Where dollars go, regulation, reporting and risk follow. The demand and interest in ESG-aligned corporations shows no sign of ebbing, and businesses will need to do what they can to expand their ESG reporting and risk assessments.
2021 was a banner year for ESG (environmental, social, governance) investing, with nearly $650 billion invested into ESG-focused funds worldwide. No one considers ESG alignment or the socially responsible investing (SRI) movement a fad or a passing moment, and the demand for sustainable investment opportunities has proven insatiable. The trend is set to continue. Bloomberg Intelligence predicts that ESG assets are expected to represent more than a third of the $140.5 trillion in projected total assets under management – at over $50 trillion by 2025.
This level of expected investment cannot be ignored. Stakeholders will demand that companies address and manage climate change, carbon emissions, biodiversity, human rights, labor standards and board composition, among other topics. Companies will be incentivized to do so to secure continuing investment. Additionally, Biden’s Build Back Better bill will likely be considered by Congress in the first half of 2022. Passage will benefit ESG funds, even if the final legislation is less robust than the original draft.
Investing in the “S”
2022 will lead to more investor focus on the social issues of ESG. 2021 saw continuing public pressure and press on social justice issues, and the ongoing pandemic has redefined the workplace and corporate America at large as pivotal in addressing broader societal issues. In addition, the “Great Resignation” has created an urgent need for corporate focus on employee retention. Investors will be paying attention to successes and failures in this regard.
In a recent report published by Sustainable Fitch, the ESG research firm found that “[i]nvestors, regulators and stakeholders in capital markets are paying increasing attention to social issues and this ESG theme will rise in prominence over 2022. In conjunction, the nexus between environmental and social issues will become stronger as ESG integration becomes more sophisticated as more disclosures and data become available.”
During 2021, companies faced fresh pressure to replace rhetoric with action in boosting diversity and equality among their ranks. Investors have often been more hesitant to use their votes on social issues, compared with environmental or climate-related ones, but that is shifting. Most recently, Goldman Sachs Asset Management said it would be voting against nominating committee members at companies where there are not two diverse candidates on the board. And as a further case in point, a number of ESG ETFs with a specific focus on diversity, equity and inclusion launched last year.
On a related note, companies will face continued pressure in 2022 for more flexible working terms and conditions from employees who have been forced to work remotely during the pandemic. And companies should also expect to see more of the unionization efforts that have recently hit corporations, including Starbucks, John Deere and Amazon, as well as increased scrutiny on workplace culture and the social mobility of the company’s workforce.
Ready, Set … Disclose
The money will continue to flow into ESG in 2022, and when the money flows, the regulations follow. While the United States has been behind Europe and the United Kingdom in requiring transparency, accuracy, and ESG data from public companies, 2022 may well prove the year that the U.S. catches up. Expect the SEC to take a front and center role. The SEC originally planned to adopt new rules for enhanced disclosure of ESG-related filings in 2021. While this didn’t happen, these rules are likely to be announced in early 2022. While companies have long been voluntarily disclosing ESG metrics, there has been much cherry picking and inconsistency. Both ESG and climate disclosures are expected to become mandatory for entities filing with the SEC.
Importantly, in March 2021, the SEC announced the creation of its Climate and ESG Task Force in the Division of Enforcement. The task force is made up of two dozen lawyers and accountants from across the SEC’s offices and specialized units. In its press release, the SEC described the goals of the Task Force:
Consistent with increasing investor focus and reliance on climate and ESG-related disclosure and investment, the Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct. The task force will also coordinate the effective use of Division resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations.
The initial focus will be to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. The task force will also analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.
In early December 2021, Chairman of the SEC, Gary Gensler publicly commented that the pending climate risk disclosure rules will require companies to provide greater detail and information about how climate-related metrics are measured. He stated, “Yes, it might be aspiration, but then what stands behind [those commitments]? … You can’t really manage what you’re not measuring.” This Commission effort to dig into the details behind stated corporate commitments is a new push, and what it truly means for ESG and sustainability professionals in corporate America will unfold in 2022.
In addition, in November 2021, the International Financial Reporting Standards Foundation (IFRS) announced the creation of the International Sustainability Standards Board (ISSB), which is intended to “deliver a comprehensive global baseline of sustainability-related disclosure standards.” The ISSB draft is also expected to be published early 2022. While the ISSB lacks teeth, the body is expected to be influential as investor demand for global consistency increases. While it all remains unclear for the moment, details about exactly what must be disclosed and in what format are likely to shake out in 2022, making it another breakout year for ESG compliance.
