5 key ESG trends to consider for improving your sustainability transformation

2023 has presented us with significant challenges in the management of ESG criteria [See Part I of this series of articles in the Laragon Blog ]; especially for those companies convinced that establishing a strategic response and planning in the face of geopolitical, social, environmental, and economic risks it is no longer enough. Continuous and coherent action is required from and for all stakeholders to achieve a sustainable transformation in organizations.

This roadmap is intrinsically linked to digital transformation and a more resilient and updated vision of a business with purpose, high profitability, and positive impact (along its three ESG strands: environmental, social, and governance).

Here are five trends that we -at Laragon Sustainability Solutions- believe will be key throughout this year for stakeholders in their assessment of risks and opportunities in sustainability, health, safety (EHS), quality, and regulatory compliance.

1. Compliance - Regulation and reporting

Regulatory compliance is one of the fundamental pillars of corporate sustainability. Companies must comply with environmental and workplace health and safety regulations, as well as human rights and anti-corruption laws. In addition, sustainability reporting has become an important tool for communicating companies' ESG performance.

Throughout 2023, sustainability disclosure requirements are expected to become more stringent and standardized. In particular, the European Union has introduced a taxonomy framework to help investors identify which investments are truly sustainable.

Sustainability regulation is now in the spotlight not only in the EU but increasingly in the US and APAC markets: from requirements for financial institutions to conduct climate resilience testing, to deforestation-free market access rules, to investors pre-empting potentially mandatory indicator reporting requirements in the Sustainable Finance Disclosure Regulation (SFDR).

As time runs out to achieve a 1.5°C pathway in the fight against global warming, regulators around the world are looking to the financial sector, both to accelerate capital flows to more sustainable activities and to better gauge the risks to financial stability from climate change.

What room for maneuver do regulators have to manage sustainable finance? Administrations in major jurisdictions around the world, such as Europe, the United Kingdom, and the United States, among others, have introduced or are preparing mandatory sustainability reporting requirements for companies, and most will be influenced by the ISSB (International Sustainability Standards Board ) standards.

So far, the ISSB has published two standards (general requirements and climate) and the European Financial Reporting Advisory Group EFRAG has published 12 European Sustainability Reporting Standards. In addition, the final version of the European Sustainability Reporting Standards (ESRS) covering a wide range of environmental and social issues has already been approved within the framework of the EU Corporate Sustainability Reporting Directive (CSRD).

Over the next two years, thousands of companies will start reporting according to these standards. In Europe alone, 50,000 companies will have to report according to ESRS. This will require substantial investments to get it right. There is also a double challenge for companies that must report under ISSB and ESRS.

Scope 3 Emissions

Companies must monitor and report their CO2 emissions, which is the first key step in reducing them. To do so, companies must classify their carbon footprint into three scopes. According to the corporate GHG Protocol standard, a company's greenhouse gas emissions are classified into three scopes[1] . Scopes 1 and 2 are mandatory reporting, while Scope 3 is voluntary and the most difficult to monitor. However, companies that manage to report on all three scopes will gain a sustainable competitive advantage.

Companies reporting under the new climate reporting standards being developed by ISSB will have an additional year to report Scope 3 emissions, i.e., those that originate in a company's value chain and are outside its direct control.

Scope 3 emissions reporting requirements are one of the most controversial aspects of the new disclosure standards and will be at the heart of large corporations' plans and targets in 2023. These emissions typically represent most of the carbon footprint of many companies but are often the most difficult to track and calculate, as they occur outside the direct control of companies, in areas such as supply chains or in the use of their products by their customers.

SFDR Regulation and EU Taxonomy - technical regulatory standards

The EU's SFDR and Taxonomy sustainability regulations make ESG reporting mandatory as of this year. The SFDR framework is intended to improve transparency and create a level playing field. The Regulation consists of disclosure requirements at the organization, service, and product-level to standardize sustainability performance, thus avoiding greenwashing and enabling comparisons for sustainable investment decisions.

