Sustainability is the only option
Business needs to bridge the gap between thinking about sustainability to being sustainable in practice. The reality for business is that Environmental, Social and Governance (ESG) reporting is no longer optional. The good news is that sustainable performance is demonstrably achievable – and may benefit your business.
ESG regulation is continually evolving – and requirements regarding supply chain are ever increasing. Building ESG processes into business operations is a substantial task for any company. Add to the mix, greater customer, investor and internal stakeholder expectations, and we can see why some businesses fear that ESG regulation brings the potential to erode – rather than enhance – their company’s value, reputation and relationships. To avoid this, it is vital to address today the potential compliance failures which might undermine your supply chain ESG obligations tomorrow.
As part of our ESG thought leadership series, we conducted original research across a variety of sectors and industries to assess the extent to which UK organisations have applied due diligence with regard to their supply chains, and whether they are ready to meet changing global standards in this area.
Following the report, we assembled a wide group of stakeholders and commentators with ESG expertise from across the energy, built environment, healthcare, tech, and transport sectors. They described their experiences of managing the shifting requirements - particularly reporting and due diligence, and the main challenges they face in the supply chain. They explained how these challenges can be overcome and even leveraged to carve competitive advantage.
The need to act now
The panellists agreed that businesses need to address compliance with the regulations specific to their supply chain right now. For a start, market expectations clearly centre around greater transparency, which puts pressure on businesses to carry out ESG disclosures as soon as possible. The lack of compliance with ESG regulations can also put businesses at a competitive disadvantage in the eyes of investors and consumers. Further, the volume of due diligence required is already large and growing, so postponing when to start reporting will only delay further issues to the future. In addition, mandatory disclosure obligations, which vary widely according to company size, turnover, and trading position, may include penalties for noncompliance, so the sooner businesses familiarise themselves and get comfortable with what is being asked of them, the better.
The reality, however, is that there is great discomfort in the business world. In our recent survey of 360 companies, 32% said they are completely unprepared to meet their ESG supply chain disclosure obligations. Among those, only 29% (or fewer than 3 in 10) believed their organisation fully understands the legislative and regulatory landscape governing ESG corporate disclosure. In short, businesses are struggling.
There’s clearly an overarching gap between where businesses are and where they would like to be. Many organisations are reporting gaps in their understanding of the regulations, knowing which apply to their business, and being prepared to meet them. They are generally struggling to keep on top of it and need stronger guidance, particularly on which requirements to prioritise, and in establishing the exact scope of each regulatory obligation: to what type of business does it apply?
Keeping track of the regulations
Amongst the discomfort that businesses are facing, the sheer amount of different regulatory disclosure requirements was presented as one of the main concerns. Different countries and sectors have different requirements, which often overlap, but may require different ways of presenting the data found. There is no centralised source of ESG regulations, and businesses have found it difficult to establish what exactly applies to them, and when, as well as what the baseline for disclosure requirements is: what do they actually have to report on?
To help keep track of regulations, it was suggested that a bespoke tracking system that assists businesses in establishing what applies to them specifically is adopted. However, developing this system, or outsourcing it, could be costly. Further, being aware of what regulations and disclosure obligations are applicable is only part of the issue. Once that is established, companies need to understand what is required of them to comply with these.
Collecting quality data from suppliers
As a key aspect of ESG reporting, businesses must collect data from suppliers to be able to analyse their impact accurately. Ensuring the right quality of data from suppliers is collected is crucial. There must be value in what is reported, otherwise it undermines the reliability of the data.
Involving suppliers in the conversation on disclosure, by ensuring they understand the questions, rather than dictating what needs to be done, is an essential feature in collecting quality data.
Some businesses are addressing this by providing suppliers with training to help them fulfil data requests effectively. Providing templates alone is usually not enough. Training will ensure suppliers fully understand the importance of data collection and will support them in how to measure adequately , or interpret, the metrics needed. Applying the same rigorous approach across the board will allow for consistency in the data gathered across suppliers.
