Incoming ESG Regulatory Requirements: Why It’s About Strategy First, Metrics Second

As the public consultation season officially begins, businesses around the world are watching with anticipation as governments ramp up their ESG disclosure rules. This time, it’s not a matter of giving feedback to voluntary frameworks or standards — it’s about the power players that are introducing far-reaching, game changing and legally mandated rules.

We’re referring here to the SEC, the U.S. Department Labor (DOL), International Sustainability Standards Board (ISSB), International Financial Reporting Standards Foundation (IFRS) and European Financial Reporting Advisory Group (EFRAG). Regulatory developments are no longer standalone ideations, they are pieces of a larger puzzle creating a global market in which financial and ESG information is accessible and decision-useful on the same scale.

We believe that with clear and precise regulations, we all can drive strategic opportunities that empower a healthier economy, a more just and inclusive society, a concerted effort to achieve climate goals, and even overall environmental aspects like biodiversity.

As regulators finally raise the bar, advocates hope to capture the right attention from leaders across C-suites and boardrooms. The primary concern now: nobody is fully prepared for what will come next.

Beyond the initial enthusiasm and inspirational remarks shared publicly by business leaders, there’s an unmissable anxiety and confusion that comes to light in one-on-one conversations. At all of the leading ESG and sustainability events we have attended in recent months, hundreds of business leaders and experts have shared some level of ambiguity.

There are a number of technical considerations driving the shared sense of inadequacy. Reporting on more than 400 ESG metrics to meet the EFRAG standards or on Scope 3 emissions under the SEC proposal won’t be a walk in the park. But there are even more significant implications for companies in this new reality. Now more than ever, success boils down to strategy first, metrics second. A clear and comprehensive strategy is needed to define priorities and allocate resources appropriately and to really understand the why and how, before jumping headfirst into the what. The latter has led far too many corporate executives into the red zone of “greenwashing.”

That’s why these policy developments go far beyond transparency and finally strike at the heart of governance, asking for greater accountability on decision-making processes around ESG risks and opportunities. In order to create a more resilient market, governments recognize that there are process improvements to be made at the corporate level.

What this means in practice:

• There will be winners and losers. Corporate leaders who procrastinate are simply on the wrong side of history. Those who do not adjust quickly will fall behind in a space that makes it near-impossible to catch up in. Those working to keep up must heed with caution, as greenwashing initiatives will not hold up in the post regulatory space. As Kristin Siemen, chief sustainability officer at General Motors, said at a recent event: “It’s about winning with integrity.”
• The differentiation opportunities associated with voluntary ESG reporting demand more sophistication and focus. Policy has raised the bar, demanding disclosure on a wide set of sustainability issues. And yet, “if you’re waiting for regulation, then you’re too late,” explained Carletta Ooton, head of ESG at Apollo. Having a clear, defensible and data-backed process to understand and monitor material risks and opportunities is table stakes. Regulation and standards lag in comparison to disruptions corporate leaders face today (think Covid, geopolitical conflict, social inclusion).
• Competitive advantage requires strategic foresight. The ability to anticipate and quickly adapt to what’s emerging as material is where market differentiation and value creation opportunities exist. It’s about horizon scanning, and having a wider scope of real-time data to support that in a systematic way. Focusing exclusively on what the standards and regulations demand is a check-box exercise, and innovation stagnates within the box. That’s why data-driven and dynamic materiality assessments are “game changing and the best thing I’ve seen today,” according to Savannah Haeger, senior communications specialist at FedEx.
• The convergence of ESG and financial materiality demands that the headcount, talent, budget and resources be adequate across the board. Synergies, as basic as speaking the same language, to more complex things like tracking regulatory developments, can be achieved with the right expenditure. Investments in the right talent, leadership and technologies connect and empower teams — from ESG to finance, legal, strategy, risk and compliance.
• There’s an “ESG land grab” at play within companies and among service providers. Individuals across the enterprise now want to be associated with the hottest ticket in town. “Suddenly, everyone wants to be your dance partner,” Alex Thompson, chief communications officer at Thomson Reuters, said about the elevated role of ESG professionals today. But ESG is not a singular thing to be claimed; it’s a complex set of issues that require cross-functional expertise and partnership-based solutions.

Businesses are not left in the blind to figure out the pieces of this puzzle. Key institutions and regulators are providing guidance on recommended best practices. EFRAG released a report on best practices on ESG risks and opportunities, highlighting data-driven materiality assessments as a “key process.” The SEC indicates in the climate-related disclosure proposal that the commission “recognize[s] that determining the likely future impacts on a registrant’s business may be difficult,” and that various software tools are available to assist. In other words, given the increase in the sophistication of regulatory requirements, technology is no longer an option, but a must have — not only for companies that are looking to be the leaders, but also for those that are at the start of their journey.