The SFDR applies primarily to financial institutions (banks, insurers, asset managers, and investment firms) operating in the EU. Non-EU entities will be indirectly affected through EU subsidiaries, provision of services in the EU, and market pressure.

On the other hand, the EU Taxonomy aims to reward and promote the integration of ESG criteria and sustainability into companies' operations and business decisions. It encourages environmentally friendly business practices and technologies through a classification system, in which organizations identify which of their economic activities, or the economic activities in which they invest, can be considered "environmentally sustainable."

It includes six key environmental objectives, which are climate change mitigation and adaptation, sustainable use and protection of water and oceans, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems.

The European taxonomy is expected to have a significant impact on sustainability disclosure and investment decision-making in Europe and beyond. According to a Net-Zero Business Barometer survey, 61% of companies surveyed believe that the European taxonomy will be a useful tool to guide their sustainability strategy.

The Taxonomy aims to support investment flows toward these activities. Another objective is to provide standardized criteria for assessing ESG performance, as opposed to companies that demonstrate their performance only through reporting.

According to a study by the European Commission, the use of the EU taxonomy could boost sustainable investment in the EU by up to 4% of GDP by 2030. Although it focuses on sustainable finance, its scope extends far beyond banking and other financial services.

Regulations as the emergency beacon

Legislation and regulations are a key ESG trend for sustainable transformation in 2023. Companies that do not comply with these sustainability regulations may face penalties and fines. On the other hand, there are significant opportunities for companies that adopt sustainable practices.

Early adopters of sustainability administrative schemes and policies will be better positioned to meet the expectations of stakeholders, including investors, consumers, and regulators. According to a study by the consulting firm McKinsey, "Companies that adopt ESG practices have superior long-term financial performance compared to companies that do not."

In addition, the adoption of ESG practices can help companies reduce sustainability-related risks and identify opportunities for growth and development of new products and services.

2. Critical environmental issues: Climate change, decarbonization, and biodiversity

Climate change remains one of the greatest challenges to sustainability. Companies are accelerating their plans to reduce greenhouse gas emissions and achieve carbon neutrality by 2050. To achieve carbon neutrality, companies must establish a clear and ambitious roadmap.

According to a report by Verdantix, 76% of the companies surveyed consider that setting long-term objectives and defining a roadmap are the main challenges on the road to carbon neutrality.

Climate change adaptation and mitigation

The climate change debate is on the rise, and this year more focused on adaptation and mitigation measures. There is a collective public-private recognition that we are getting closer and closer to exceeding the 1.5°C threshold above which climate disruption worsens.

In addressing and limiting the effects of climate change, it is important to prioritize a just transition in which economies are greened as fairly and inclusively as possible and no one is left behind.

The breakthroughs on adaptation and mitigation achieved at COP27 in Egypt, together with a new global biodiversity treaty agreed upon at COP15 in Montreal, have further intertwined the ways in which businesses can respond to societal and planetary needs through decarbonization and natural restoration.

Climate change is an undeniable reality that is transforming our planet at an unprecedented rate. From extreme weather events, such as hurricanes, floods, and droughts, to the loss of species and the degradation of entire ecosystems, the impacts of climate change are becoming increasingly evident and worrisome.

Against this backdrop, the international community is committed to taking measures to curb global warming and achieve a more sustainable economy. One of the key strategies in this regard is the roadmap to net zero, which involves reducing greenhouse gas emissions and offsetting those that cannot be eliminated. According to the United Nations Environment Program (UNEP), more than 120 countries have already committed to this goal.

Roadmap to net zero

It is now key to prioritize deep emissions reductions in line with science (over offsetting) and to ensure that any offsets used are robust.

Article 6 of the Paris Agreement, on carbon markets and credits, covers both "compliance" markets, which allow countries to trade emissions credits from abatement and removal activities with each other, and "hybrid" domestic-private markets, which allow countries to sell credits to companies (under Article 6.4).

