How emerging markets can prepare for the EU’s new ESG regulations

In December 2021, European leaders emerged from the COP26 climate conference in Glasgow with a resolute commitment to translate climate pledges into tangible action. Since then, the European Union (EU) has rolled out a series of regulations applying Environmental, Social, and Governance (ESG) standards to trade, aiming to curtail CO2 emissions, shield environmentally conscious European producers, and discourage unfair trade practices. An article by Boston Consulting Group (BCG) titled Why Emerging Markets Need to Prepare for the EU’s New Climate and ESG Regulations explores the implications of these regulations on emerging markets.

While the primary impact is anticipated within the EU, emerging markets face substantial challenges as many are ill-prepared for the impending regulatory wave. These markets start with a relatively low base with ESG scores that average 20 points lower than companies in developed markets. The lack of urgency, concrete actions, and multilateral cooperation puts them at risk of being excluded from crucial export markets.

“As developed markets – such as the EU – ramp up their ESG regulations, emerging markets will feel the impact. For example, around 20% of South Africa’s exports to the EU consist of carbon-intensive products such as steel and aluminium, which will be subject to a new carbon import levy from 2026. S&P estimates this could cost South Africa over $90 billion between then and 2040. Countries and companies across Africa need to respond to these new rules and take action to maintain their carbon competitiveness,” says Tim Figures, Partner and Associate Director at BCG.

Emerging markets, projected to constitute 62% of the global economy and 88% of the population by 2050, play a pivotal role in mitigating climate change. Despite emitting less CO2 per capita, they contribute 85% to the global total, a share expected to grow. Among the significant EU measures are the Carbon Border Adjustment Mechanism (CBAM) and the EU Deforestation Regulation (EUDR). The CBAM is expected to impact over 5%, which could extend to 10% by 2030, of EU imports in its initial phase and will have a significantly higher impact once the scope is expanded, putting countries in Africa at risk. 

The EU relies on most major emerging markets for only a tiny portion of its total imports, but the carbon tax could apply to nearly 10% of the value of exports to the EU of both China and Brazil, to 15% of the value of Morocco’s exports to the EU, to nearly 20% of the value of South Africa’s exports to the EU, to more than 25% of the value of India’s exports to the EU, and to more than 40% of the value of exports to the EU of Egypt and Turkey, both major producers of iron, steel, and fertilisers.

CBAM will equalise the carbon costs of materials produced in developing nations with those in the EU, hitting international trade by bringing new rules to a specific scope of goods, affecting industries like steel, aluminium, and chemicals.

Twenty-percent of South Africa’s iron and steel and nearly 30% of its aluminium exports are destined for the EU and are exposed to CBAM, while nearly half of Egypt’s iron and steel and half of its fertiliser exports go to the EU. Other African countries impacted include Morocco – 10% of its fertiliser and 60% of its iron and steel exports are intended for the EU.  More than half of Mozambique’s aluminium exports currently go to the EU; unless it can decarbonise this sector, analysts estimate the country stands to lose as much as 1.6% of its GDP as a result of the CBAM.

The EU Deforestation Regulation (EUDR) effective in 2025, prohibits the sale of commodities such as cocoa, cattle, wood, soya, rubber, coffee, palm oil, and timber harvested from recently cleared rainforests, impacting vital export sectors in Latin America, Africa, and Southeast Asia. Producers in emerging markets will potentially pass through fines or delisting by EU importers in case of insufficient disclosure, putting them at risk of losing exports and GDP if these markets do not raise ESG regulation and performance.

As with CBAM, the EUDR will initially have minimal economic impact on the EU itself. In its first phase, the deforestation regulation will directly apply to only around 2% of the trade bloc’s imports, but for certain products, the consequences will be great. An estimated €14 billion of imported Brazilian coffee and soy, much of which is grown on former rainforest, €8 billion in Chinese wood products, and €4 billion of imported Ivory Coast coffee are at risk. Around 20% of Indonesian and Malaysian palm oil, and 60% of Ivory Coast coffee and nearly 30% of its rubber will be affected.

A roadmap for ESG readiness

These measures collectively mark a historic shift in global trade dynamics, affecting nearly every major emerging-market export sector. “Emerging-market entities must act swiftly – adapting to ESG rules akin to those in Europe demands strategic planning and implementation,” adds Figures. “Establishing systems to document and report greenhouse gas footprints, embracing ‘smart compliance,’ and developing comprehensive strategies for decarbonisation and enhanced ESG performance are imperative steps.”

Companies in emerging markets face mounting pressure from various stakeholders to align commitments with tangible actions, including consumers, investors, regulators, and employees as non-compliance triggers economic results in developed markets as well. Consumers are forecasted to potentially face high prices and phase out of free allocation which will increase industry costs and costs added by data infrastructure investments.

In addition to CBAM and EUDR, the European Sustainability Reporting Standards, restrictions on minerals from conflict zones, and potential directives on corporate sustainability due diligence and eco-design further underline the EU’s commitment to ESG principles. Notably, companies in emerging markets face challenges in meeting international sustainability standards due to historical disparities, with their environmental sustainability rankings lagging behind G20 peers by around 20%.

However, ESG is now a strategic imperative for emerging markets. Research indicates that large emerging-market companies leading in climate sustainability outperformed the MSCI Emerging Markets Index by 105% from 2017 to 2022. High ESG standards enhance market access, attract investment, talent, and offer opportunities to reshape industries with sustainable business models. As regulatory pressures escalate, creating value through ESG becomes more complex.

To remain competitive, companies in emerging markets must undertake a multiphase ESG readiness journey. This includes mapping ESG regulations, identifying gaps in measurement and reporting capabilities, and developing a holistic sustainability transformation roadmap. The roadmap should address strategy alignment, governance, organisational culture, product and service sustainability, regulation-specific capabilities, and global coordination.

“Global trade, strongly linked to global GDP, is evolving into a potent tool for promoting sustainability,” says Figures.

While emerging markets cannot navigate this shift alone, international collaboration and assistance from advanced economies are essential. Aligning carbon accounting standards, deploying green subsidies, forming inclusive climate clubs, and leveraging international institutions are critical steps to support emerging markets in their transition.

The surge in ESG-linked regulations presents formidable challenges, and failure to respond risks severe economic consequences for vulnerable populations. Compliance is achievable with proactive efforts from companies and governments, offering a pathway to competitive advantages and long-term opportunities in sustainability leadership.

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