How New Regulations Are a Game-Changer in Just and Sustainable Business

Introduction

Companies and business leaders are facing some of the most significant changes to regulatory requirements concerning just and sustainable business. The rising tide of regulations means that matters that once were delegated to the sustainability team without significant input or oversight from the Board or the C-suite are now addressed in those fora. These changes mean that companies must navigate different expectations and processes. At the same time, investors, customers, employees, and other stakeholders are raising expectations amidst increasing geopolitical volatility and fragmentation and in the context of the accelerating energy transition, climate disruption, emerging AI, and other disruptive technologies.  

These developments can significantly boost just and sustainable business, and the regulations ensure that companies embed them into their strategy and operations. However, the developments can also lead to a narrow focus on compliance, risk-averse actions, and overly cautious communications. The task ahead—with a key role played by the Chief Sustainability Officer (CSO)—is to ensure that both the spirit and the letter of the law are followed and that ambition is not sacrificed to achieve compliance.

Executive Summary

The field of just and sustainable business is entering a new era where actions that have previously been voluntary are becoming mandatory. This represents a sea change in how companies conceptualize, deliver, and report on their efforts to deliver on ambitious commitments for all stakeholders.

This new wave of regulation will generate important momentum on crucial topics, ranging from the energy transition to protections for human rights; to equity, inclusion, and justice (EIJ); to reporting and disclosure. All this is welcome, as is the undeniable fact that these developments will also ensure—and in some cases require—that executive management and Boards consider just and sustainable business questions more seriously and formally.

This shift also raises many key questions and some potential risks. The compliance models that regulation inevitably brings can also be a double-edged sword: raising the floor to ensure baseline performance, but in some cases, also inhibiting risk-taking and innovation where proof points on progress may be challenging to deliver. For example, verifying technical questions like water use in a materiality assessment is complicated but doable; the same processes for measuring and verifying impacts on human rights or economic inclusion raise multiple questions. 

Due to the heightened legal significance of several regulatory requirements, the constellation of business functions actively engaged in sustainability discussions has broadened. This is beneficial in principle and means that the need to strengthen fluency in just and sustainable business for Finance, Treasury, Legal, Compliance, Investor Relations, and other functions, as well as Boards of Directors, is more important. For many of these functions, for example, their focus will be on the verification of data that are disclosed in annual reports. The reality is that in some cases (e.g., water use, Scope 1 emissions), data can be verified. In other cases (e.g., Scope 3 emissions, human rights impacts), data are inherently qualitative or otherwise reflect judgments that are not easy to verify in the same way as financial data. Corporate officials and Board members are expected to sign off on such disclosures, so they must have requisite confidence in the information, as well as an appreciation of the source and nature of the data.

A Shift in Mindset

In this context, it is also likely that different mindsets will emerge in important decisions and processes. We would characterize what we fear, and what we hope to see, as follows:

We fear: “The emphasis on regulated transparency and discoverability means we need to be careful about anything we record. It is in our best interests to only know and show risks where we already have a good history of addressing them.” There are signs that the rise of regulation is resulting in more of a narrow compliance mindset that runs the risk of damping down ambition.

We hope to see: “It is in our best interests to know and show all our risks and what we are doing to address them. This enables us to improve performance and demonstrate to regulators that our due diligence processes are thorough, credible, and defensible.”

Regulations can vary between different jurisdictions, in some cases quite substantially. This reinforces—and indeed deepens—the challenge for companies operating globally, as they aim to determine which standard to apply or how to manage multiple standards. Finally, these developments challenge how businesses should approach regulation. The role of individual businesses and business associations in reflexively opposing government policies on just and sustainable business is no longer tenable (if it ever was), and it is likely to get even greater scrutiny.

Taken together, these developments have the potential to achieve real progress. It is essential that companies follow both the spirit and the letter of new laws and regulations; aim for the highest common denominator across jurisdictions; and not only use established “hard law” requirements, but also “soft law” standards coming from non-binding principles, such as the UN Guiding Principles on Business and Human Rights, to serve as the foundation of compliance.

Latest Developments

There is action on many fronts. Regulation on a European level, which will apply to all companies of a certain size doing business in the European Union, leads the way. The US is interesting both due to actions such as the climate disclosure regulation expected later in 2023 from the US Securities and Exchange Commission, but also because of the unique nature of the US governance model, with states and cities taking action on a wide range of issues, often in a conflicting manner, and the role of the courts in resolving governance disputes.

A non-exhaustive list of new regulatory frameworks includes:

• US Securities and Exchange Commission Climate Disclosure Rule: Companies must report climate-related risks and emissions data, including Scope 3 emissions that come from a company’s supply chain. The ruling is expected by the end of 2023.
• EU Corporate Sustainability Due Diligence Directive (CSDDD): The CSDDD calls for certain companies to set up mandatory due diligence practices to identify, prevent, or mitigate adverse impacts of their corporate activities on human rights and the environment.
• EU Corporate Sustainability Reporting Directive (CSRD): Since January, the new EU’s CSRD ensures that investors and other stakeholders have access to the information that they need to assess investment risks arriving from sustainability issues.
• EU Digital Services Act: A form of mandatory human rights due diligence for social media companies
• EU AI Act: A form of mandatory human rights due diligence for companies providing and using AI

While a great deal of attention is paid to Europe and the US, important developments are arising in many other parts of the world. Japan has announced mandatory ESG reporting requirements for listed companies. In Chile, issuers of publicly offered securities and other regulated entities are now required to disclose on ESG as part of their Annual Reports.