A high percentage of companies consider carbon credits to be a crucial part of decarbonization plans in 2023: a recent global survey of more than 500 business leaders, coordinated by Conservation International and We Mean Business Coalition, explored the priorities of companies seeking to reduce emissions. According to the survey, 92% of companies consider long-term decarbonization a priority and 100% of them are already working to achieve these climate goals.

In addition, 79% of business leaders agree that science-based targets are crucial to hold companies accountable and stay on track with decarbonization goals.

One of the most nuanced issues facing companies seeking to decarbonize is that of carbon offsets and voluntary carbon markets. The combined value of these markets exceeded $1 billion in 2021. The fact that net-zero emission targets already cover 91% of GDP is a clear indication that exponential growth in demand is on the horizon.

According to the research, one-third of companies are actively investing in the voluntary carbon market, while 51% see it as a viable option in the future. However, concerns around "greenwashing" (44%), the quality of carbon credits (33%), and the lack of regulation and market transparency (38%) are the current obstacles to increasing business investment in this area.

The demand from experts and stakeholders revolves around zero net emissions transition plans, which support long-term corporate emissions targets with interim milestones and outline the steps needed to change business models and investment.

Decarbonization plans should detail how workers will be supported and how the need to upgrade and retrain their skills will be addressed. Climate change mitigation depends on global zero-reduction commitments.

As the pressure to reduce carbon emissions intensifies, companies are seeking validation of the Science Based Targets (SBTi) Net-Zero standard for their scientific roadmaps to decarbonization. SBTi validation of targets implies business value generation and increases confidence.

However, the SBTi Standard is not without its critics, and companies may find limitations to its methodology and requirements. Organizations must address the complexities surrounding the reduction and neutralization of carbon emissions to create a successful net-zero strategy. A recent Verdantix report examines the challenges of SBTi and recommends key steps to ensure a realistic and credible roadmap to net zero.

The leading role of Climate and environmental summits

A new "Climate Action Summit" will be held in September, prior to the start of the 28th Climate COP in Dubai. At the last Cop27, a historic new funding framework was established to help developing nations cover the cost of loss and damage. The fund will help countries most vulnerable to climate change. At COP28 it will be very relevant to assess the progress of this past year on the Sharm-El-Sheikh Adaptation Agenda.

The agreement to create a loss and damage financing mechanism further established that the responsibility for the mechanism would rest with the UNFCCC under the Paris Agreement. The Agenda is a comprehensive list of global tasks to help improve the resilience of more than four billion people to climate-related risks.

The UN launched a new action plan to provide more of the world's population with early warning systems for extreme weather events. And it calls on governments to invest $3.1 billion in these systems between 2023 and 2027, equivalent to just 50 cents per person per year. The United States and the EU, as joint leaders of the Global Methane Commitment, announced new accessions during COP27. Now, 150 nations have committed to reducing methane emissions by at least 30% by 2030.

Similarly, at the close of 2022, the global COP15 on biodiversity was held in Kunming- Montreal. The Convention on Biological Diversity's new Global Framework for Biodiversity aims to halt the deterioration of land and water, restore 30% of degraded ecosystems on land and sea by 2030, and unlock new sources of finance for nature's recovery. There are 23 action-oriented targets to be achieved by 2030.

The agreed treaty (Kunming-Montreal Global biodiversity framework ), which will impact corporate environmental strategies, includes measures to mobilize billions of dollars of funding; reform harmful subsidies; improve corporate disclosure on impacts on nature; and increase the proportion of terrestrial and aquatic habitats designated as protected.

On the positive side, many companies will now analyze their environmental footprint through the prism of biodiversity. Although disclosure in this area is still in its infancy, new standards and guidance continue to evolve, and many organizations plan to be more proactive by engaging in these voluntary initiatives.?

3.?Innovation [for a decarbonized economy and circular economy]

The need to reduce greenhouse gas emissions and move towards a decarbonized and circular economy has become increasingly urgent. To achieve this transformation, innovation, and technology are key. Companies that lead the way in implementing innovative solutions to reduce their carbon footprint and move towards a circular economy will have a competitive advantage in an increasingly changing and demanding world.

