ESG Compliance: From Buzzword to Business Imperative

Navigating the New Landscape of Compliance: Embracing ESG Factors for Sustainable Success

By Frank P Orlowski, President Ation Advisory Group

Compliance is a cornerstone of sustainable growth and long-term success in the ever-evolving business world. While traditional compliance frameworks, such as those established by Sarbanes-Oxley (SOX) and the Foreign Corrupt Practices Act (FCPA), have been instrumental in safeguarding financial integrity and ethical conduct, the modern compliance landscape demands a broader approach beyond just “dollars and cents.”

?The” Climate Change Movement” has skyrocketed over the past four years (regardless of where one stands politically) with an increasing focus on environmental, social, and governance (ESG) factors is driving a new era of compliance management, one that extends beyond financial and legal considerations to encompass a holistic view of corporate responsibility.

?The term "ESG" was first coined in 2004 in a report titled "Who Cares Wins?" by the World Business Council for Sustainable Development (WBCSD). The report found that companies that considered environmental, social, and governance factors outperformed their peers over the long term.

However, ESG investing has roots in the 1960s with the rise of socially responsible investing (SRI). SRI investors excluded companies from their portfolios involved in activities they considered harmful, where tobacco (thanks to the American Lung Association) and products made in South Africa during the apartheid era were in the “negative spotlight.” ?

In the 1980s, SRI investors began to focus more on positive screening, investing in companies that were actively promoting environmental and social responsibility. In the 1990s, the term "ESG" began to gain traction as investors realized the importance of considering these factors in their investment decisions.

However, it was not until 2004 when the "Who Cares Wins?" report was published and caused a watershed moment for ESG investing. The report, which the United Nations commissioned, found that ESG factors could significantly impact a company's long-term financial performance. This led to a surge of interest in ESG investing, and the number of ESG-focused investment products proliferated.

Today, ESG investing is a mainstream practice. According to the 2023 Global Sustainable Investment Review, ESG assets under management (AuM) reached $46.6 trillion in 2022, up 27% from 2021. ESG investing is now considered an essential part of many investment strategies. Clearly, with this movement and enormous economic impact, the term ESG is no longer a mere buzzword or peripheral consideration but has become an integral part of the evolution of a company’s overall performance on sustainability, requiring a need for a new form of compliance and controls and a robust compliance and controls program.

The challenge, however, is that this new form of compliance and controls is in its infancy. One only needs to look at the “early days” of compliance for Sarbanes Oxley (SOX) and FCPA Compliance, where companies spent millions on consultants to help them ensure adherence and ongoing compliance. However, the “scorecard” of what constitutes compliant vs non-compliant was not yet solidified.

The same holds for ESG. The rules of an “ESG Gold Star” are practically unclear. For example, Whole Foods was ranked 26 out of 100 Progressive grocers in ESG and is considered the first “fully organic” grocer. However, one only needs to purchase an instant soup at Whole Foods to see over seven individually nonrecycled plastic-wrapped ingredients inside the soup container and the external packaging (The Whole Foods Plastic Problem, March 2023). The point is not to condemn Whole Foods per se but to illustrate that adherence to ESG and what defines Organic is undefined and not standard, regardless of what an organization publishes/advertises. ?Therefore, a robust design of a ESG Compliance and Controls program is essential.

?ESG factors are no longer mere buzzwords or peripheral considerations to which companies can say they are adhering as they have become integral to evaluating a company's overall performance and sustainability. Investors, regulators, and consumers require a rigorously designed, implemented, and supported compliance and controls program. A robust compliance and controls program must be implemented to scrutinize companies' ESG practices, demanding transparency, accountability, and a commitment to positive social and environmental impact.

?This shift in focus has necessitated a paradigm shift in compliance management that integrates ESG principles into the very fabric of corporate governance.

ESG compliance encompasses a wide range of considerations, including:

• Environmental: Managing greenhouse gas emissions, reducing pollution, and adopting sustainable practices.
• Social: Promoting diversity and inclusion, upholding fair labor practices, and ensuring ethical sourcing.
• Governance: Strengthening corporate governance practices, enhancing transparency, and fostering stakeholder engagement.

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To begin any effective ESG program, a formalized approach is required, which can be outlined in four areas:

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1.??? ESG Risk Assessment: Identifying and evaluating ESG-related risks, such as climate change impacts, supply chain disruptions, and reputational damage.

?2.??? ESG Policy Development: Establishing clear policies and procedures that address ESG considerations, ensuring alignment with industry standards and best practices.

?3.??? ESG Data Management: Collecting, analyzing, and reporting ESG data, providing stakeholders with insights into the company's ESG performance.

?4.??? ESG Training and Awareness: Educating employees about ESG principles and their role in implementing ESG practices.

?5.??? Assessment and Certification: The most critical element is an assessment or a certification to ensure an understanding of ESG-related matters by all stakeholders. This does not have to be a complicated test but can include case studies or scenarios where an understanding of ESG knowledge can be appropriately assessed. Once completed, a certification solidifies the full understanding.

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The benefits of embracing ESG compliance extend beyond regulatory compliance and reputational management. Strong ESG practices can lead to:

Enhanced Financial Performance: Companies with strong ESG practices often demonstrate superior financial performance, attracting investors and reducing the cost of capital.

Reduced Operational Risks: Proactive ESG management can mitigate risks associated with climate change, regulatory changes, and social unrest.

Improved Stakeholder Engagement: Strong ESG practices can foster positive relationships with employees, customers, communities, and suppliers.

Enhanced Brand Reputation: A commitment to ESG principles can strengthen a company's brand reputation, increasing customer loyalty and market share.

??Adopting an ESG compliance and controls program is not confined to large multinational corporations; however, it is a responsibility that extends to companies of all sizes and industries. While the specific implementation strategies may vary based on company size and industry context, the underlying principles of ESG compliance remain consistent. Companies must recognize that integrating ESG considerations into their compliance frameworks is not merely a matter of compliance but an investment in their long-term sustainability and success.

?The increasing focus on ESG factors is not a passing trend but a fundamental shift in how companies are evaluated and held accountable. Companies must design, develop, implement, and maintain a robust ESG Program. ?Organizations that embrace ESG compliance will be well-positioned to navigate the challenges of the 21st century and contribute to a more sustainable and equitable future for all.

?For any questions or more information please get in touch with Frank Orlowski at [email protected]