Comprehensive Guide to ESG Compliance: Top Risks and Regulations
As corporations have moved to focus on ESG compliance and investors have shifted towards supporting those organizations, there has been a transition in focus from the traditional financial decision-making paradigm to also include a company’s ethics and sustainability practices. This prioritization of ESG-based decision-making denotes a fundamental modification in corporate success metrics, emphasizing the values of accountability and transparency of long-term sustainability.
What is ESG and why should you care?
ESG is made up of three main topic areas, or pillars, that companies are expected to report.
- The E, standing for environmental, relates to a company’s impact on the environment, which might be measured by carbon emissions, waste management practices, pollution controls, commitment to natural resource conservation, and animal welfare considerations.
- The S, or social component, evaluates the company’s internal social relationships and its contribution to society. This can include labor practices, employee health and safety initiatives, diversity and inclusion efforts, human rights adherence, and engagement with the wider community.
- The G, which stands for governance, assesses how a company is run, specifically focusing on aspects like board diversity, executive pay, auditing practices, internal controls, and shareholder rights.
Many companies are choosing to report on their ESG compliance as consumers and investors become more environmentally and socially conscious. By prioritizing ESG factors, companies can differentiate themselves in the market, attract a larger customer base, and foster stronger relationships with stakeholders, including employees, investors, and regulators.
Given the increase in ESG compliance reporting in recent years, there has been a significant shift to validate ESG metrics and ensure accountability and truthfulness in reporting. Investors, governments, and consumers are not only seeking companies with strong ESG practices, but also demanding verifiability in their ESG disclosures. In this new environment, companies are now obligated to ensure the accuracy of their ESG data, demonstrating that their ESG practices are not just claims, but substantiated facts. Failing to provide accurate and truthful ESG information can lead to serious consequences, as both governmental and non-governmental entities have begun imposing sanctions for non-compliance.
Increasingly, companies are taking proactive steps to ensure compliance, but encounter challenges that impede their ability to provide quality measurements. Companies are finding that there are several root causes including lack of strategy for compliance, poor data quality and gaps in governance practices. Organizations must address these root causes in order to guarantee compliance and avoid the potential cost of publishing inaccurate results.
The first step to ensuring compliance is to understand the legal and regulatory requirements that exist. Organizations’ legal teams should do a full review of the requirements that impact them and define a plan for compliance.
Risks of Non-Compliance
Below are a few examples of existing and upcoming laws and regulations that require legal review to ensure requirements for compliance are understood.
Upcoming Laws, Regulations and Requirements
- US SEC ESG Disclosure Rules: The US Securities and Exchange Commission (SEC) is currently considering new rules that would require all registered public companies to disclose more information about their ESG practices and how they integrate ESG factors into their decision-making processes. Risk of non-compliance can lead to monetary penalties. In 2022, the SEC Task Force announced several enforcement actions related to misstatements in companies’ public disclosures relating to ESG matters.
- European Union Sustainable Finance Disclosure Regulation (SFDR): Financial market participants are required to disclose information about their ESG practices and how they integrate ESG factors into their decision-making processes within the European Union. Because the requirements under the law depend on country-specific implementations and penalties vary by jurisdiction, it is important for legal teams to review and interpret the law to assess the impact to each organization.
- US State Laws: Several states have proposed or enacted ESG regulations to require companies to disclose accurate ESG related information. Enforcement varies by state, but there is a growing trend to keep firms accountable.
- NASDAQ Board Diversity Disclosure Requirements: NASDAQ Board Diversity Disclosure requires companies listed on Nasdaq’s U.S. exchange to “publicly disclose board-level diversity statistics annually using a standardized template” and “have, or explain why they do not have, diverse directors.”
Increasingly governments are enforcing these laws. For example, Goldman Sachs Asset Management is one example of a firm that has been fined for non-compliance. In 2022, the firm agreed to pay $4 million after the SEC found that proper ESG protocol was ill-defined and inconsistently followed leading to inaccurate reporting.
Companies that fail to observe ESG compliance standards also face risks of not meeting investor expectations, which can impact their financial performance and access to capital. Today, more than ever, investors are incorporating ESG factors into their investment decisions, and they expect companies to demonstrate their commitment to sustainability and social responsibility. Moreover, investors are increasingly using ESG ratings and scores to evaluate the long-term sustainability and risk of their investments.
Companies that do not meet these expectations may face:
- Reduced investor interest
- Difficulty accessing capital
- Increased cost of capital
In addition, investors may also initiate shareholder resolutions or divest from companies that do not meet their ESG standards, which can further damage the company’s reputation and financial performance. It is essential for companies to meet ESG compliance standards to meet investor expectations and ensure their long-term sustainability and financial success.
Kenway’s Ability to Work through Barriers to Success
Companies often struggle to accurately report on ESG compliance results which can lead to strategic decisions around focus areas for improvement being misled and in non-compliance with regulatory requirements. The barriers listed below are some examples that need to be considered. Without a plan to address these challenges, many organizations will risk reporting non-compliance and inappropriate investment in ESG improvements. A comprehensive assessment of the company’s current standing and an evaluation of what it will take to reach the desired endpoint is imperative.
- Lack of standardization: There is no universally accepted framework for ESG reporting, which leads to inconsistencies in the data collected and reported by different companies. Various organizations, such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), and the Task Force on Climate-related Financial Disclosures (TCFD), each have their own guidelines and metrics, making it challenging for companies to adopt a standardized approach and ensure data comparability across standards.
- Subjective nature of some ESG factors: Certain ESG factors, such as corporate governance practices or employee satisfaction, can be difficult to quantify and measure consistently. This subjectivity can lead to discrepancies in data and make it challenging for companies to benchmark their performance against industry peers or track progress over time.
- Data availability and reliability: Companies may struggle to access reliable and up-to-date data on their ESG performance, particularly when it comes to their supply chains or operations in different countries. This can be due to a lack of internal data collection processes, deficient data quality controls, insufficient monitoring of suppliers, or the use of different reporting standards across jurisdictions.
Kenway Can Help with ESG Compliance
Kenway Consulting offers support to companies seeking to improve the validity and reduce effort required to produce their ESG reporting by instantiating data governance and management best practices. By working with Kenway, organizations of any size can begin to measure their current results, identify strategic focus areas for investment and improve their ESG metrics, establishing confidence in their performance for investors, regulators and consumers who are increasingly looking for companies to demonstrate a commitment to sustainability and responsible business practices.
Kenway specializes in data management and data governance and helps companies overcome these challenges in several ways:
- Data collection and analysis: Kenway assists companies in implementing robust data collection and analysis processes which ensures that ESG compliance data is accurate, timely, and reliable. This may involve identifying relevant data sources, developing data collection tools, and creating processes for aggregating and analyzing data.
- Data Governance: Kenway helps establish data governance policies and procedures to ensure the ongoing quality and integrity of ESG data. This may include defining data ownership, establishing data quality standards, and implementing regular data audits and validation processes.
- Technology solution selection: With its expertise in data management, Kenway aids organizations in identifying, selecting, and implementing technology solutions to support ESG data collection, analysis, and reporting. This may include selecting appropriate software platforms, integrating data sources, and developing custom analytics tools.
By partnering with Kenway, organizations can overcome the challenges associated with ESG data collection and reporting, enabling them to more effectively measure their ESG performance, comply with reporting requirements, and demonstrate their commitment to sustainability to stakeholders. Contact us today to learn more about how Kenway can support your ESG reporting efforts at email@example.com.