Don’t Be Deceived About ESG Sentiment. Companies Must Up Their Compliance Game.

Reports of ESG’s death are greatly exaggerated. If anything, it’s hit a growth spurt as new regulations come online: 99% of the Fortune 500 published some form of ESG data last year.

Workiva research shows 87% of corporate reporting professionals will find it challenging to comply with new ESG due-diligence regulations, however, putting renewed emphasis on ESG compliance internally.

Evolving ESG laws represent more than just an incremental increase in due-diligence compliance requirements; rather, they signal a rapid change in the corporate regulatory landscape, with corporate value chains front and center.

For example, risk management leaders need to collaborate with their procurement and sustainability peers to collect "investor- and regulation-grade” ESG data from their supply chains and implement processes to meet each law’s due-diligence requirements.

Those that don’t could face potentially steep consequences and miss an opportunity for ESG compliance to be a competitive differentiator.

Sustainability Regulations Expand

Broad ESG laws and regulations rising globally mandate that companies make meaningful changes to business practices and relationships. Many laws are in Europe but apply as well to large, North American-based multinationals that operate in Europe.

Europe and beyond, here’s where the ESG regulatory landscape stands today:

• Corporate Sustainability Due Diligence Directive (CSDDD) – Roughly 5,500 EU-based companies and at least 1,000 non-EU companies will have to identify broad sustainability risks and impacts throughout their value chains and collaborate closely with their partners to mitigate them. Non-compliant companies could be subject to public naming and shaming, removal of products from markets, fines of up to 5% of their global net turnover, and civil liabilities worldwide.
• Corporate Sustainability Reporting Directive (CSRD) – More than 50,000 covered companies listed in the EU bloc or having significant operations there – regardless of where they’re based – will need to report their double materiality. They’ll also have to disclose transition plans to meet the Paris Agreement’s 1.5 °C goal.
• California’s Climate Corporate Data Accountability Act (SB 253) – Passed in 2023, the law will require companies with more than $1 billion in revenue to account for and report their Scope 1, Scope 2, and Scope 3 emissions beginning in 2026. Non-compliant companies can be fined up to $500,000 in a reporting year.
• Canada’s anti-slavery supply-chain law (S-211) – Beginning January 2024, many companies must publish annual reports on the measures taken to address and prevent forced and child labor in the production, selling, distribution and import of goods within and into Canada. It allows non-compliant or untruthful companies to be fined up to $250,000 per case.
• U.S. Smoot-Hawley Tariff Act/Uyghur Forced Labor Prevention Act (UFLPA) – The 1930 Tariff Act already prohibited companies from importing goods, materials and products made with slave labor. The 2021 UFLPA created inspection and enforcement regimes and now requires companies to conduct due diligence to comply. Non-compliance can lead to seized imports and operational, financial and reputational damage. Since the UFLPA went into effect in June 2022, nearly $3.5 billion worth of shipments have been seized at U.S. ports.

Pete Rau of EcoVadis: “Realize the value.”

These laws are multidimensional, requiring in-scope companies to disclose reports on historical ESG data and trends, future ESG target setting, progress tracking, climate-transition timelines and reduction/impact forecasts. Some laws also require companies to assess and report their double materiality – their environmental and social impact, and how that impact affects their businesses.

In fact, only 17% of companies have processes for screening new suppliers for sustainability-related risks, putting them behind on complying with these stringent requirements.

Getting Ready for Regulatory Requirements

While existing and emerging ESG laws have their nuances and specific requirements, they all require companies to rethink their risk management and compliance strategies. Business leaders should develop systematic approaches for identifying, mitigating and reporting on ESG issues throughout their supply chains that are scalable, repeatable or transferable across multiple laws.

Procurement and risk management leaders must engage their internal executive stakeholders to gain budget for investments in the digital technologies and skills necessary to drive regulatory compliance and sustainability performance. This may involve investment in compliance and risk management tools, data collection and analytics solutions, or a more comprehensive digital transformation initiative.

Procurement and risk leaders must also work with their peers to develop and implement best practices to drive results and realize the value of their sustainability programs. Here are some recommendations based on inputs from 600 procurement practitioners:

1. Digitize to scale: Deploy digital solutions to collect better risk and sustainability data. This will help gain visibility into your end-to-end value chain to identify risk exposure as well as improvement opportunities. Integrate digitally with internal stakeholders and suppliers to close process gaps, drive consistency and facilitate data sharing.
2. Engage suppliers: Go beyond due diligence, risk exposure, and even risk measurement. Benchmark their risk and performance, guide and support improvement, and engage them on opportunities to drive innovation.
3. Build the right skills: Modern procurement and supply-management operations are data and tech-heavy and require teams to have a good balance of people and technical skills. Train your current team on data management and analytics best practices, in addition to negotiation and other traditional procurement skills.
4. Tailor focus areas to the business: When determining risk areas to focus on, don’t try to boil the ocean – it’s hot enough already. Prioritize the ESG risks most applicable to your business and industry and, over time, work to incorporate other risk domains.
5. Improve visibility: A lack of global visibility across supply-chain sustainability risks hampers efforts to drive meaningful change throughout the value chain. This is particularly true of deeper tiers, which companies need insights into their risks under new global regulations.
6. Integrate ESG data Into procurement: The majority of organizations face challenges integrating sustainability data into procurement technologies, limiting performance across the value chain.

Compliance Drives ROI

Regulators are on track to make ESG part of business performance. Market leaders already know that, with the right foundation, proactive companies can prioritize sustainability and be compliant while gaining value in the form of resilience, competitive advantage and growth.

A recent study shows that “companies that focus on ethics, environmental and labor practices within their supply chains” have profit margins three to four points higher than their peers. What’s more, in carbon-intensive industries, companies that use more renewable energy sources also report higher EBITDA margins.

Indeed, having strong ESG and sustainability programs and complying with related laws and regulations is not just a fad, but is part of good business fundamentals. Through robust compliance measures, companies can also do right by people, planet, and profit.

Pete Rau is VP of Enablement & Solution Consulting at ESG risk and compliance solutions provider EcoVadis.