Navigating the landscape of ESG regulations

Global regulations are increasingly requiring companies to disclose information regarding the nonfinancial aspects of their business to interested stakeholders. This includes the European Union’s Corporate Sustainability Reporting Directive (CSRD), which expands the existing Non-Financial Reporting Directive. The CSRD significantly broadens the number of in-scope companies and requires them to disclose on topics including human rights, environmental impacts, climate change, and the double materiality concept.

The Securities and Exchange Commission’s (SEC’s) proposed climate-related disclosure rules, issued on March 21, 2022, would impose new ESG reporting requirements on U.S.-based companies. Additionally, there has been a proliferation of global regulations focused on responsible sourcing and mandatory human rights due diligence, including conflict minerals, Germany’s Supply Chain Act, and the Uyghur Forced Labor Prevention Act, among others.

The heightened regulatory attention on these issues reflects increasing awareness of the risks and opportunities that go along with changing norms related to a wide range of ESG topics: from climate awareness to diversity, equity, and inclusion (DE&I) standards to executive compensation. More than ever, companies are under pressure to revamp their approach to ESG, not only to meet regulatory demands, but also to avoid reputational harm due to noncompliance.

What do these shifting regulatory sands mean? First, companies need to have an intimate understanding of the jurisdictions in which they operate, and accordingly, the local regulations with which they must comply. This understanding includes product compliance obligations for the markets in which companies sell their products. While expectations about ESG protocols and reporting are growing everywhere, specific guidelines vary by geography. In each jurisdiction where a business earns revenue or has certain levels of personnel or customers, regulations might be triggered. And in the case of a new acquisition in a new jurisdiction, a company might be subject to a slew of new requirements overnight.

Companies might also have to look outside their own four walls to assess total ESG exposure. While an enterprise itself might be out of scope for certain rules, companies might find that the customers or suppliers are in scope. With carbon emissions, for example, even if a company has a handle on its own emissions, its total carbon impact might be affected by others in the supply chain, and that might affect the company’s regulatory burden. All of this means that global companies will need to keep ESG regulations front and center.

Historically, the people in charge of sustainability reporting could work entirely separately from risk management and regulatory compliance departments. However, now these teams have to collaborate to create a more holistic approach. With an overarching ESG strategy that includes all parties and with open communication across silos, the entire process can be handled more efficiently.

To get started, companies first need to take inventory of all their ESG programs and exposures. A cross-functional team should be established with visibility throughout all levels of the organization and across operational units. The sales team needs to know what human resources is doing, both need to know what initiatives are taking place in the communications department, and so on. The members of the cross-functional team need to have sufficient seniority and access to information across business units and geographies that they can collectively see the entire scope of ESG-related risks and opportunities.

Considering that the global regulatory landscape is dynamic, companies need to be nimble, with established and well-thought-out plans for how they can apply best practices from one jurisdiction to another. If a company is in compliance with a regulation in Germany and that ruling is replicated in France, with the appropriate processes in place, the company should be able to quickly comply in France.

With all the technology and data available today and with greater incentives for whistleblowers to report companies that are noncompliant, it’s much more difficult for companies that are not meeting regulatory expectations to fly under the radar.

Failed compliance efforts are likely to surface quickly, and noncompliance creates exposure to fees or fines and – perhaps more importantly – to reputational harm. When compared with other companies, noncompliant organizations will benchmark poorly, and they risk being downgraded by ratings agencies.

Companies today are competing on ESG metrics and using them for competitive advantage – so being minimally compliant just won’t cut it. ESG regulations set a minimum standard, and companies that go beyond those minimums and embrace the challenge of the changing regulatory landscape can position themselves for success.