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Regulations around the ethical and environmental credentials of businesses are tightening, leading companies of all sizes to rely more heavily on their lawyers. In the first of two features on ESG reporting, Katharine Freeland looks at the position of clients
The low down
Once upon a time, only ‘right-on’ companies disclosed their environmental, social and governance impact. Their motivations ranged from virtue to virtue signalling. But ESG reporting now resembles an industry in its own right – with a complex web of international standards and legal requirements, and hawk-eyed regulators and litigants on the lookout for false claims. SMEs are not exempt, as the larger companies they do business with require commitments on standards from suppliers. The responsibility for correct reporting, whether mandatory or voluntary, is a natural opportunity for legal and compliance departments, and the law firms that advise them. Not least, more regulation covering ESG reporting is in the pipeline.
Environmental, social and governance (ESG) covers a vast, pervasive, and constantly evolving area. It has spawned a glut of regulation, frameworks and codes of practice across geographies and industry sectors.
Although sometimes confused with looser notions of sustainability and corporate social responsibility (CSR) that preceded it, ESG refers to a set of reporting standards which use data and metrics to measure a business’s environmental and social impact. Stakeholders including investors, consumers, employees and the business itself can then use that information to aid decision-making.
While the advent of mandatory reporting has pushed ESG considerations to the forefront in the regulated financial sector, those operating in other areas cannot downplay ESG or push it to one side, even when not under an obligation to report. ‘Getting ESG right can be an opportunity to improve efficiency, manage business risk, gain a competitive advantage, enhance access to capital and grow business and brand,’ says Amy Waddington, senior counsel in the London office of Weil, Gotshal & Manges.
Waddington, a member of the firm’s Sustainability and ESG Advisory Group, continues: ‘Getting it wrong can lead to accusations of greenwashing, jeopardising hard-won reputations and alienating valuable stakeholders.’
Many businesses have to grapple with EU legislation. This includes the Sustainable Finance Disclosures Regulation, which affects financial market participants; the Corporate Sustainability Reporting Directive (CSRD), which introduces more stringent ESG reporting requirements and third-party assurance for reported information; and the Taxonomy Regulation, designed to protect investors from ‘greenwashing’, among other things.
The Corporate Sustainability Due Diligence Directive (CSDDD), soon to be published in the EU’s Official Journal, requires businesses to identify and in some instances prevent, end or mitigate the adverse effects of their activities on human rights and the environment.
SME challenges
‘Many SMEs’ sustainability efforts fall short as they lack the knowledge, skills and direction to be truly sustainable,’ says ESG and sustainability consultant Nazareen Mills-Meyer. ‘If you look back five years, this function would be assigned to a business department such as HR, forming part of their remit alongside the main job, so largely brushed over. Now, however, ESG has become increasingly important for businesses of all sizes.’
Although SMEs are not currently bound by the directives, with only listed SMEs falling under the CSRD for example, they are often part of the supply chain for non-exempt larger businesses which require information about suppliers. And they need to plan for the future.
Bates Wells partner Louise Harman says: ‘Although the EU’s ESG legislation is currently focused on large-scale businesses, it will apply to SMEs at some stage. So it makes sense to think about reporting requirements now.’
For those without extensive in-house support, meeting ESG expectations can be difficult. Sources of support have been established to meet the challenge.
The government backed the launch of the UK Business Climate Hub in August 2023, which is designed to ‘help UK SMEs save cash while going green’. Another source of support is the SME Climate Hub. Its director Pamela Jouven says: ‘Our recent survey found that small and medium-sized businesses require additional policy support, funding and resources to reduce their emissions at the rate needed to limit global temperature rise.’
The SME Climate Hub provides free tools and resources for SME businesses to help them manage climate risks, access new capital and meet changing regulations.
In-house legal teams
A starting point for all businesses is to create an ESG ‘hub’ or responsible person to capture all ESG requirements across the sectors and jurisdictions in which they operate.
For most businesses it makes sense for the legal and compliance functions to take the lead. Although ESG reporting cuts across traditional business teams, including PR and communications, HR and procurement, its emphasis on compliance and reporting creates a natural tie-in with the role of general counsel and the compliance team.
