Growing demands by shareholders and consumers for more responsible and sustainable business practices have already reshaped the corporate ESG landscape, at least in some cases. Now come new legislative moves, both in the U.S. and the U.K., focused on “due diligence.” The new laws seek to compel corporations to proactively examine their supply chains, in order to establish that they’re actually doing the right thing. Or, realistically, not doing the wrong thing.
The European Commission announced in February that it has adopted a proposal for a directive on corporate sustainability due diligence, in order to foster sustainable and responsible corporate behavior throughout global “value chains,” and “advance the green transition and protect human rights in Europe and beyond.”
“Companies play a key role in building a sustainable economy and society,” the commission said. “They will be required to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights, such as child labor and exploitation of workers, and on the environment, for example pollution and biodiversity loss.” The commission went on to say it believes these new rules will bring legal certainty and a level playing field for businesses. For consumers and investors, they will provide more transparency.
Meanwhile, in March, the U.S. Securities Exchange Commission (SEC) announced a long-awaited draft rule on climate disclosure that would require registrants to “include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business [and] results of operations.” The SEC said the required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions.
“I am pleased to support today’s proposal because, if adopted, it would provide investors with consistent, comparable and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers,” said SEC Chair Gary Gensler. That’s a big “if,” though. And in the case of the European due diligence legislation, it’s a big “how.”
“It’s certain that there will be a law,” says Matthew Kirk, a public policy adviser at the law firm of Squire Patton Boggs, of the EC directive. “This piece of legislation has been bumping around the place for some time already, and it will be quite contentious. Broadly speaking, the European parliament is going to want it to be more intrusive, and member states are likely to be worried about the implications for European competitiveness.” Kirk estimates it will be around two years before any legislation sees the light of day.
The most pressing matter seems to be: How deep into their tiers of suppliers will companies have to go? “The way this legislation is drafted, they will have to go right down, way beyond Tier 1,” Kirk says. But then there’s the question of how auditable the information is that’s gathered. “That’s going to be one of the much-debated areas. Where you set the bar on auditability really depends on how deep you want to look.”
Kirk points out that most companies who currently present ESG audits, voluntarily, use less rigorous standards than they do for financial accounts. “A lot of companies tend to take the approach that ‘we’ve found nothing to suggest…’” he says. “That’s not going to pass muster anymore.”
At minimum, Kirk believes, the EU Parliament will insist that audits go deep enough to address human rights abuses, at least where they are perceived to be taking place. “What’s happening in Europe is there have been individual elements of due diligence required of companies to combat modern-day slavery, conflict minerals and gender pay gaps, and this is supposed to be the legislation that wraps everything together,” he explains. “It wouldn’t surprise me to see elements pushed forward more than others, and it’s likely to be these.”
Carbon footprint is the other very interesting area to be addressed, Kirk says. “The depth into the supply chain you have to go into in terms of disclosure of carbon emissions will be another hotly debated topic. And we expect that to have a relatively high audit standard.”
In the U.S., there is the inevitable problem that legislative efforts can fall in the gaps between federal and state administrations. But companies have no reason to feel complacent about the very real changes coming, says Jackson Wood, director of industry strategy for global trade intelligence at Descartes Systems Group.
“Whether you call it ESG, corporate social responsibility, supply chain transparency or resiliency, what’s not going away is the requirement for companies to do more due diligence and be more transparent with shareholders and customers about what they’re doing to de-risk the business and be a better corporate citizen,” he says.
It’s tempting to be skeptical, however. Former U.S. Secretary of Labor Robert Reich, now a professor of public policy at the University of California at Berkeley, contemptuously noted in a September 2021 op-ed in the Guardian the opposition of the U.S. Business Roundtable, which includes chief executive officers of big hitters such as Apple, Walmart and JPMorgan, to President Joe Biden’s $3.5 trillion reconciliation bill, which included measures to enhance workforce training, alleviate poverty and reverse climate change. “Corporations will do whatever they can to maximize their profits and share values, social responsibility be damned,” he said.
Wood is more cautiously hopeful, saying that in his experience, clients seeking advice on compliance and risk management are becoming more interested in learning what they shouldn’t do as well as what they can’t do.
“What started to happen five years ago, but has been picking up in the last two years, is the emphasis around the stuff you probably shouldn’t do,” Wood says. “And that’s where corporate social responsibility and ESG falls.” He increasingly sees corporations demurring when it comes to dealing with a supply chain partner that has a spotty record on environmental protection, or cozy relationships with less-than-savory actors. “That, to me, is the broader context of this trend that has been unfolding over time.”
Wood is certain that change is coming. “Companies must decide if they want to get ahead of this ESG wave,” he warns. “They need to ask: Do we invest in it now, when it’s not as stringent a requirement as the tea leaves suggest it will be in the months and years ahead? Or do we just concentrate on all the regulatory stuff now, and deal with these ESG requirements when they’re real? But it’s only a matter of time before this becomes just like any other regulatory requirement.”
Kirk agrees. It’s time to move past “greenwashing” and other forms of lip service, he says, even if it’s mostly in pursuit of a competitive advantage. “Those who have been taking sustainability reporting seriously will still need to step up, because there will be a significantly increased requirement,” he says. “But they mostly have the mechanisms in place to achieve it. However, those who have been greenwashing will find this a pretty rude shock, and will have to make considerable efforts to get themselves into a position where they can comply with the new legislation.”
As ever with widespread change in the commercial sector, laws are good, but consumer pressure is better. It’s clear that companies only change when they get hit in the pocket, hard. Johnson & Johnson reported profits of $20.9 billion in 2021, the year it agreed to a $100 million settlement over cancer-causing chemicals in its talcum powder. For someone earning $100,000 per year, that fine is the equivalent of a little under $500 — about the same as getting your car towed. It makes far more sense to go after J&J’s sales, which were nearly $94 billion that year.
“The expectation of consumers is going to play a key part,” Wood says. “We’re seeing this very powerfully in the Russia-Ukraine situation, with companies self-sanctioning. Regardless of whether they can legally do business with Russia, they’re not going to do business with Russia, because the [popular opinion] headwinds are just too strong. They want to signal to customers that they don’t stand for these types of activities.
“A lot of companies are getting on the offensive, signaling that they’re a progressive organization that believes in things like democracy and freedom,” Wood continues. Yes, he admits, it’s a branding exercise. But it’s still a good thing if corporations actually act as they say they will.
Ultimately, the real power lies with the consumer.
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