Natalie Stafford, Head of S-RM’s ESG practice, takes stock of the first two months of 2024 and the key ESG trends starting to emerge.
Amid the backdrop of the promise of regulatory change, whether the CSRD, CSDDD, domestic modern slavery and human rights laws, or SEC disclosure requirements, there is an enduring theme emerging already this year: how companies both manage ESG risk and deliver value in 2024 will lie in the adaptability of their governance framework.
At S-RM we see in our conversations with clients that, in most cases, ESG strategies are now in place, programmes set up and reporting underway. But the extent to which ESG and sustainability are truly transformative of the way in which an organisation does business relies on whether existing governance frameworks are critically examined and overhauled where necessary. S-RM has identified 10 significant trends already emerging in 2024, each with the potential to buffet ESG priorities and programmes without a robust governance framework in place.
1. A regulatory focus on human rights
The protection of human rights is no longer relegated to non-profits. Corporate responsibility to respect, prevent and mitigate human rights risks is expanding at national and regional level. 2024 is the year where ultimately 50,000 companies will need to start complying with the new EU Corporate Sustainability Reporting Directive (CSRD). The Corporate Sustainability Due Diligence Directive (CSDDD), with a phase-in approach to reporting obligations expected to start in 2027 (subject to current EU wrangling), will further place human rights at the heart of a company’s due diligence processes. In 2024 companies will either be going through applying the CSRD rules for the first time, or thinking about how to integrate these and the CSDDD into their processes for when they do fall in scope. Both Directives will need cross-functional ownership to comply with the new set of sustainability requirements. While CSRD requires companies to conduct a double materiality approach to adhere to the new European Reporting Standards (ESRS), the CSDDD mandates a corporate due diligence duty to identify and mitigate human rights and environmental impacts across a company value chain. Transparency and a closer collaboration with suppliers will matter like never before. Even companies that are not directly in scope but within the value chain of a company that is, will need to provide information to meet the standards or as part of their due diligence process.
This ‘ESG phenomena’ cannot be seen in EU isolation or as a top down regional approach. Countries such as Germany under its Supply Chain Due Diligence or France with The Duty of Vigilance, already require companies to identify and prevent human rights violations across their supply chain. Without doubt, as government enforcement and financial sanctions rise, we expect a domino effect of companies to incorporate ESG and human rights due diligence into their risk management systems. Ignorance is no longer bliss. Companies must know what is in their supply chain.
2. Consumer activism demanding corporate accountability
‘Naming and shaming’ is not new, but in an age where most consumers read the news through social media, and influencers speak up about their personal values, economic pressure can quickly come to bear on some of the biggest companies to change their practices. The ongoing conflicts across Ukraine, Palestine and Myanmar, among others, have created successful boycotts to deliberately stop the purchase of products from a brand for ethical, environmental, social or political reasons. Beyond the immediate reputational damage that this may cause to brands, public opinion might forgive but not forget. Impacts will vary from a drop in revenue, reputation loss or lower employee retention rates to name a few. To avoid a boycott in the age of social media, brands need to know their customers’ values, understanding that their expectations do matter. This will prompt businesses to review their policies, strengthen their due diligence and practice what they preach in order to build consumer trust and enhanced long-term value. Companies should cast aside the aim to portray ‘a perfect business’. Today’s consumers simply don’t buy it. Instead, companies need to integrate an honest narrative of their own due diligence processes and take consumers through their own improvement journeys.
3. Artificial intelligence and technological solutions are already here. But they need to be better understood
We have all heard that AI is the future. In reality AI is already mainstream, but still remains curiously lacking from some ESG programmes. ESG is all about data, but still too much remains sat on clunky Excel spreadsheets, which means it is not being used to best effect. The automation opportunities now offered by AI, along with the ability of its technology to detect worrisome trends or anomalies, means it now needs to be a core part of any ESG programme, particularly when, in many cases, the size of an ESG team remains the same, but the work it is expected to do is only increasing.
ESG is all about data, but still too much remains sat on clunky Excel spreadsheets, which means it is not being used to best effect.ˮ
For a private equity firm, for example, there is the ability for each portfolio company to log onto a system and enter their ESG data against Sustainable Finance Disclosure Regulation (SFDR) or CSRD requirements, or for a large corporate with a complex supply chain to run simultaneous sanctions and adverse media checks against 200,000 companies within its value chain, immediately highlighting those which pose a greater risk and require more in-depth engagement, or exclusion. These are the types of process that we are increasingly seeing AI being used to speed up, freeing up the time of ESG teams.