According to a report by the International Energy Agency (IEA) , "Investment in low-carbon technologies and sustainable infrastructure is essential to move towards a more secure and sustainable future". In addition, the report highlights that "technological innovation is a key driver for the energy transition and for reducing GHG emissions".

In this regard, renewable energy, electric mobility, energy efficiency, and the circular economy are some of the areas in which innovation and technology are having a significant impact.

The Circulars Accelerator report highlights that the circular economy has the potential to reduce greenhouse gas emissions by 39% by 2050. In addition, the report highlights that the circular economy is not only an opportunity to reduce the environmental footprint of companies but also "to generate new business models and revenue streams".

The 2023 edition of Circle Economy Group's Circularity Gap Report (The Circularity Gap Report ) highlights that the global situation is worsening year on year, driven by the increased extraction and use of materials and that only 7.2% of the 100 billion tons of virgin natural materials used each year return to the economy after their first use. The report assessing the environmental benefits of the circular economy notes that increased materials extraction has reduced global circularity from 9.1% in 2018 to 8.6% in 2020, and now to 7.2% in 2023.

This leaves a huge circularity gap: the world relies almost exclusively on new (virgin) materials. It means that more than 90 % of materials are wasted, lost, or unavailable for reuse for years, as they are locked up in long-lived stocks such as buildings and machinery. Materials that are reintroduced into the global economy after the end of their useful life, also known as secondary materials, represent 7.2% of all materials entering the economy: this is the circularity metric.

In 2023, we will be watching to see which companies step up their efforts to extract secondary metals from e-waste, both to keep regulators happy and to boost access to critical metals for clean energy technologies.

Energy efficiency is another area in which companies can obtain greater savings and reduce their carbon footprint. According to the report by the International Energy Agency, "the implementation of energy efficiency measures can reduce CO2 emissions by 40% by 2040".

In terms of assessing risks and opportunities in sustainability, health, and safety (EHS), quality and compliance, innovation, and technology can be instrumental in identifying areas for improvement and reducing risks in the supply chain.

4. Governance - More transparency

Companies are beginning to recognize that their actions have a significant impact on the environment, society, and the economy and that they must take steps to mitigate this impact. But sustainability is not just about doing the right thing. It is also an opportunity for companies to improve their performance and reputation, and to meet the demands of investors and customers or users who are increasingly concerned about sustainability.

Investors and regulators continue to scrutinize companies' responses to global challenges such as climate change, new technologies, or labor relations during a cost-of-living crisis. How can companies create boards that help them withstand such scrutiny? One of the trends in sustainable transformation is an understanding that organizations must focus on corporate governance.

Corporate governance refers to how a company is managed and supervised, and how policies and procedures are established and implemented. Good corporate governance involves transparent and accountable decision-making that considers the interests of all stakeholders, including shareholders, employees, customers, suppliers, the community, and the environment.

Corporate governance is essential to sustainability because it helps companies assess and manage risks and opportunities. According to a report by the United Nations Global Compact, companies that adopt sound governance practices are better able to identify and manage sustainability risks, such as pollution, climate change, and human rights. These companies are also better equipped to take advantage of opportunities such as energy efficiency, product innovation, and reputation enhancement.

Governance is also important in assessing sustainability, health, safety (EHS), quality, and regulatory compliance. Companies with strong corporate governance practices are more committed to proper compliance with environmental, labor, and social laws and regulations, which reduces the risk of fines and penalties. In addition, these companies can improve the quality and safety of their products and services, which increases customer and consumer confidence.

The latest GRI (Global Reporting Initiative) Global Sustainability Trends report revealed that 73% of companies reporting on their sustainability cite governance as one of the main issues. In addition, the UN Global Compact Action Network's Sustainability Trends Report has noted that 68% of companies surveyed have established sustainability committees or have incorporated sustainability into their existing committees.

