Sustainability regulation: ESG disclosures and demand for accountability set the tone for the future

Background

Nearly 20 years after the acronym ESG (environmental, social and governance) was introduced on the global stage in an investment context, the concept today has become equated with sustainability and corporate responsibility. There has been a growing recognition that companies and investors alike have become too focused on short-term investment horizons and profits at the expense of long-term sustainability, and that short-term profitability can often have a negative impact on the environment, workforce and society at large.

The annual Conference of the Parties (COP) of the United Nations, and the resulting Kyoto Protocol (ratified in 2005) and 2015 Paris Agreement, formally acknowledged the growing threat of climate change and the need for governments and corporations to do something about it. Faced with climate events of extreme severity happening at an alarming frequency, and the related societal and political fallout, the C-suite began to recognise that climate change could indeed pose a threat to a company’s resources, supply chains and financial performance.

In particular, the Paris Agreement states that “international cooperation and coordinated solutions at all levels” are needed in order to limit global warming to 1.5 degrees Celsius. To achieve this goal, countries must limit their greenhouse gas (GHG) emissions drastically, achieving net zero emissions by 2050. Many countries have already adopted or are in the process of adopting regulations to support this goal, requiring companies within their jurisdictions to report on their ESG performance and progress toward achieving the net-zero target.

Pressures and Drivers

Until January 2023, when the Corporate Sustainability Reporting Directive was adopted by the European Union, most ESG disclosures were voluntary, driven by the following stakeholder groups:

Investors

A recent McKinsey & Company study among the chief investment officers of 19 leading investment funds confirms what most observers and policymakers already know: “Short termism” in investment decisions is out and long-term value creation considerations are in. Twenty percent of those surveyed pointed to ESG impacts as a decisive long-term value factor; supply chain efficiency and resilience was a factor for another 31%. In some industries like energy, materials, pharmaceuticals and consumer products those factors ranked even higher.

Some of the largest institutional investors, such as Blackstone, with US$1 trillion of assets under management (AUM), have made sustainability a cornerstone of their policy, and others are making their voices heard. For example, in the run up to the adoption of the European Sustainability Reporting Standards (ESRS) in July 2023, nearly 100 investors called for more, not less, strict disclosures, underscoring the importance of that information to their investment decision-making. Meanwhile, the number of signatories to Principles for Responsible Investment — a United Nations affiliate made up of investment managers that formally introduced and continues to herald ESG — has grown from 63 signatories with $6.5 trillion in AUM in 2006 to more than 5,300 signatories with $121 trillion AUM as of the end of 2023.

Customers

Several studies and surveys indicate that customers want the brands with which they do business to support social, environmental, socioeconomic, and even political causes that are important to them. And many of those — millennials and GenZs, in particular — are backing this sentiment with their spending. Organisations are facing growing demands from customers for more transparency into their sustainability practices and those of their supply chain partners, with transparency closely linked to consumer trust in the brand. B2B customers, on the other hand, need clarity as to how the sustainability practices of their vendors and partners will affect their own ESG targets.

Workforce

Similarly, robust ESG programs are proving essential to talent recruitment and retention in a fiercely competitive hiring environment. Forty-six percent of GenZ job seekers say the green reputation of a respective employer will impact their decision to take the job. Companies like Patagonia, which proactively promotes fair labour practices and environmental stewardship, have long enjoyed deep employee loyalty. Meanwhile, employees are leveraging ESG to make changes within their companies, in some cases pointing out discrepancies between an organisation’s rhetoric about the rights of workers and its actions. Freedom of association and workers’ rights are also increasingly favoured by shareholders and investors, who view the lack of these rights as a talent recruitment and retention risk, according to a Harvard Law School report.

As a result of demands by the aforementioned stakeholders, companies have gone to great lengths to showcase their efforts to build businesses guided by sustainable, social and environmental stewardship. What is different today is that these efforts are no longer based on cherry-picked, voluntary information but are guided instead by specific requirements intended to demonstrate, and hold accountable to, forward movement on sustainability goals.

A Game-Changer for ESG

A growing number of governments and governmental bodies around the world have stepped up to demand
new — in some cases, mandatory, standardised and verifiable — ESG performance reporting. Some of the reporting regulations issued or in the process of being finalised have requirements for materiality, double materiality and attestation, and affect both public and private companies, as well as non-profit and other entities. Noteworthy current or planned regulations to date include the following:^[1]

Other disclosures related to ESG and sustainability include a host of modern slavery acts related to supply chain risks across numerous countries. Germany enacted one of the most stringent reporting requirements on human rights and environmental due diligence.

The list above is just a fraction of the ESG regulations and guidelines sweeping the globe. There are a number of regulations related to corporate governance, board diversity, workers’ rights and other aspects of ESG, as well as regulations specific to individual industries and companies of certain sizes. To understand the full scope of regulatory requirements affecting your company, conduct a global regulatory assessment.

How Are Companies Affected?

Current and emerging ESG regulations set an expectation for companies not only to provide transparency (i.e., disclose numbers), but, in some cases, also to report progress toward ESG targets using common standards and KPIs.

Organisations that make sustainability claims for marketing purposes but lack the evidence to substantiate the statements, either because of an ungoverned ESG program or carelessness, could run afoul of “greenwashing” laws as governments around the world increasingly crack down on the practice. Beyond the regulatory requirements and potential penalties, boards and C-suite executives should consider the benefits of executing a verifiable sustainability strategy by measuring it against the costs and implications of doing business as usual. The good news is that, in many ways, creating value by Protiviti concentrating on earnings durability and downside risk already incorporates many concepts associated with ESG. In other words, executing on ESG goals and ensuring long-term business value are not mutually exclusive, but supportive of each other.