The ESG obligation

We’re seeing a new era of ESG compliance and it’s more important than ever for companies to have comprehensive ESG policies in place, writes ​​Dr Kaushik Sridhar.

Environmental, social and governance (ESG) norms have moved from the margin to centre-stage. At the same time, ESG compliance has become an increasingly complex and challenging regulatory environment for companies to navigate. Inadequate or substandard data does not suffice.

When businesses consider a new investment, product, or service provider, they often rely on others’ claims to forecast their own returns or profits. But what happens if those claims are inaccurate and then forecasts are inflated? Faulty due diligence can lead to unmanaged risks and liability.

Compliance is no longer confined to dealing with one-off cases and “bad apples” within organisations. The challenge lies in building and demonstrating a culture of compliance.

Institutional investors such as sovereign wealth funds are increasingly taking a role in ensuring ESG compliance by voting for ESG changes at AGMs and even withdrawing investments where companies are seen to be lacking. By using financial clout to promote positive corporate behaviour, these investors are forcing companies into compliance.

One example is the Norwegian Sovereign Wealth Fund, the largest such fund in the world. With global investments of approximately £800 billion, the fund owns approximately 1.3 per cent of global equities. This fund has recently focused on excessive CEO pay and voting rights. It refuses to invest in companies that fail to live up to environmental and ethical standards, including tobacco companies and manufacturers of certain weapons. Some publicly listed companies (approximately 100 to date) have been banned from the fund for breaching human rights and causing environmental damage.

Recently, there has been a move by regulators to impose liability for compliance on entire organisations (as opposed to particular individuals). This has meant that companies have to be able to show a global culture of compliance and avoid structural issues that lead to non-compliance.

With ESG compliance becoming policy imperative, companies need to demonstrate ethical leadership and a collective wisdom to achieve expectations under the global theme of ESG.

Increased levels of corporate transparency have been brought about by whistleblowing, corporate leaks and the huge dissemination of corporate information online, often through social media campaigns. Corporates and CEOs are increasingly being asked to exercise a high degree of moral and ethical leadership. These factors have forced companies to look more closely at their health and safety, environmental and wider human rights practices to ensure compliance not only with legislation, but also with developing moral and ethical expectations.

In the same way ESG is innovating the way we look at financial investments and environmental impact, sustainable governance innovates the way we look at compliance and compliance officers as gatekeepers.

Compliance officers are another form of assessing and tracking compliance within a company, and this can be extended to ESG as well. Compliance officers take the role of working with the business to ensure ESG disclosures are accurate, truthful, and complete, which can be an issue with simple data providers. Responsibility and accountability for results is broadened for each. For investing, it’s delivering financial and corporate responsibility; for compliance, it’s delivering protection from legal and regulatory liability but it’s also making an impact as a trusted business leader.

It is more important than ever for companies to have comprehensive ESG policies in place. Businesses can no longer sweep breaches under the carpet by sanctioning and removing certain individuals within their organisations but must instead build a culture of compliance.

Today’s rapidly evolving compliance landscape is increasingly technical and multi-jurisdictional in nature. Particular rules apply differently depending on which jurisdictions companies are operating in. Internal corporate policies and regulatory frameworks may benefit from regular independent audits by external lawyers, to help ensure – and demonstrate – compliance.

The new era of ESG compliance should be a breath of fresh air for companies. This sort of compliance need not, indeed should not, be a headache. Rather, the companies that thrive in this new dynamic will be the ones that view ESG compliance as a forcing function to do what is best for their own investments and their own bottom line.

There is an opportunity to grab for those that can see it.