According to MSCI's 2023 Trends to Watch in ESG and Climate more investors voted against corporate climate strategies in 2022 compared to 2021, especially when a company's emissions trajectory was not in line with global targets. However, energy market turbulence and the focus on energy security may change voting behavior on Boards of Directors. This is a year to carefully assess whether opposition to corporate climate strategies will continue or whether more investors will give companies the benefit of the doubt about their climate plans in challenging market conditions.

Due to the added complexity now mixed into investor messaging and engagement, disclosure expectations and shareholder proposals will focus even more on ESG data. Companies, both private and public, must improve their data measurement and reporting models for GHG and other environmental and social issues.

A final aspect also very relevant in corporate sustainability this year relates to the need for greater transparency in companies that link executive compensation to ESG factors. Those that help their employees cope with the convulsive economy with bonuses and unscheduled raises, and those that set net zero and positive targets, pursue circular solutions such as reuse and repair business models to reduce waste or increase supplier diversity to bolster inclusion and equity efforts for improving the overall organizational resilience.

5.?The S in ESG: Diversity, equity, and inclusion

As we move toward a more sustainable economy, it has become increasingly evident that social issues cannot be ignored in the corporate sustainability agenda. Diversity, equity, and inclusion (DEI) as well as social inequalities are issues that are becoming increasingly relevant.

According to the World Economic Forum's Global Risks Report, "pre-existing inequalities have been exacerbated, and the need to address the structural problems that underlie them has been highlighted". Furthermore, the report notes that social inequalities are the second largest risk globally in terms of impact and likelihood, after climate change.

Therefore, it is important for companies to address these issues not only as an ethical matter but also as a matter of risk management. According to the MSCI report, companies with greater diversity in their workforce have a lower risk of failure.

It is to be expected that the actions (and inaction) of the corporate sector on social issues will be questioned more and more every day. Many large companies have committed to updating their diversity, equity, and inclusion (DEI) policies and processes; some have established related strategies beyond compliance levels, and many have hired DEI professionals.

In the "2022 Edelman Trust Barometer " report, it is highlighted that "62% of respondents believe that companies have a responsibility to take action to address social issues and not wait for governments to do so". In addition, the report notes that companies that lead in building a more equitable and inclusive future are more valued by their employees, customers, and shareholders.

In addition, in 2023, with the European Due Diligence and Environmental Directive, large companies will have to be prepared to address their human rights challenges, which will also affect smaller companies that are part of their ecosystem.

Organizations that ignore social issues also face reputational and legal risks. Discrimination, pay inequality and lack of access to opportunities are issues that can be publicly reported and have a negative impact on the relationship with all stakeholders.

Diversity, equity and inclusion, and social inequalities are issues that cannot be ignored in the corporate sustainability agenda. In addition to being an ethical issue, addressing them is key to managing risks and opportunities in an increasingly changing and complex world.

Conclusion

The analysis of trends that will impact sustainability, ESG, health, safety, security (EHS), and quality risks and opportunities throughout 2023 must include the most in-depth, multi-level, and multi-stakeholder assessment of the organization's objectives and commitments, defining the steps (actions and policies) that should be taken to achieve a solid sustainable transformation.

At Laragon Sustainability Solutions , we support the digitization and technological transformation of our client's sustainability strategies, operations, and risk management. Organizations committed to the progressive achievement of their ESG and QEHS objectives are to lead the change in their respective industries.

[1] Scope 1 emissions are direct emissions from resources owned and controlled by the company. In other words, emissions are released to the atmosphere as a direct result of a set of activities, at the company level. Scope 2: indirect emissions - owned. Scope 2 emissions are indirect emissions from power generation purchased from a utility supplier. In other words, all GHG emissions are released into the atmosphere from the consumption of purchased electricity, steam, heat, and cooling. Scope 3: indirect emissions - not owned. Scope 3 emissions are all indirect emissions - not included in scope 2 - that occur in the value chain of the reporting company, including upstream and downstream emissions.

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