Majority of Companies Say They’re Not Ready for ESG Regulations

New ESG regulations are taking hold in the EU, but the vast majority of businesses say they feel underprepared to meet mounting sustainability standards.

A new study from global intelligence and cyber security consultancy S-RM revealed that a whopping 84 percent of Europe-based corporations and 82 percent of regional investors don’t feel confident in their ability to comply with the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD), which was signed into law recently.

In fact, S-RM’s survey of 550 senior ESG decision-makers within corporate organizations and 200 senior ESG decision-makers at investment firms showed that the awareness of and capacity to manage ESG issues are “significantly lacking” in businesses across the board. Data showed that 74 percent of companies believe they’re not “fully mature” in handling matters concerning the environment, social impact or governance.

“Maturity was defined as having a clear strategy — there’s a program, data is being collected and they’re reporting on it,” S-RM head of ESG and sustainability Natalie Stafford told WWD sister publication Sourcing Journal. “There’s a sense that they know what their obligations are, they know what they want to do, and they’re on the journey towards doing that.”

As it turns out, ESG leads feel that their corporate toolboxes and existing skillsets are woefully underdeveloped to take on the heightened standards they’ll now have to meet — especially when it comes to issues within the supply chain, they reported. Notably, 77 percent of those surveyed don’t currently include the concept of responsible supply chains in their ESG strategy.

“This was one of the the big surprises when we gathered the data,” given that “supply chain is so pivotal to ESG,” Stafford said. The issue may stem from the fractured, siloed functionality that pervades many organizations.

Supply chain teams work separately from ESG teams, and both are often disconnected from legal teams tasked with ensuring compliance with laws and regulations. “That kind of organizational structure has preexisted [the focus on] sustainability,” Stafford explained, “and we just don’t feel like that is joining up with a wider corporate purpose when it comes to ESG.”

With so much opacity internally, it’s easier to understand how those tasked with ensuring ESG success might feel like they’re in the dark. “Are these teams connecting? Are they actually conveying requirements to each other and passing on risks and making sure value is being added?” These are the questions many are likely beginning to ask themselves, Stafford said.

“I think certainly in some firms, it’s becoming clear that the way some responsibility initially fell — which was often on legal teams — just doesn’t work because it meant that they were taking very legalistic, very compliance driven approach,” she added. “Which is fine if you’re just managing risk, but you also need to be looking at generating value from ESG and sustainability.”

Many firms rely on their legal arms to ensure that they’re compliant with regulations like the Uyghur Forced Labor Prevention Act (UFLPA), Stafford said by way of example. But she said she believes the only way companies can stop the cycle of playing catch-up when it comes to environmental and social stewardship is to be proactive, and to integrate ESG best practices into their operations as a business imperative.

That evolution will likely start to take shape in the coming years, she said. Today, environmental issues — the “E” in ESG — take precedence over the “S” and “G” by no small margin. SR-G’s survey showed that ecological impact continues to be the primary focus for 39 percent of ESG leads at corporations and 42 percent of ESG decision-makers at investment firms. By contrast, about one-quarter of both groups admitted that there was little or no awareness about social issues or challenges within their industries.

“The environment side is the one that everyone we speak to feels is the most developed — that’s where these budgets have gone,” Stafford said, noting that for some firms, it actually may feel like a lighter lift. “I think the environmental side to some degree is a little bit easier to deal with; you set your targets, and those targets generally are pretty far off. You’re not really having your feet held the fire.”

“To some degree, you can explain away why you haven’t managed to reach your greenhouse gas emission targets as quickly as we wanted to — if there’s some bad press about that, you can deal with it,” she added. “But if you discover that you’ve got slave labor within your supply chain….We’re talking about really emotional and evocative issues, which is very hard for companies to deal with if they get hit reputationally.”

But with the advent of the CRSD and CRDDD, as well as the Global Reporting Initiative, the focus on social objectives is likely to ramp up. Forty percent of those surveyed said they plan to increase spending on social efforts. “Budget allocation is expected to change over the next five years, and social is going up by 1 or 2 percent, which doesn’t look like much, but when you consider the scale of some of the budgets, then it does represent quite a change.”

Much of that spend will go toward amassing external expertise, from audits to consultants and accreditations, Stafford believes. “There’s a recognition that there may not be that expertise internally, and if an external independent body has come in and done a gap analysis on the human rights policy, for example, or has gone out and done human rights impact assessments at key sites, it gives [companies] that bit of protection.”

An outside perspective is often necessary for firms looking to develop long-term ESG strategies. “It’s about working out what is proportionate for the size of the company, the scale of the operations, the scale of the risk, and building an approach which suits where they are as a company,” Stafford said.

While the research focused heavily on Europe-based ESG decision-makers, U.S. firms and investors are also concerned about EU regulations — moreso than any other ESG action taking place at home, in fact.

Twenty-two percent of American investors and 24 percent of U.S. corporations surveyed said they were most concerned about the CSRD, while 30 percent of Stateside investors and 16 percent of corporations said they were most worried about the CSDDD. By contrast, 0 percent of investors and just 3 percent of U.S. corporations said they were most concerned about the UFLPA, and 4 percent of investors and 6 percent of corporations said they were most worried about SEC Climate-related disclosures.

“Even for those companies which don’t fall directly in scope” — like American ones — “as soon as they fall within the value chain of any company that is in scope, they’re going to have to abide by [EU regulations] anyway,” Stafford explained. “If they can’t do everything that’s required, or they don’t have the right modern slavery policies or human rights policies, or they don’t have the data to provide to the company that they’re supplying to, they’re just not going to win the business.”

In some ways, “regulation isn’t even the biggest driver” for companies to make ESG progress — though many firms are certainly worried about it. Stafford believes investor pressure, along with consumer pressure (especially in industries like apparel), is what’s really compelling companies to make changes.

“There’s a sense that this is just the way things are going — it’s like a wave moving through the corporate world,” she said. “It’s not stopping, so you either get on board now and start to get yourself together, or you get left behind.”