Lucy Blake, partner at Jenner & Block’s London office and co-chair of the firm’s human rights and global strategy practice, says: ‘The legal and compliance functions are used to analysing and evaluating risks holistically in multiple different contexts, such as bribery, sanctions and data privacy. As such, most companies already have processes in place to assess the risks posed by their own operations and third-party relationships in these areas. They are also likely to have implemented controls, such as policies and procedures, enhanced due diligence, training, monitoring and audits. This means they would not be starting from scratch in adapting these risk assessments and controls to mitigate ESG risks.’
To forge the most effective ESG strategy, the legal and compliance functions must engage and work with multiple business teams to promote best practice and mitigate risk. The scope of potential ESG touchpoints is extensive: those who lead on sustainability executing decarbonisation strategies; business and operations teams putting the commitments into practice; marketing and communications professionals drafting press releases (that may carry the risk of greenwashing by over-claiming); and HR implementing diversity, equity and inclusion (DEI) strategies. Every team needs to be educated about the risks, including the board, who are ultimately responsible and may be accused of corporate misfeasance in the event of misreporting.
Managing the ESG function also requires nuance because, depending on the sector focus of the business, the opportunities that ESG presents as well as the risks need to be communicated to senior leaders.
Blake says: ‘Companies can reap many rewards from a strong ESG performance, including attracting ethically driven customers and investors, greater employee satisfaction, reduction of waste and increased innovation. The transparency about a business’s environmental footprint required by new regulations, such as CSDDD and CSRD can also be a great opportunity for positive PR communications.’
Reporting: glossary
ESG’s three ‘pillars’
Environmental. This relates to an organisation’s impact on the planet. This includes emissions such as greenhouse gases and air, water and ground pollution. Does a business use virgin or recycled materials in its production processes and how does it ensure that the this is recycled back into the economy rather than ending up in landfill? ‘From a reporting perspective, this is the most complex pillar,’ according to Deloitte.
Social. This looks at the organisation’s impact on people, such as staff, customers and the community. It includes employee development, labour practices, and DEI. Also relevant are product liabilities concerning the safety and quality of products, reporting on supply chain labour, health and safety standards and sourcing issues.
Governance. This is how the business is governed. Is the methodology transparent, with honest reporting on its impact and activities? Under this falls shareholders’ rights, board diversity, executive compensation (and how this aligns with the business’s sustainability performance), and analysis of corporate behaviour such as corruption and anti-competitive practices.
Emissions: scopes
The ‘scopes’ for reporting on emissions come from the Greenhouse Gas Protocol (GHG Protocol), an international organisation working to provide standardised frameworks for measuring and reporting on GHG emissions:
- Scope 1 emissions – greenhouse gas emissions that a business creates directly, for example while running its boilers and vehicles.
- Scope 2 emissions – indirect emissions, such as the electricity or energy bought for heating or cooling buildings.
- Scope 3 emissions – the most challenging scope of all. Under Scope 3 are all the emissions that the business is indirectly responsible for up and down its supply chain – that is to say, emissions produced when buying products from suppliers, as well as from products when the customer uses them. For most businesses the majority of their GHG emissions are outside their own operations and more difficult to track and control.
Language and tone
Businesses are now more circumspect when it comes to making bold pronouncements on net zero, mindful of the stringency of Scope 3 emissions reporting and the influx of ESG legislation and regulation.
There has been a slew of greenwashing cases in the press. In March, a Dutch court ruled against airline KLM and its ‘fly sustainably’ marketing campaign. The Competition and Markets Authority (CMA) also secured legally binding commitments from fashion retailers ASOS, Boohoo and Asda (George) to use only accurate and clear green claims.
Regulator scrutiny, increasingly backed by direct enforcement and fining powers such as those afforded to the CMA in the Digital Markets, Competition and Consumer Act 2024, has put businesses on notice.
Yet ‘greenhushing’ – when a company refuses to publicise the steps it has taken towards net zero and ESG goals because of an exaggerated fear of making a false claim – is also unhelpful.
‘Companies often find themselves walking a tightrope between saying too much or too little,’ says Katherine Howbrook, head of PR at consultancy MD Communications. ‘But the right balance can be achieved by setting realistic, measurable goals, openly sharing both achievements and challenges in sustainability initiatives, and engaging stakeholders through honest dialogue.’
