What ESG Means to Your Organization and Which Laws or Regulations Apply
What is ESG and how do we measure it?
ESG is high on agenda of both individuals and corporations and encompasses the following areas:
Environmental: Assesses how a company performs as a steward of nature
Social: Examines a company’s relationship with internal/external stakeholders; and
Governance: Assesses a company’s leadership, executive pay, internal controls and shareholder rights.
In a recent 2021 report, Forbes neatly summarised ESG as “illustrating a company's identification and quantification of its risks and opportunities, as well as highlighting the ethics of a company. Such measurable considerations are beneficial both for external partners and investors and company executives in making strategic decisions.”
This article explores how countries are seeking to address national targets for social and environmental issues by introducing legislation that mandates companies to undertake due diligence into both their direct practices and entire supply chains. Aside from such mandates and companies wanting to do the right thing, ESG is a key factor for investors and will impact all companies regardless of whether they are subject to a mandate1.
There are a variety of ways to measure a company's approach to ESG, including but not limited to:
- Having a clearly defined set of internal policies explaining the company’s goals and strategy for environmental & social issues;
- Documenting and publishing any ESG breaches that may have occurred; and
- Having a clear mechanism for how a company will deal with any ESG breaches.
With increasing regulation on this topic, it is no longer at a company's complete discretion to decide how they want to measure ESG performance, and in certain cases companies must instead adhere to regulations that prescribe specific due diligence requirements and reporting obligations on a recurring basis.
A snapshot of ESG Regulation Landscape over the past decade
California Transparency in Supply Chains Act was enacted in 2010 and came into force on 1 Jan 2012. Under the Act certain categories of retailers and manufacturers with annual worldwide receipts exceeding $100 million operating in California had to disclose their efforts to eradicate slavery and human trafficking from their direct supply chains. The reporting obligations covered five areas:
- Verification - does a company undertakes due diligence in its supply chain to evaluate and address human rights risks;
- Audits - does a company audit their supply chain to ensure they comply with related policies;
- Certifications - does the company require direct suppliers to certify their compliance;
- Accountability - does the company maintain standards and procedures for employees/contractors failing to meet standards; and
- Training - does the company provide training in regards to human trafficking & slavery
This piece of legislation was particularly important because it was one of the first supply chain transparency laws in the world and California was the first US state to introduce this kind of legislation.
Uyghur Forced Labor Prevention Act 2021 (UFLPA) is due to come into force on 21 June 2022 and creates a rebuttable "any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part" in the Xinjiang Uyghur Autonomous Region (XUAR) of China, or by certain entities within the region, are produced with forced labor and therefore prohibited. This presumption puts the onus on companies leveraging goods manufactured in the Uyghur region to demonstrate that no imported goods have been made with forced labour.
Lieferkettensorgfaltspflichtengesetz (LkSG) (German Supply Chain Act 2023) was finalised in 2021 and is due to come into force on 1 Jan 2023 for companies headquartered or with a branch in Germany with more than 3000 employees (extending to those with more than 1000 employees on 1 Jan 2024). Whilst ESG legislation is not new, the LkSG is a significant because it is the first example of a country having one piece of legislation that encompasses a number of risk domains (Environmental, Forced, Child Labour, Freedom of Association) within the entire supply chain as opposed to just direct suppliers.
European Draft Directive on Corporate Due Diligence, is yet to be finalised but the latest proposal published in February 2022 indicates that the directive will cover a number of risk domains much like the LkSG and will also apply to a wider range of companies as the scope covers the following groups:
- Group 1: All EU limited liability companies with > 500 employees and EUR 150 million worldwide turnover;
- Group 2: Other EU companies operating in defined high impact sectors with > 250 employees and EUR 40 million; and
- Group 3: Non EU companies active in EU with minimum turnover of Group 1 & 2
This Directive has a long history and it was originally due to be introduced in June 2021 before being indefinitely postponed resulting in Germany forging ahead in a bid to not delay their National ESG goals. The European Draft Directive is once again high on the European Commission's agenda and once the directive has been finalised, all 27 member states will have two years to transpose this into their own National laws.
Though ESG legislation is not a new concept, there is currently an international push for legislation that addresses a broad range of risk domains and the entire supply/value chain.
The German Supply Chain Act (LkSG) and European Draft Directive on Corporate Due Diligence are examples of this.
Looking at the ESG trends over time, it is clear that whilst countries are aligned to some extent on an end goal, they all have different approaches as to how they will address this. This patchwork of regulations means that companies need to start to understand their supply chains and think of a streamlined approach to how they will tackle varying legislation. It is also important to take into consideration that any enacted legislation can be subject to change.
As mentioned above, the European Draft Corporate Due Diligence, once implemented, will mean that all 27 member states need to transpose this into their own national legislation. It also means that Germany may also need to change their own LkSG legislation as they implemented it ahead of European law. Coupa’s Global Product Compliance team monitors regulations impacting the Coupa BSM community in real time to help customers meet their compliance requirements.
The ESG legislation topic is constantly evolving and companies should do the work to stay ahead of changes that may impact their business processes, reporting and their public perception.
1Why is ESG important for companies and investors?, Plan A Academy, 13 Jul 2021.