How Companies Can Prepare for ESG Risks and Regulatory Changes Across the Globe
Resilience and growth are dependent on business leaders taking action to respond to ESG risk and opportunities.
ESG continues to rise in importance across the globe, but regulations and stakeholder expectations vary significantly across regions.
Climate regulation is one of the biggest areas of divergence by region.
Companies must address ESG risks proactively to stay competitive, be compliant, attract investment and satisfy stakeholders.
Environmental, social and governance (ESG) issues are gaining more attention at the highest levels of organizations around the world. A recent Aon survey found that the ESG-related topics such as relevant regulatory changes, workforce shortages and climate were among the top 10Opens in a new tab risks for business leaders. It is critical for organizations’ boards of directors and leadership to look for better ways to proactively manage their approaches to ESG to articulate their strategy from a position of strength and avoid potential litigation, regulatory penalties and reputational risk.
“There’s vulnerability for companies from all areas of risk, including financial, people-related, reputational and litigation, but with the right approach they can address their ESG risks in a way that protects and grows their business, and benefits society,” says Patty Errico, partner in the Corporate Governance and ESG Advisory practice at Aon’s Human Capital Solutions.
Now is the Time to Face Risks
In general, corporate oversight of ESG, as well as companies that invest in funds and companies that focus on ESG, have received greater attention and scrutiny in recent years. One reason is a decrease in annual ESG equity funds1, largely due to macroeconomic factors. In the U.S., criticism of ESG topics has caused some state pension funds to raise concerns about certain companies and investors2 with highly visible ESG activities. On the other side, scrutiny of potential corporate “greenwashing” continues.
These developments aren’t derailing companies’ investment and commitment to ESG. Instead, they are causing organizations and investors to get more precise about risks and opportunities — stressing the need to focus on the data and metrics used to measure material factors.
“While the language of ESG may evolve from this movement, the underlying risks are here to stay — and they are growing in urgency for companies to address,” says Aria Glasgow, head of North America ESG and Corporate Governance Advisory practice at Aon’s Human Capital Solutions.
The current environment makes it even more important for companies to have a thoughtful approach to ESG that’s communicated clearly to stakeholders. It should also align to organizational culture and be integrated into decision making.
When making ESG disclosures, organizations should consider communicating with the right level of detail, weighing short-, medium- and long-term risk, says Errico. “For example, disclosing a goal to reach net zero by 2040 is so far in the future. You should think about the level of detail you need to disclose today to satisfy investors that you will reach that goal.”
ESG needs to be integrated into a company’s enterprise risk management framework — a reality that is not being met by many organizations, says Tracie Thompson, head of ESG and climate for Aon’s Commercial Risk Solutions. For example, as insurers and regulators further scrutinize the physical and transitional risks of climate change, companies need to demonstrate a credible risk management process as they would for all risks.
Half of the top 10 business risks executives identify today are related to ESG issues.
Source: Aon’s 2022 Executive Risk Survey
Bringing ESG risks into the enterprise risk management strategy will enable access to durable insurance capacity and ensure that coverage includes new and emerging risks that are not typically considered by the risk management function within a firm.
A Snapshot of ESG Developments Across the Globe
Regulations, cultural norms and best practices vary around the world. Different regions are in various stages of thinking about ESG and, in some cases, addressing it through regulatory drivers. It’s important for companies to be aware of evolving regulations and best practices in varying markets of operation.
Here’s a closer look at ESG developments by region.
Companies globally with senior leadership support and sponsorship for DE&I initiatives
Source: Aon’s 2022 Global DE&I Survey
Europe and the UK
- In the UK, the Task Force on Climate-related Financial Disclosures (TCFD) framework has evolved from a voluntary framework to a mandatory requirement for certain listed companies3, asset managers and owners. Large UK-registered private companies and limited liability partnerships are also now required to report climate-related financial disclosures in a similar, but less stringent framework as TCFD.
- In 2021, the UK government’s Roadmap to Sustainable Investing set expectations for wider disclosures called the Sustainability Disclosure Requirements (SDR). The initial consultation focuses on sustainability disclosures, fund labeling and a general anti-greenwashing rule for regulated asset managers. Additional consultations are expected to expand and evolve the regulation over time, incorporating the final UK Green Taxonomy and the International Sustainability Standards Board (ISSB) disclosure standards.
- There are wider sustainability disclosures that will impact any UK company with more than 150 million euros ($165 million) of annual revenues in the EU, where compliance with the EU Corporate Sustainability Reporting Directive (CSRD) will be mandated.
- Board-level diversity disclosure was required in April 2022 for UK-listed companies and in November 2022 for EU-listed companies.
- The European Green Deal Industrial Plan, announced in January 2023, has led to various EU directives. These include the EU taxonomy that aims to identify the proportion of sustainable assets, the Sustainable Finance Disclosures Regulation (SFDR) geared to financial market participants, and the CSRD that will be implemented as soon as 2024 for certain companies. The CSRD includes requirements to disclose Scope 3 emissions and more detail on the social risks within ESG, such as working conditions, equal treatment and opportunities for all the employees in the value chain, as well as pay equity disclosure (for more information, read our article “Navigating the New EU Directive on Pay Transparency”).
- Aon’s recent pulse survey on how companies in the Middle East are addressing ESG finds that many organizations are prioritizing human capital management compared to environmental issues. However, some Northern African and Middle Eastern countries are getting more involved on the international climate stage, with Egypt hosting the United Nations COP27 conference in 2022 and Dubai hosting COP28 later this year.