Focus on ESG in Your Supply Chain
The supply chain represents the largest potential ESG risk for most companies, yet it is also holds the biggest promise to make a positive impact – and the ongoing pandemic has brought the concept of supply chain into everyday public discussion. As a result of the regulatory activities, the pressure is on for companies to disclose ESG data. Most global companies have substantial supply chains, and these third-party relationships contribute significantly to an organization’s ESG impact and goals, and should be directly addressed in disclosures. As the compliance community has learned through years of watching businesses take the hit for bad behavior of business partners in anticorruption enforcement actions, similarly, supply chain ESG risk can quickly become the organization’s ESG risk. As such, ESG due diligence will accelerate and expand in 2022.
Like third party anticorruption risk, it is impossible to eliminate ESG supply chain risk, but we can mitigate it with consistent assessment and monitoring. Does your organization hold supply chain partners to the same ESG-related standards expected by your core operation?
Particularly in Europe, regulations such as the EU Directive on Mandatory Environmental and Human Rights Due Diligence and Germany’s upcoming Corporate Due Diligence Act require continuous due diligence of third-party relationships from an ESG perspective. While the U.S. will not likely require the same level of scrutiny, the SEC is considering what “human capital” data companies will be required to disclose, and new requirements may well include data relating to labor conditions in a company’s global supply chain.
It won’t be easy. Like third party anticorruption risk, it is impossible to eliminate ESG supply chain risk, but we can mitigate it with consistent assessment and monitoring. Begin with a review of onboarding and contracting processes. Does your organization hold supply chain partners to the same ESG-related standards expected by your core operation? ESG leaders are employing the usual diligence tools but with an ESG lens: questionnaires, certifications, on-site inspections, interviews, and scoring frameworks. Compliance and ESG leaders will partner closer than ever with sourcing and procurement teams to ensure responsible supply chain practices and accountability.
Increased ESG-Related Budget, Engagement, Data and Metrics
Executive leaders that have waited to foster ESG engagement and programming will step it up in 2022. With increased scrutiny from the investment community, the regulators, and the public at large, corporations must determine how to take on ESG, from determining whether the effort stands alone or is owned by an existing business unit. ESG data and benchmarking will become increasingly important, as will ensuring proper metrics are maintained and reported in a transparent way. Human capital and diversity will continue to play a critical role, as will demonstrating climate metrics against industry benchmarks.
It’s widely recognized that one of the biggest obstacles to implementing ESG is that the data used to measure and report on it is not standardized. Even where data is on hand, the metrics available vary across and even within territories and regions. Given the uncertainties around data and disclosure, it is perhaps understandable that companies have yet to fully consider – and be sure about – the legal and reputational implications in relation to ESG commitments. Many will be aware of businesses that have already fallen foul of accusations of greenwashing – that is, the use of unjustified claims to prove ESG credentials – as a result of the lack of, or misuse of, data. Greenwashing is often a deliberate strategy. It’s an attempt to capitalize on the demand for environmentally conscious products and services but where more time and money is spent on marketing ‘environmental’ credentials than undertaking real sustainability measures. But greenwashing can also happen inadvertently, when not enough attention is given to the actions and compliance of a business or its third parties in supply chains. The negative impact upon value, however, is still the same.
The critical need for reliable and consistent data will therefore become more and more urgent, driven by increasing pressure and expectations of companies to step up and report on their ESG commitments. The time for hesitancy and reluctance towards greater transparency and disclosure, driven by a fear of legal and/or reputational consequences, has now passed.
While meaningful data analytics and AI in ESG may seem distant, the SEC has made it clear that the agency is getting smart in this area, and companies would be well advised to do the same. Creating a central repository will prove useful and is a good place to begin. While the ESG journey may be daunting, it also creates opportunity for business to demonstrate good corporate citizenry and set its corporate identity apart. Ready or not, it’s coming – so best be ready.
Valerie Charles, a Partner with StoneTurn, has more than a decade of experience in advising and defending companies under investigation, as well as those focused on implementing and improving their corporate compliance programs. She has deep experience serving both as outside counsel and as an in-house compliance leader. Valerie also has extensive expertise leveraging technology in both proactive and reactive compliance matters. Valerie helps companies develop, implement and enhance effective corporate compliance and ethics programs that meet government expectations; handle due diligence relating to M&A transactions; and address third-party and supply chain risk issues.
Tracey Groves, a Partner at StoneTurn, brings more than 30 years of experience in corporate governance, ethical conduct and behaviors, regulatory compliance, risk assessment, and culture change. She counsels leaders of complex, global organizations on environmental, social and governance (ESG) strategies that accelerate growth and innovation, drive ethical conduct and culture, and unlock responsible business performance.