Contractualising disclosure obligations ensures that disclosure requirements are embedded in the relationship between businesses and their suppliers from the outset. Many businesses are already doing this, although this will heavily depend on existing relationships with suppliers and other considerations (such as geography). Other businesses may require some minimal standard clauses, these differ from supplier to supplier and sector to sector . Although, some are universally acknowledged like, for example, modern slavery.
The cost benefit of reporting
Ensuring a business’ supply chain is meeting ESG regulatory requirements requires investment, resources, and constant monitoring. Some reports are expensive to run, creating considerable cost for already-squeezed SMEs. Also, money spent towards the cost of reporting and/or ensuring due diligence means less money to spend elsewhere in the business – including activities with a more obvious ESG impact. With these factors combined, mitigating the cost of undertaking due diligence can be a challenge for some businesses who are struggling to convince their boards to allocate budget to due diligence.
Costs of due diligence requirements can also complicate commercial relationships. For example, when engaging with a new business, the due diligence required at the outset can make working together less financially feasible (or even cost prohibitive).
In addition, some businesses are being required by customers or investors to comply with a broader scope of ESG requirements than those set by regulatory instruments alone. For example, investors in renewable energy are pushing Net Zero goals which are not always applicable depending on the businesses with which they are working . In some instances, by pressurising companies to tick certain boxes, investors are driving companies to provide unreliable information.
The risk of audit fatigue
Around the table, it was mooted whether increased due diligence was the best way to maintain or improve ESG performance and minimise risk. Attendees discussed whether, after a certain benchmark of data is collected, there might be better alternatives than continually auditing suppliers. One approach that seemed sensible was to get better at accurately interpreting the data already available, rather than copiously collecting large amounts of information and not appropriately extracting what is needed from it. The suggestion being that the former would allow for businesses to enhance performance by truly understanding the areas that require urgent attention.
What can businesses do right now?
In some instances, compliance with one piece of regulation will actually enable in-house teams to comply with others. Analysis of different types of ESG regulations has extracted six key action area that will help businesses comply with the majority (if not all) of the requirements:
- Enhanced legislative review: businesses must ensure that they are up to date, and constantly informing themselves about the relevant regulatory obligations for them ;
- Materiality and disclosure focus: understanding materiality is key to understanding supply chains and where to focus effort. The consequence of not reporting on one key area can have the material impact of not complying with incoming legislation, such as CSRD;
- Increase due diligence as a whole: implementing a culture of due diligence is an opportunity to demonstrate commitment to corporate responsibility and to prepare for incoming or changes to legislative requirements;
- Registrations: product focus specific – ensuring everything businesses are producing complies with the relevant registration requirements;
- Material and product strategy: Lots of the new regulations for supply chains take into consideration product design. Businesses need to ensure products and packaging is legally compliant/eco-compliant.
- Communications and reporting: Businesses should ensure they are meeting the relevant green claims guidelines on the claims they are making in their communications to avoid greenwashing challenges and that they understand the reporting requirements which apply to them.
What to expect next?
Hopefully, businesses have reached ‘peak discomfort’ so these challenges will become easier to resolve as businesses develop better understanding of what is required, best practices emerge and are adopted, and suppliers get more effective at providing data. The outcome being that the process becomes less onerous, on both time and money terms. The importance of getting ESG compliance right cannot be underestimated and, if implementing it effectively, this can be a powerful tool for client and talent attraction and retention as well as marketing purposes.
Leveraging our market-leading ESG expertise, Burges Salmon provides strategic and operational advice to clients, working with them to unlock the opportunities there to be seized. We have launched a number of tools to consolidate all ESG guidance and legislation into interactive platforms, including an ESG Risk Review, ESG Corporate Disclosure and ESG Pensions tools as well as a Modern Slavery Statement compliance check.
By equipping our clients with all the relevant information (cost, effort, time, implications of (non)compliance), we empower businesses to make the right commercial choices and be a force for good.