with a presence in Germany must adhere to the rigorous ESG reporting mechanisms mandated by European authorities. One alarming issue that has emerged, however, is the lack of awareness among many Chinese enterprises of the nuances of these sustainability regulations. Furthermore, a dearth of expertise in ESG disclosure is exacerbating the situation. The ramifications of such lapses can be severe, including regulatory penalties, reputational damage and the erosion of investor confidence. It is therefore imperative that Chinese companies not only comprehend the EU’s sustainability expectations but also acquire the requisite knowledge and resources for transparent ESG reporting.
Quality of data also plays a role
Conversely, German companies operating in China, along with their supply chain partners, may underestimate the complexities of gathering emissions data and ensuring the data’s quality. This underestimation could lead to headquarters facing unanticipated financial costs and the risk of greenwashing.
In the realm of ESG regulations, such as the CSRD, Germany's Supply Chain Due Diligence Act (SCDDA, or LkSG in German) stands out as a prominent example. It has applied to all businesses with more than 3,000 employees since January 1, 2023 (2024: 1,000 employees). The law requires assessing global value chains and to implement the statutory obligations, for more transparency in supply chains and to bolster human and environmental rights. Another stricter version is the Corporate Sustainability Due Diligence Directive (CSDDD) which is set to take effect throughout the EU in 2026.
China is an essential supplier for the majority of these businesses. At the moment, China lacks national regulations governing supply chains. Supply chain controls are being discussed, but no real legislation has been passed. One of the current discussions is about supply chain due diligence and corporate social responsibility, particularly in the mining industry. Many worldwide corporations affected by supply chain legislation are demanding more of suppliers and have begun blacklisting those that fail to meet their due diligence requirements. This is having an impact on Chinese suppliers in particular, who are struggling to meet the companies’ expectations while remaining compliant.
Proactive measures are therefore essential – including comprehensive training, collaboration with ESG experts, and diligent data management – if companies want to safeguard stakeholder trust and ensure financial stability in an increasingly ESG-conscious global marketplace.
ESG regulations in Europe have progressed especially through the CSRD. These frameworks mandate ESG disclosures for a broad spectrum of large companies, extending to encompass small and medium-sized enterprises (SMEs). The aim is to enhance sustainability reporting and align with the European Green Deal, emphasizing comprehensive reporting across various sectors. In contrast, China's approach to ESG reporting has evolved from voluntary to a mix of mandatory and voluntary disclosure, with a focus on major polluters and public firms, and an emerging trend towards voluntary reporting driven by increasing awareness and ambitious carbon targets.
Comparison
Guidance for ESG reporting in China and the EU (embadded)
More/Contact:
Jing Yu: jing.y.yu@pwc.com
and ...
Felix Bohmann: felix.bohmann@pwc.com
Kevin Xiang: kevin.xiang@pwc.com