In addition, the wide array of non-binding but broadly applied standards continue to advance. Chief amongst these is S1 and S2 coming from the International Sustainability Standards Board (ISSB), which aims to establish globally applicable reporting and disclosure standards. This effort comes alongside the Task Force for Climate-Related Financial Disclosures (TCFD) and, in 2023, the Task Force on Nature-Related Financial Disclosures (TNFD). The TCFD is already being incorporated into national law in the United Kingdom, and it is likely that this will spread and that the TNFD will also be adopted as legally binding. There is an interplay of widely accepted “soft law” with an expansion of “hard law” requirements, which is reshaping corporate actions and requirements.

What Does This Mean for Business?

We hope that the new wave of regulations will promote ambition over compliance and strategic thinking over transactional thinking. These developments mean that the role of the CSO or equivalent in leading just and sustainable business just got more important—and more complex. Currently, the CSO is more of a business partner than a “stakeholder whisperer,” and this individual remains crucial in ensuring that the company stays focused on actions that will be considered credible, not merely compliant.

The CSO also has a key role in ensuring that regulations set the floor, not the ceiling, for just and sustainable business and that company efforts are ambitious. The greater level of attention, visibility, and scrutiny of compliance (e.g., senior executive and board review) will significantly increase the impact of the CSO, while also requiring the work to be of even higher quality. In a compliance process, every word is subject to scrutiny and critique.

For any company looking at just and sustainable business through the lens of new regulations (and that really means all companies), the following will enable business leaders to jump-start ambition rather than inspire caution:

• Strategy: Business strategies are never driven by legal requirements, and the same is true of sustainability requirements. Senior management and Boards are now mandated by law to focus on multiple aspects of sustainability. That mandate should be considered necessary, but not sufficient, to exert effective leadership. It is more important to develop innovative business strategies that deliver long-term value while also addressing climate change, increased equity, and social license to operate. Consider legal requirements as the baseline and continue to promote innovation and ambition.
• Leadership Competencies: It is essential that Board members and executives obtain the required skills and understand how to exert leadership in this changing environment. Best practices include training board members on material topics and emerging trends through formal means (such as executive education) or informal means (such as regular briefings and inviting the participation of external speakers). The role of the General Counsel becomes more important, for obvious reasons. They cannot play this role effectively, however, if they are focused only on legal risks pertaining to regulations and do not also consider how to transcend basic requirements.
• Ambition: As noted above, new regulations are also delivering overlapping and inconsistent rules across different jurisdictions, and these must respect leading voluntary standards that have come to define “sustainability soft law.” It will prove valuable to go beyond the letter of new laws and embrace the spirit of the objectives beyond regulations.
• Policy Advocacy: Companies should promote harmonized ambition in regulation and not succumb to lowest common denominator approaches. They should also oppose regulation that violates international human rights law, well-established standards of responsible business conduct, or reduces ambition on climate, DEI, and other important matters. The credibility of business remains hindered by the fact that traditional business associations routinely and reflexively oppose or “water down” emerging requirements. Businesses committed to just and sustainable business should advocate for legal requirements that reward leaders and are consistent with international standards. Reinforce the need for business associations to promote progress, and hold them accountable when they don’t.
• Communication: One of the emerging areas of regulation—and enforcement—is on anti-greenwashing laws. Companies have more reason than ever before to be clear about the distinctions between greenwashing (e.g., deliberate misrepresentation) vs. ambitious forward-looking statements (much-needed aspiration). Communications, especially in the US, will also have to be understood through the lens of potential challenges by stakeholders and shareholders, something we expect to see increase as Boards are asked to sign off on company assertions. It is also necessary that companies think not only about communications that meet legal requirements, but also the diverse needs of external stakeholders, customers, and employees. One mode of communication won’t get the job done.
• Data Integrity: Data verification, as well as the processes that generate data, just got more important. This raises the stakes for the CSO and requires that auditors are fully capable and that Directors can sign off with confidence. For quantitative information such as workforce diversity, pay equity, water use, and climate information, this takes time but is achievable. For human rights and emerging issues such as climate justice, verification is more of a challenge, with few clear guideposts yet available.
• Culture Change: The new wave of regulation raises the profile and importance of sustainability, which requires an all-company approach. For example, if a company’s Board and management must verify its actions and results on climate and human rights in the supply chain, then product design, procurement, transport and logistics, and other functions must be fully bought in and results measured. Promote and enable culture change to ensure that performance matches requirements so that compliance is sustained over the long term.