Sustainability is becoming an increasingly important issue for businesses around the world as they’re faced with mounting pressure to reduce their environmental impact.
A key way that organizations are looking to improve their sustainability credentials is through ESG (environmental, social, governance) frameworks, which can cover risks hidden far down your supply chain, including:
In addition to the risk domains covered under ESG, the frameworks also vary. Under the environmental criteria, companies are being required to enact corporate policies addressing climate change, while the social initiatives center around employee, customer, supplier relationships, and safety. Under the Governance criteria, regulators are paying increased attention to companies’ transparency into ESG areas, reporting, audits, internal controls, and more.
In addition to the broad scope of ESG requirements, companies have additional points to consider when it comes to ESG beyond their own ratings. Increased fines and penalties for ESG infractions could have a major financial impact on companies in the coming years.
While we’re still in the beginning stages of ESG, risk leaders will be faced with pressure to achieve compliance and implement initiatives as this discipline develops.
The German Supply Chain Due Diligence Act is a recent example of new ESG regulations that are demanding more action from organizations. This law places due diligence on companies that have a principal location in Germany with 3,000 employees, and foreign companies that have branches in Germany with 3,000 employees. In 2024, this will decrease to companies with a principal location in Germany with 1,000 companies and foreign companies who have branches in Germany with 1,000 employees.
But smaller organizations shouldn’t consider themselves off the hook; they may also be affected if they are a link in the larger organization’s supply chain, and organizations must find a way for suppliers to be able to file any complaints to alert the company they work with.
In-scope organizations who are aware of violations of the Act and who do not take remedial actions will be penalized with financial penalties of €50,000 and administrative fines of up to 2% of their annual average revenue if it exceeds €400 million.
Other upcoming regulations such as the EU Corporate Sustainability Reporting Directive coming into effect in 2024, as well as existing frameworks such as the UK Modern Slavery Act, and others, show that these expectations are expected to increase in scope and accountability. So, even if you’re not in-scope for the German Due Diligence Law, don’t sit on your laurels; further legislation is likely to follow, especially in the SEC and OSHA sectors.
This will inevitably lead to an increase in the financial cost of non-compliance. Therefore it’s critical for companies to stay ahead of the curve and monitor changes in their respective industry.
With the growing risk of non-compliance, third parties, suppliers, and external stakeholders are expecting companies to be compliant with ESG regulations. We’re already starting to see teeth when it comes to this. In November of 2022, Goldman Sachs Asset Management was fined by the SEC for failing to follow requirements around ESG investments. The SEC press release states, “From April 2017 until June 2018, the company failed to have any written policies and procedures for ESG research in one product, and once policies and procedures were established, it failed to follow them consistently prior to February 2020.” In settling the charges, Goldman Sachs Asset Management has agreed to pay a $4 million penalty.
Penalties, even outside the ESG space, are up. Overall, in 2022 the SEC filed over 750 enforcement actions, a 9% increase from the previous year. This resulted in over $4 billion USD in civil penalties, the most in SEC history. The SEC highlighted ESG as being a specific concern.
As new legislation is set forth, they will lead to very costly ramifications for companies. Examples like the SEC penalty are a strong signal that companies need to invest in ESG compliance operations, as increased monetary fines and lost revenue could mean less capital investment.
And it’s not just your direct organization and operations. Under most of the current (and probably future) regulations, companies need to ensure that their entire supply chain is compliant. Companies will still be held accountable for infractions by third, fourth, and Nth parties.
In addition to finances, there are many other reasons implementing ESG initiatives is important to your business. Even if access to capital or customer satisfaction is not a primary concern for your organization, there are still benefits to establishing a resilient and sustainable supply chain.
Ethical consumption, a type of consumer-based activism through supporting companies with ethical practices, is rising. In a 2020 study by professional services firm, Accenture, data showed that 60% of participants were making more sustainable, ethical, or environmentally-friendly purchases since the start of the COVID-19 pandemic. Transparency into the ethical (or unethical) practices is gaining in necessity, thus any ESG-related incident can expose reputational vulnerabilities. If a company’s third party (or even Nth party) does not meet sustainability expectations of customers, regulators, or local community, the company can face reputational damage, negative news coverage, etc.
But most important of all, ESG initiatives are designed to help make the world a safer, more sustainable place. And while this blog post is centered around ESG legislation, organizations should think beyond compliance and determine how their business practices (and, just as importantly, the business practices of their suppliers and sub-contractors) affect the world around them. ESG-related initiatives such as reducing your carbon footprint, inclusionary hiring practices, identifying and eliminating modern slavery and human trafficking within your supply chains all play a role in making the world a better place.
Unfortunately, we can’t wave a magic wand that eliminates our risks and vulnerabilities in this space. Likewise, there’s no one-size-fits-all approach when it comes to avoiding incidents and ensuring compliance with ESG regulations.
Instead, an adaptive strategy is required, utilizing technology for supply chain risk management alongside risk intelligence and continuous monitoring. These elements help organizations identify, manage, and mitigate risks within their supply chains through automated processes that mature with your TPRM and ESG programs.
Technology can’t solve every problem, however; responsibility rests on the shoulders of management and risk/ESG leaders. Creating a corporate culture of compliance, where everyone inside the organization and in the extended enterprise is aware of practices and policies, is paramount to building resilience and getting everyone on the same page. We will be exploring risk intelligence and other components of these processes in upcoming blog posts of our 2023 prediction series.
With the right technology, risk intelligence, management responsibility, and ongoing vigilance, organizations can make sure they remain compliant with ever-evolving ESG regulations.
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