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In March, the SEC proposed regulations to standardize the sustainability-related disclosures companies must make. These include emissions, climate-related risks and the steps the companies are taking to address each issue. If these regulations are passed, businesses will need to collect and report their sustainability data much as they do financial data.
Recent Supreme Court decisions on climate efforts have complicated this proposal, and it remains unclear what version of these regulations will wind up in place when the dust settles. However, it appears certain that some kind of ESG (environmental, social, and governance) disclosure regulations will be in place in the U.S within the next two to three years. The public appetite for corporate environmental responsibility is real, and many other countries have adopted similar measures. For example, the European Union’s Corporate Sustainability Reporting Directive (CSRD) will be rolled out in the next couple of years.
Adapting to climate risk disclosure
What will this mean for U.S. businesses? It means we need to make some changes. Sustainability may be at the forefront of our minds, but now we need to take action. We lag behind countries and economic zones like the EU that have made strides with these kinds of regulations.
Research suggests that up to $5 trillion annually worldwide will be invested in sustainability by 2025 — the most extensive capital reallocation in history. We’re beginning to see a large push for technology and processes that can track and reduce emissions and increase sustainability down the road.
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Businesses should take this opportunity — the calm before the regulatory storm, if you will — to get a head start by putting those technologies and processes in place. These systems can be complex and require the involvement of a variety of parties — executives and managers across functions and geographies, logistics teams, suppliers, partners and others down the supply chain — so it will take some time to get them up and running.
Speaking of the supply chain: While Scope 1 and 2 emissions can be easily tracked — as those refer to direct emissions from owned or controlled sources and the indirect emissions from purchased heating, cooling, steam and electricity — collecting and analyzing Scope 3 emissions will be tricky. Scope 3 emissions are those that can be traced back to a company’s broader supply chain, and they can account for two-thirds of a business’s total carbon footprint. Until now, businesses have been self-reporting their Scope 3 emissions. But if these new regulations are passed, there will be a lot more scrutiny around reporting for many businesses. For example, according to the SEC’s current proposal, 10-K filers and foreign private issuers who file 20-F would have to disclose Scope 1 and 2 emissions in fiscal year 2023, then Scope 3 come 2024.
Pending regulations — and the complexity of implementing tools to meet them — introduce a new category of risk for U.S. companies. There are a few considerations businesses should keep in mind when looking to prepare their ESG programs and data management systems for the future:
1. Be proactive on sustainability efforts
The regulatory bodies and rating organizations monitoring ESG and sustainability efforts are going to be on the lookout for initiatives with continuous impact. That means no small, knee-jerk reactions, but rather thought-out, robust solutions. Yes, ESG ratings are already a thing, and while it’s unlikely that they will be used directly in gauging whether regulations are being met, their impact on the perception of a company means you should not ignore them.
If you take too long to get proper sustainability efforts in place, your ESG rating may suffer, and it might make your negotiating position with new partners and vendors trickier. Similarly, being seen in the public eye as not doing enough toward sustainability will create negative brand associations that are hard to overcome.
2. Build in visibility
For some time, visibility has been a difficult thing for many organizations to integrate into their supply chains. According to a Deloitte survey, good visibility into even critical suppliers is lacking — less than 75% of polled organizations reported they felt they had good insight into that layer. It got worse when looking at their second and third tiers: Only 15% of respondents reported good visibility into those suppliers.
Not only does a lack of visibility increase risks (as you can’t fix what you don’t know is going wrong), it will make accurate reporting and forecasting of Scope 3 emissions nearly impossible — and open a business up to fines for not meeting regulatory requirements.
Achieving visibility into your data collection systems requires making it as easy as possible for suppliers to provide that emissions data to you. If you don’t require that data, or it’s difficult for suppliers to input it into a third-party management system, they have little incentive to go out of their way to provide it. When selecting vendor management solutions, businesses should prioritize systems that allow them to both require emissions and sustainability reporting and make it simple and quick for suppliers to input that data.
Building those requirements into the system from the point of onboarding is the most efficient way to start capturing this data. But for existing suppliers and vendors, it should be built into the normal workflows.
3. Remain flexible on suppliers and their climate risk
It’s helpful to think of sustainability requirements as another category of risk. When evaluating new suppliers or partners, you need to consider, along with all other risks, the possibility that they will make it difficult for you to keep up with reporting requirements.
Not only does that hold true for any potential new supply chain partners, it also requires companies to closely assess their current suppliers and see what risks they already have on their hands. It might be necessary to divest from some suppliers over time — or even rapidly.
Have a plan in place for combing through current suppliers, assessing their ESG risks, and making a plan for each one. Start with your critical suppliers and work your way down. It might be a matter of working more closely with an organization to establish a way of providing that data, but it could be something more significant, like shifting a small percentage of that supplier’s contract to a less risky organization while the risk persists.
4. Consider international and industry-specific regulations
Finally, be sure to also consider the unique regulations and complications surrounding your suppliers. Just like the EU, many countries have ESG regulations, and that number will increase significantly in the next few years. If you’re doing business in those countries, you need to adhere to their regulations as well.
The same holds true for industries where you and your suppliers do business. Some industries will have more stringent sustainability reporting requirements and expectations, or require specific data that is irrelevant to others. Here, that flexibility and visibility come in handy; the process and end goals for working with each supplier on ESG reporting and data collecting will not always be the same, so companies need to be able to adapt their processes to match what’s required.
It’s also worth mentioning that suppliers’ industries and geographical locations bring with them other types of risks that might make ESG data collecting difficult. Geopolitical tensions are high, and previously stable countries are finding themselves embroiled in war or social upheaval, or bordering a country in such a situation. It might be hard to access the data you need from suppliers in countries that have been disrupted by geopolitical events. On the same note, as the climate changes at an accelerated pace, extreme weather events are becoming more common; the location of your suppliers and their proximity to high-risk areas should be a major consideration.
Toward a more sustainable tomorrow
As the globe seeks to reverse — or at least slow — our impact on the climate, businesses need to think today about how their supply chains will take shape in 2025, 2030 and well beyond. Proven sustainability isn’t just something to use as a differentiator in the marketplace; it’s going to become table stakes in the next decade or two. The only things up in the air are the finer details of how these regulations will take form. Businesses that act quickly to build that data collection and reporting into their supply chains will have a leg up on those that delay.
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