AI is also increasingly being seen as supporting the value creation objective of any good ESG programme. Whether using machine learning to identify patterns in existing ESG data and make predictions or satellite imagery for biodiversity prediction and assessment, for example, these technologies can be used to inform strategic decision making and ensure ESG doesn’t become just a mass data-gathering exercise.
But AI and technology are not the panacea to all ESG’s challenges. In itself, AI is a significant energy consumer and generates large carbon emissions. And a greater dependence on technology, particularly that which holds or processes commercially sensitive information could be attractive to cyber threat actors, with data gathered through hacking released into the public domain to damage a company’s reputation. It is these types of risks, and how to mitigate them, that ESG teams are increasingly grappling with as they onboard more AI and technological solutions.
4. Greenwashing and greenhushing – finding the right balance
This year we are already seeing the increase of ESG fraudulent marketing taking its toll. Companies across the world will need to be more careful when advertising their products. “Eco”, “green”, “carbon neutral” or “environmentally friendly” now need to be evidence-based claims. Failure to do so, will be considered an infringement under the EU Green Claims Directive or the UK Green Claims Code, to name a few. And we are finally seeing some real litigation in the area, with sizeable financial penalties attached. The Australian Securities and Investments Commission (ASIC), the Australian regulator, took three funds to court for greenwashing last year. It says enforcement will continue to be a priority for it in 2024 and we are already expecting more court action.
“Eco”, “green”, “carbon neutral” or “environmentally friendly” now need to be evidence-based claims.ˮ
Those companies which have reacted by “greenhushing”, i.e. deliberately choosing to not report their ESG credentials for fear of being judged under the public scrutiny for “not doing enough”, are finding this is just not a sustainable way forwards in the current political and consumer environment. Businesses will need to find the balance of what they can and cannot publicly state by assessing their environmental claims against those not defined by the EU and be more specific in their claims, such as whether they refer to the product as a whole or part of the product.
We are expecting to see mission creep from greenwashing right across the themes that comprise ESG. It is no longer just claims of ‘green’ credentials that are being questioned, but increasingly aspects of the Social and Governance pillars of ESG too. “Genderwashing” or the more broad “social washing” are being heard more often, as contradictions in corporate marketing are investigated.
5. Board and C-Suite responsibility
The rise of ESG regulation is pushing investors to demand greater responsibility to demonstrate shareholder value. We will see KPIs more explicitly aligned to an organisation’s ESG goals, as ESG continues its mainstreaming, and a slow but increasing trend to match C-Suite compensation with ESG targets, or at the very least a reduction in carbon emissions. Efforts to diversify boards will also not go unnoticed, with expectations growing that this has to evolve from a box-ticking exercise to being a core part of a company’s culture to drive growth, trust and innovation. Progress will still be slow, but those leading the charge and moving beyond the basic requirements of regulators or exchanges will see them move ahead of the pack as they review their governance frameworks to adapt to a changing corporate world. The year ahead will leave any uncertainty in leadership obligations towards ESG requirements behind.
The year ahead will leave any uncertainty in leadership obligations towards ESG requirements behind.ˮ
6. Supply chain cyber-attacks and how to prevent them
Supply chain cyber-attacks are not new, but they are both increasing in number and in the potential damage they can inflict as companies integrate advance software technology to manage their supply chains more effectively. Supply chain software depends on a variety of third-party APIs, and open-source codes operating across a range of organisations and geographies. This represents a real window of opportunity for hackers to introduce malware through the weakest links exponentially rising the number of affected victims and impact.
Integrating cyber security and cyber governance as part of a good ESG programme will be even more critical, particularly when it comes to supply chains. We are already seeing a focus on making suppliers’ assessments more stringent and mandating pen testing and internal cyber training for some of the most critical parts of the supply chain. It is only as strong as its weakest part.
