ESG related legislation and regulation is an increasing focus for countries that share common climate objectives, sustainability goals and values. By Maria Cronin, (pictured) Partner at Peters & Peters
Companies with international operations face complex ESG-related challenges and potential exposure across multiple jurisdictions. This means that those companies must adapt their business practices and models to comply with the developing rules and regulations in the various countries in which they operate. ESG-related legislation and regulations are increasingly targeting all types of business model and supply chain, presenting an all-encompassing task for multinational organisations.
A clash between ESG goals, ethics, and political agendas?
There is no singular ESG-edict. This is perhaps unsurprising given the impact of different markets, practices, and the level of variability across different jurisdictions in the political will to achieve climate objectives. As a result, there is no one size fits all solution for organisations when it comes to ESG compliance.
Multinational companies must therefore give careful consideration to ensuring that they are compliant with this diverse and growing set of rules and regulations. Thomson Reuters recently reported that 71% of C-Suite and functional leaders anticipate the growing significance of ESG in corporate performance, with one executive commenting that there were “close to 40 regulations on their radar.”
As well as the volume of new rules and requirements, organisations also face challenges relating to the clarity of the legislation (or lack thereof), and divergences in approach and guidance between different jurisdictions. For example, the new EU Deforestation Regulation requires companies that trade in seven common commodities (e.g. coffee, cattle, and wood) and multiple derived products to comply with local ESG laws (in country of production) and to follow a prescribed method of transparency with respect to due diligence. Failure do so, or if a product is not ‘deforestation free’, will preclude that product from being sold in the EU. Ensuring compliance with this Regulation, including adhering to local ESG laws potentially across multiple jurisdictions, is likely to impact business operations, resource allocation and profits.
Not only are multinationals juggling the interpretation and implementation of ESG-legislation across geographies and jurisdictions, they are also having to manage the overriding conflicting political agendas surrounding ESG. While some countries have climate-related incentives and subsidies for businesses, other countries are slower to implement similar advantages. A change at the ballot box or a sudden political U-turn could either hasten or dampen the rate of progress for businesses in respect of ESG-related policy changes.
By way of example, the U.S. Inflation Reduction Act has committed approximately US$400 billion in subsidies over the next 10 years for business investment into green technologies, with the additional aim of creating jobs and boosting the US economy. Conversely, in March 2023, Republican governors from 19 federal states issued a statement calling for the prioritisation of shareholder profits over ESG ideologies. In May 2023, Florida enacted ‘anti-ESG’ legislation, which seeks to drive rates of return by pushing decision-makers to consider financial factors over ESG-related factors, when making business decisions, and non-preferential status for ESG-compliant organisations in the procurement and contracting process.
The political differences with respect to ESG are also visible in Europe. For example, whilst the EU Corporate Sustainability Due Diligence Directive was approved by the EU last month, the final version of the Directive was greatly reduced in scope compared to its initial draft to satisfy concerns of member states. The Directive, which still needs to be approved by the European parliament before it comes into force, will provide a minimum set of due diligence requirements and will establish a framework for complainants to sue EU companies for human rights abuses and environmental harm in their supply chains.
Multinationals also face hurdles from shareholder and climate activism. There has been a significant uptick in claims brought by minority shareholders and NGOs for failure to address ESG-related risks and climate change objectives, particularly where state enforcement has been markedly absent. This has forced companies to adopt new ways of operating and also to assessing ESG related risk.
Keeping Up with Legislative and Geopolitical Developments
As a result of this rapidly changing landscape, multinationals and smaller companies are investing proactively in internal and third-party solutions to stay abreast of their regulatory requirements. This includes conducting internal investigations into vendors and suppliers, collecting data, and contracting with consultants to improve business operations in an ESG context. Data-driven changes are becoming increasingly reliant on AI and analytics.
Some multinationals are focussed on compliance with existing regulation as it comes into effect, whilst others may be mindful of potential ESG issues at the start of business expansion and implementing ESG-ideologies before any overarching legislation is in place. This could, however, put these companies at a competitive disadvantage if ESG reforms do not come into effect until much later down the line.
Adaptability of multinationals is key to navigating ESG risks. The need to grapple with ever-changing legislation imposed on the context of international business models, in the shifting sands of political attitudes and geopolitical strains increases the operational risk to multinational companies and is forcing them to consider how best to monitor, comply and report on their ESG performance.
Where subsidies are insufficient or non-existent, stringent ESG requirements may deter companies from taking the leap to international expansion. Companies may need to choose between the ethical considerations of adhering to ESG ideals and opting to operate in anti-ESG jurisdictions to maximise profit. A decision that will no doubt be influenced by shareholder and investor pressure.
Will there be anti-ESG jurisdictions, where multinationals or smaller companies positively choose to operate and manufacture, much like certain benefits that come with operating offshore bank accounts? This does not circumvent their potential inability to expand and trade within certain markets, depending on the product, but that may be a price that they are willing to pay.
Each multinational must work to find tailored solutions that work for their business model and operations – there is no cookie-cutter way of doing this.
