Impact of EU Compass on your ESG Strategy

The European Commission recently published the Competitiveness Compass: a plan to “steer the EU towards greater sustainable competitiveness”. One key element of this extensive plan is the simplification of EU regulation, starting with ESG reporting. Understandably, we have been approached by clients, who are concerned about the impact on their ESG strategies. Is this the beginning of the dilution of European ESG policy, in response to political shifts in Europe and the US?

At KPMG, we believe the European ESG transition will continue, albeit with stronger focus on key priorities such as decarbonization and energy affordability. Notably, the EU remains firmly committed to its decarbonization agenda and is even considering raising its ambition level to a 90% GHG reduction by 2040.

The Competitiveness Compass represents a long-awaited response to the Draghi report. Published last summer, this report examines how the EU can reignite its economy amid increasing global competition, particularly as it lags behind the U.S. and China.

The report, authored by former European Central Bank President Mario Draghi, concludes that Europe's economic slowdown stems from three key issues: a lack of focus in policy objectives, inefficient use of common resources, and insufficient coordination between national and European levels. To revive economic growth, Draghi highlights three priority areas: fostering innovation, accelerating decarbonization and competitiveness, and enhancing security and resilience.

The Draghi Report highlights innovation as a key area to focus policy objectives: If the EU seeks to foster innovation, why does it continue to impose additional regulatory burdens on SMEs? In response, the European Commission has announced plans to reduce administrative burden costs by 25% for all companies, and 35% for SMEs by the end of its current term (December 2029). The first areas of focus will include sustainable finance reporting, sustainable due diligence, and taxonomy reporting. The Commission also aims to simplify the Carbon Border Adjustment Mechanism (CBAM) for smaller market players.

With the first 'Omnibus Package' expected on 26 February, KPMG anticipates the following changes to ESG reporting:

• Alignment of partially overlapping regulatory frameworks (CSRD, EU Taxonomy, CSDDD, and SFDR) with a stronger emphasis on decarbonization and circularity. This may occur through:
  • Replacing mandatory requirements (often indicated by "shall") with voluntary requirements (often indicated by "may"), or
  • Significantly reducing reporting requirements other than ESRS E1 (which focuses on climate change) and ESRS E5 (which focuses on circularity).

Uncertainty remains regarding the extent to which other ESG topics will continue to be subject to mandatory reporting obligations. As a result, companies should prioritize advancing their decarbonization and climate resilience strategies over other ESG topics.

• A significant reduction in ESG reporting obligations (CSRD and CBAM) for SMEs. This could take the form of a 'light' version of existing ESG reporting requirements or a full exemption by raising the turnover and employee thresholds.
• Potential modifications to the design of the CSDDD and the EU Deforestation Regulation, following announcements to adjust regulations that disproportionately impact smaller companies within the supply chain.

The Competitiveness Compass outlines multiple decarbonization policy measures, positioning them as drivers of economic growth. The communication highlights the importance of decarbonization for both energy security and climate change. Collectively, these measures contribute to an intermediate climate target of 90% CO₂ reduction by 2040, to be incorporated into the European Climate Law. First in line is the Clean Industrial Deal, expected to be published in Q1 2025.

Based on the Competitiveness Compass, we anticipate focus for the current Commission mandate on the following key climate and energy policy themes:

• General policy instruments will be replaced with sector-specific policy packages, maintaining a technology-neutral approach. Energy-intensive sectors (e.g., steel, metals, and chemicals) will benefit from trade defense instruments (e.g., CBAM) to ensure a level playing field, while transition support will be provided through action plans and restructured state aid. The Commission announces policy intervention will be based increasingly on:

“assessment of needs and market outlook, focusing on technologies key for decarbonization and economic resilience, emerging sectors, or on technologies where current EU domestic production risks being put under pressure by international competitors benefiting from an uneven playing field, subsidies or support polices leading to non-market overcapacity.”

• A strong push to lower energy costs through:
  • Expanding renewable electricity capacity,
  • Maturing renewable energy market instruments,
  • Reducing tariffs and taxes.

High and volatile energy prices for end-users will become a key political focus. In the long term, efforts will focus on maturing the Power Purchase Agreement (PPA) markets, reducing power price dependence on fossil fuels. Industrial users will be incentivized for demand flexibility.

• Permanent carbon removal will be incentivized to improve its business case, but no significant incentives are expected before 2027.

These measures indicate a shift in policy emphasis by the European Commission. While the previous term focused on introducing Green Deal regulations and standard-setting, the current term is centered on: 1. Streamlining newly implemented regulations to improve their integration into everyday business activities. 2. Aligning industrial and decarbonization policies by stimulating sector-specific investments, thereby strengthening EU industry—a move in line with the Draghi Report’s recommendations.

Hence, while the exact ESG reporting simplification plan—set for publication on 26 February with the first Omnibus Package—is still pending, KPMG expects the EU to:

1. Refine and focus ESG reporting requirements; and
2. Accelerate the decarbonization agenda through sector-specific support packages.

This is not a dilution of ESG policy per se but rather an effort to "economy-proof" ESG policies, ensuring their long-term viability and integration.

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