7. Pre-deal ESG due diligence and capability building
More and more investors are undertaking ESG due diligence as a result of the rise of corporate governance requirements across markets ranging from the SEC to the Hong Kong Stock Exchange and many more in between. Pre-deal ESG due diligence has been around for a long time, but we’re seeing a shift in terms of the sophistication of the ask. As organisations increasingly look to conduct double materiality assessments in line with expectations from European regulators, there is a move away from approaching ESG due diligence as a box-ticking exercise focused on, for example, the 5 ESG issues that matter to the investor, and more towards looking at the company and investment in the round. Getting this right can lead to an early opportunity to hone in on value creation opportunities post-investment.
These material findings could represent further legal liabilities or imply environmental remediation costs. That is why already this year we are seeing growing interest in conducting more detailed and often on-the-ground due diligence to understand particularly thorny issues. These discreet and hyper-targeted investigations can really make the difference in ensuring the money paid for due diligence is not just used to fulfil a box-ticking exercise.
8. More resource for biodiversity
While most companies are measuring their carbon footprint and reporting on their carbon emissions across at least Scopes 1, 2 and often 3, businesses on the front foot are now paying closer attention to their biodiversity exposure too. Most organisations are still at an early stage in even trying to understand their biodiversity exposure and how they can have a positive impact in the area. We are still some way off the widespread presence of nature-related sustainability targets for companies, but we are seeing the allocation of more financial resources to finding nature-based solutions, or at least trying to understand the complexity of this issue.
Businesses are seeking to understand where they are sourcing their products and the environmental impact of their upstream and downstream logistics. Open source data like ENCORE, for example, can help identify biodiversity dependencies and impacts across geographies, as companies are seeking a closer collaboration with suppliers to measure the ‘biodiversity footprint’ of their products.
But, unlike carbon emissions, it is very difficult to measure progress in biodiversity. Few companies make nature-related disclosures, there are no straightforward metrics and it is difficult to determine what a “good” outcome looks like when any change in the addition of certain flora, fauna or animals will have a knock-on effect on other aspects of nature. However, with the additional financial resource allocated here, and a growing number of policy measures, from the EU’s deforestation regulations, to the Taskforce on Nature-Related Financial Disclosures (TNFD) kicking off disclosure guidelines for organisations to report on nature-related dependencies, impacts, risks and opportunities, 2024 has the potential to be a big year for biodiversity when it comes to ESG.
2024 has the potential to be a big year for biodiversity when it comes to ESG.ˮ
9. A pause in the regulatory march forwards
In recent years we have seen a raft of ESG-related directives, regulation and legislation emerge, most notably from the EU and its member states. Whilst the path has been consistently forwards and indeed even as we entered 2024 companies across the world were starting to really think through how they could integrate the upcoming requirements of the CSDDD regulation into their processes. But, the decision by Italy and Germany to abstain on a crucial EU vote which would result in the implementation of the CSDDD saw the vote postponed at the last minute. Suddenly the future of this flagship directive is up in the air.
The CSDDD is intended to require companies of a sufficient size to ensure their value chains are free of human rights abuses and environmental damage. There had always been concerns voiced over the impact on SMEs in particular, but Germany and Italy’s decision to abstain marks the first real pause in the regulatory march forwards. The CSDDD may well yet come to pass, but what this pause does show is that in a bumper election year where 70 countries are due to hold elections of some form, including to the European Parliament, domestic policies and priorities may have a big part to play in how businesses develop their sustainability priorities.
The CSDDD may well yet come to pass, but what this pause does show is that in a year full of elections, domestic policies and priorities may have a big part to play in how businesses develop their sustainability priorities.ˮ
10. The rise of ESG litigation
The risk of ESG litigation has never been higher. Whether by private litigants, often in class actions, or by government bodies, this litigation has the objective of either changing corporate behaviour and/or seeking financial compensation. Consumers, shareholders and local communities are coalescing to take action and hold companies accountable, often for activities that occur in their supply chains. Much of the litigation to date has focused around climate and carbon emissions, as well as misleading claims. This trend is continuing into 2024, but we expect to see an increase in the Equality, Diversity and Inclusion claims brought against companies which do not live up to their public statements. The sheer volume of information that is now publicly available, along with the ease through which it can be transmitted via social media, means human rights and labour rights issues in supply chains are being exposed. There is also no hiding from it for businesses. If social media consumers know there is an issue, corporates should too, and they will now be held accountable in court.
If you'd like to speak to Natalie and her team about your governance frameworks and the ESG trends in this article, please reach out here.
