Corporate social responsibility (CSR) has been laying the groundwork for ethical corporate behavior for decades now. But Environmental, Social and Governance (ESG) has leapfrogged its way past being another iteration of CSR, to dominating the corporate agenda.
The EY 2022 U.S. CEO survey found 82% of respondents now view ESG as a core value driver for their business. For business executives across the world, ESG is a priority for continued growth and success.
Adoption of ESG programs is driven by key trends spanning the globe – from European Union legislation and voluntary disclosure adoption, to aggressive target-setting on carbon neutrality, enforcement rules, and task force creation.
What’s Behind the Recent Push Toward ESG?
While corporate awareness of ESG isn’t new, consumers and investors are really pushing for the most recent and rapid changes. New consumer behavior trends signal a desire to engage with common value-aligned brands. From an investor standpoint, sustainability risks are increasingly viewed as financial risks.
Companies and investors are starting to agree that ESG issues are material to the business.
So, what’s going on here? There are two major trends to focus on:
ESG Disclosure Adoption
What’s going on in the U.S., and what can the U.S. (and rest of the world) learn from other regions like the EU, which is quickly moving toward continental carbon-neutrality by 2050?
The 2014 Non-Financial Reporting Directive (NFRD) was the first disclosure statute on corporate-sustainability reporting in the EU. The imminent Corporate Sustainability Reporting Directive (CSRD) significantly reinforces current reporting requirements, capturing approximately 50,000 business entities.
Meanwhile in the U.S., March 2021 saw the establishment of a U.S. Securities and Exchange Commission (SEC) taskforce initiative to proactively identify ESG-related misconduct. SEC Chairman Gary Gensler reiterated the SEC’s commitment to providing investors with comparable decision-useful climate-related information to investors.
Approximately one year since the establishment of this taskforce, Gensler and the US SEC has announced they will propose rules that mandate the disclosure from publicly traded companies about climate change and associated risks. The proposal will take place during a March 21, 2022 meeting.
And just last December, the International Financial Reporting Standards (IFRS) created the International Sustainability Standards Board (ISSB) – consolidating leading issuers of voluntary ESG disclosure guidance. As a result, new standards are coming.
Third-Party Risk Management
The evolution into a more holistic approach to third party risk management over the past 18 months definitively stems from European developments.
In June 2021, the German Supply Chain Due Diligence Act was ratified and will be enforced starting in 2023 – companies operating in the country will work with their third parties from both business operations and environmental perspectives. Similar developments in France and the Netherlands are under way.
A number of NAVEX customers discuss sustainable procurement strategies by actively seeking supplier diversity – with a focus on climate risk, green energy and water efficiency, as well as employee wellbeing.
Corporations everywhere are proactively taking responsibility for their actions and holding themselves accountable. No longer can the focus rest, in isolation, purely on business operations. New laws, investor values and company proactivity are converging to drive this change.
Enter Risk and Compliance Management
Who exactly is overseeing this crucial transition?
Risk and compliance has been a cornerstone of corporate management since the early 1990s. Increasingly though, ESG oversight is falling within its core responsibilities. And while some compliance leaders may see this as a strain on already-limited resources, for others, its synergistic potential overrides many concerns.
Armed with several decades of experience within this realm, risk and compliance officers are undoubtedly primed as the best placed to oversee ESG-related activities. Already part of risk and compliance are:
- Diversity, equity and inclusion (DEI) initiatives
- Social and human capital data tracking
- Third party risk management
It’s therefore a natural fit to extend risk and compliance oversight to all ESG initiatives.
The convergence of ESG with ethics and compliance incorporates business operations, the environment, social and human capital, and governance – all are interlinked. In compliance, companies adopted new regulations over a time span of 20 to 30 years. With ESG, it’s happening a lot faster.
Compliance officers know what they don't know – and they know where to get the answers.
Where ESG has already been established organically, self-governance has been part of the regulation process. The attitude within supply chains and third-parties has shifted from having a lot of leeway, to requests for value chain data on supplier selection with questions like:
- What is your product design?
- Is it designed with privacy in mind?
- Is it designed with the possibility of resilience?
- For physical goods, could you send that product back to the company that created it, can it be disassembled and resold?
Self-governed entities are becoming increasingly regulated. With additional laws comes more enforcement. And this is trending upward with even more enforcement and related penalties on the horizon in the EU, Asia, and in the U.S. with the SEC.
The ‘G’ of ESG, Ownership and the Board
ESG is extremely important to investors, and it adds responsibilities for compliance – which can expect an increasingly front-facing role as a result. If compliance is overseeing ESG, how is the appropriate scope of responsibility determined? First, by remembering that it’s a journey and not a destination.
Begin with a shared budget and resources until specific risk areas are identified. Any resources can be refocused depending on the area of expertise needed, which is clarified with a risk assessment (known as a materiality assessment within ESG).
Depending on the industry and the diversity of the business, a dedicated ESG director or team may be more viable than a cross-functional community. Centralizing into area-specific executive leaders rather than a spread over various risk categories reduces the pain points associated with voluntary governance. If everybody owns it, then nobody owns it.
Most importantly though, the ESG budget of a company should not sit apart from the budget of business operations – doing so frames it as a “nice to have” rather than a “need to have”. Understand material risk, then look at financials, and don’t view the ESG budget as an add-on. It must be baked into the way a company operates.
Goals and targets a company aligns to don't have any accountability unless they have accountability at the highest levels. Progress toward ESG targets should be reported quarterly and reviewed annually, with corporate strategy changed accordingly to meet commitments. New data means reframed targets, and accountability and transparency are crucial for investor relations.
Boards need to take an active role here. This makes whole the bidirectional relationship between a company's success in meeting targets and the public narrative about its ambitions.
The Globalization of ESG
ESG is not just an EU or U.S. development – it’s a global movement. South Korea, Japan and New Zealand plan to achieve net zero emissions by 2050. China and Indonesia have pledged to be carbon neutral by 2060.
Global capital movement and huge green company investment speaks to this. More than 450 financial firms representing $130 trillion in assets – 40% of the world's financial assets – are plowing funds into similar net zero targets. This huge influx of capital requires measurement, transparency, consistency and disclosures.
Ongoing resiliency and human rights conversations are framed in terms of supply chain ethics. NAVEX’s survey of 400 compliance professionals across the U.S., U.K., France and Germany showed that 89% of respondents include ESG reporting as part of their organization’s compliance program.
Underscoring these changes is a maturation of ESG requirements. This demonstrates the need for a more strategic, holistic approach to how ESG is managed both within and outside corporations.
This article is based on a recent NAVEX webinar on the future of ESG in business across the globe – view the full webinar here.