Value of voluntary reporting
More and more businesses are choosing to benchmark progress to net zero goals through science-based targets rather than carbon offsets, verified by the Science Based Targets Initiative (SBTi).
In October 2021 SBTi launched its most ambitious target yet – the Corporate Net-Zero Standard. This is a defined pathway to achieve net zero emissions by 2050. It differs from previous iterations in demanding near-term targets of between five and 10 years of setting the strategy, rather than just focusing on long-term goals.
Other voluntary frameworks include the United Nations Global Compact’s 17 Sustainable Development Goals (UN SDGs) – a call to action to end poverty, promote individual wellbeing and protect the planet – to which more than 18,000 companies are committed. According to S&P Global, 49% of revenues of the 1,200 largest global companies derive from business activities that support the SDGs.
In March SBTi removed the commitments made by a number of companies – including Microsoft, Walmart, Procter & Gamble and Unilever – which had previously signed up to its Business Ambition for 1.5°C campaign.
While the reasons for the removal of the 239 companies is not given, a recent SBTi survey revealed some of the barriers to setting credible net zero targets that businesses face. These included difficulties gathering data from suppliers to meet ‘Scope 3’ (see box), uncertainty as to how to reach the targets, and concerns about litigation if they fail to keep their promises.
‘ESG is constantly evolving – the fundamentals of how to keep businesses on track to net zero through accounting and transparency are still being worked out,’ says David Hunter, senior counsel at Bates Wells. ‘Many businesses are trying to improve but it is not always easy to hit all the targets. The important thing is that they are honest about where they are – setting out what they have tried but not yet managed to achieve, what they have achieved and what they aim to achieve.’ The move to narrative reporting, he notes, is helpful in providing context for the data.
B Corp
Having B Corp status provides a recognised heft to a business’s sustainability credentials, letting customers know that its claims are underpinned with evidence. It also sets out a roadmap for the business with standards that must be met, thereby minimising internal debate on strategy and direction.
Yet recently the scheme has sparked controversy. Initially comprised of smaller businesses trailblazing a new approach to doing business, the B Corp Certification of major companies such as Nespresso, Ben & Jerry’s and subsidiaries of French food manufacturer Danone has led to questions over how B Corps are scored.
At the moment, businesses meet the 80-point requirement by picking and choosing applicable criteria from five metrics: treatment of workers, customers, community, environment and governance. Proposed changes to be introduced next year include more rigour on where B Corps stand on topics such as DEI, human rights, action on climate change and risk standards.
Role for lawyers
Reputational and governance issues are a known hazard of insufficient or misguided ESG reporting. External lawyers can pre-empt difficulties by educating clients. Webinars, ESG-focused bulletins, seminars, ESG and sustainability advice hubs flagging new regulation and legislation across business sectors are all useful tools that will engender client loyalty and promote goodwill. Joining initiatives such as the Chancery Lane Project, a global network of lawyers which works to create practical, climate-related clauses ready for use in commercial contracts, is also a way in which lawyers can use their talents to help businesses meet their climate obligations.
‘ESG and sustainability considerations are now hardwired into every aspect of our business,’ says Kelly Noel-Smith, CSR partner at London firm Forsters. ‘We collaborate with external parties where we can to maximise our positive impact.
'A business that minimises its ESG commitments or ignores them will undoubtedly be left behind'
David Hunter, Bates Wells
‘We are very pleased to support, for example, the excellent Chancery Lane Project’s pro bono initiative and its mission to provide the legal sector with resources to maximise our collective impact. All of the trainees in our commercial real estate department get involved in contributing to the project’s precedent bank of climate-aligned contractual clauses.’
Other groups include Legal Voices for the Future and Global Alliance of Impact Lawyers. These are open to the profession and aim to connect the ‘impact’ world with mainstream legal and corporate practice.
Done right, ESG reporting is a vital tool to demonstrate how a business is progressing towards its net zero objectives, providing transparency for the business, its customers and employees. Increasingly, it is not a question of opting in. ‘The trajectory should always be the need to do the right thing,’ Hunter concludes. ‘But on a commercial level, a business that minimises its ESG commitments or ignores them will undoubtedly be left behind.’
Katharine Freeland is a freelance journalist
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