- ESG regulation and reporting lags Europe, but we see some activity emerging. In January 2023, the Gulf Cooperation Council countries’ stock exchanges and financial sector regulatory authorities agreed to implement a common set of voluntary ESG reporting disclosure metrics. These incorporate 29 standards, with categories across greenhouse gas emissions, energy usage, water usage, gender pay, employee turnover, gender diversity and data privacy. Each exchange will supervise the disclosure reporting for the listed companies in their jurisdiction under this new unified framework.
- In the U.S., final rules on climate and cybersecurity disclosures, as well as proposed rules on prescriptive human capital and board diversity disclosures, are expected from the Securities and Exchange Commission.
- Asset managers continue to emphasize diversity, equity and inclusion (DE&I) progress and transparency, some pushing for EEO-1 disclosures and others moving from requiring a minimal number of women directors on corporate boards to percentage thresholds. Indeed, new data shows racial and ethnic minorities now represent 20 percent of board seats in the Russell 3000 — a milestone indicating a decade of progress towards greater diversity in the boardroom.
- President Biden’s administration proposed the Federal Supplier Risk and Resilience Rule in November 2022. This would require major or significant federal contractors to disclose their greenhouse gas emissions and climate-related financial risks and set science-based emission reduction targets. The proposed rule would have a ripple effect for other companies.
- Critics of using ESG to influence investing decisions continue to capture headlines. More than a dozen states passed measures to prohibit the consideration of ESG factors in investing state retirement funds. The Vanguard Group quitting the Net Zero Asset Managers Initiative was seen as a symbolic win for the movement. More states are expected to pass anti-ESG measures going into the 2024 presidential election year.
“While ESG activism in Asia is not as prevalent as in North America and Europe, we do see an increase in shareholder engagement by more ESG-mature organizations in the region to proactively manage risks,” says Sitara Fernando, director for Aon’s Human Capital Solutions.
Here are some highlights:
- Organizations in the region are aligning net-zero commitments with their governments’ strategies. Many exchanges have mandated sustainability reporting for publicly traded companies. The most recommended framework by regulators for climate reporting is TCFD.
- Recognizing the benefits DE&I has on overall business and talent strategies, some institutional investors are pushing larger organizations to report DE&I performance and articulate their targets.
- Boards are focusing on ESG and working towards building knowledge and capacity to understand and manage these emerging risks. However, there is a scarcity of ESG expertise in many markets, especially those severely affected by the pandemic and/or geopolitical disruption.
- Scope 3 emissions reporting is posing challenges for many organizations in Asia — especially since numerous supply chains originate or include in the region. It is likely that this will continue to lag until regulators mandate disclosures.
“For global companies, the ESG risk identification process has implications on all types of suppliers. This means that companies operating in Latin America are starting to feel pressure from their global clients to mobilize an ESG strategy regardless of their own regulatory environment,” says Anna Barrera, director in the Corporate Governance and ESG Advisory practice in Aon’s Human Capital Solutions.
Here are some highlights:
- While the region trails others in ESG reporting regulations, there are signals that organizations will not wait for regulation to advance their ESG strategy. The first ESG Summit Mexico was held in 2022. Company leaders and asset managers emphasized opportunities to address climate change and ESG pressures facing clients in the U.S. and Canada.
- As Luiz Inácio Lula da Silva takes over as Brazil’s president, we expect challenges to extractive industries like mining and agribusiness operating in Brazil’s environmentally sensitive areas.
- Issuance of sustainability-linked bonds is growing, with proceeds going toward green goals and sustainability performance targets.
- Several Latin American countries have focused on enacting human rights and diversity-specific regulations. For example, Brazil prohibits companies convicted of using child labor from participation in the bidding process, while Chile requires companies to report on diversity, internal pay gaps and occupational safety.
Monitoring ESG Progress along a Maturity Curve
Developing and overseeing an ESG strategy can be daunting given the sheer size of the topic. Regardless of an organization’s unique attributes — including industry, shareholder base, location and size — it is important to maintain progress. Aon’s ESG maturity curve shows how your organization can follow the trajectory from practical steps to tactical achievements.
Start by addressing these key questions under each of the pillars with the maturity curve as a guide toward progress.
Has your organization set up verifiable processes to collect and report environmental and climate-related metrics?
- Has your organization set a long-term emission reduction goal or have a decarbonization strategy?
- How is your organization preparing for new climate regulations, particularly for multinational firms that may have different regulations impacting the business?
- Does your board have climate expertise or formal climate oversight in alignment with peer practice?
- Is your organization reporting on social issues like diversity, human rights, and health and safety in alignment with your peers?
- Have you conducted a pay equity assessment?
- What programs and initiatives are in place to monitor and manage the organization’s talent risk?
- Do you understand social risks in your supply chain, including human rights and occupational health and safety?
- How do you leverage your ESG strategy and communicate it to attract and retain employees?
- Is your organization set up to oversee and manage risks at the board and senior management levels?
- How often does the board discuss ESG risks, strategy and disclosure?
- Does that oversight have a process for ensuring new and emerging risks are being monitored and included?
- Are ESG risks embedded in operational plans across the organization?
While steps do not need to be taken sequentially, the curve presents a general ESG progression for companies to follow when developing a corporate ESG plan. Use governance entry points to ground your ESG strategy, enhance current initiatives and offer clarity of purpose.
For questions or help with your ESG strategy, please reach out to any of our ESG advisors in your region.
1 ESG funds set for first annual outflows in a decade after bruising year
2 ESG Battlegrounds: How the States Are Shaping the Regulatory Landscape in the U.S.
3 Premium and standard listed companies, where the requirements for a premium listing in London are more stringent than those for a standard listing as set out in the Financial Conduct Authority's Listing Rules.
The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.
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