Praxity - Thought Leadership: ESG Legislation
The Rapid Changes in ESG
Joern Obermann, General Representative, Tax Advisor and German Public Auditor at FIDES, and Edward Olson, Partner in Enterprise Risk Services and National ESG Leader at MNP, discuss how ESG legislation is changing the approach to business.
Much has changed in the ESG space in a short time. Legislation has had time to be tested against the demands of the real world, and firms’ ESG measures evolve as their clients’ operating environments change. While headlines have been dominated by the coordinated pushback against legislation and perceived overreach, business has nevertheless continued to make progress on the underlying principles of ESG, and in making it work for their own business aims.
ESG and Regulation
Tax and compliance with regulations are hugely relevant ESG issues. New Pillar 2 rules are designed to disrupt the practice of offshoring profits, ensuring that the final beneficiaries pay the appropriate level of tax in the jurisdictions in which they operate. However, in today’s business environment, defining “the community” can be ever harder. Often operating across borders and with differing laws and labour costs, it can be a challenge for any business leader to get an idea of where ESG priorities should lie.
Since the EU regulations will require larger companies to publish an extensive and detailed set of information with respect to ESG matters, our clients realise that the preparation of the reporting will be time consuming and complex. There is a certain shift towards the acceptance, that even those companies that do not see a “business case” for being sustainable, understand that certain standards must be met. At the same time, our clients frequently emphasise that the pressure from their own customers increases.
Dr Jörn Obermann, General Representative, Tax Advisor and German Public Auditor, FIDES
Jorn Obermann,
General Representative, Tax Advisor and German Public Auditor, FIDES
Joern Obermann,
General Representative, Tax Advisor and German Public Auditor, FIDES
Since the EU regulations will require larger companies to publish an extensive and detailed set of information with respect to ESG matters, our clients realise that the preparation of the reporting will be time consuming and complex. There is a certain shift towards the acceptance, that even those companies that do not see a “business case” for being sustainable, understand that certain standards must be met. At the same time, our clients frequently emphasise that the pressure from their own customers increases.
Jorn Obermann,
General Representative, Tax Advisor and German Public Auditor, FIDES
With a breadth of experience worldwide and cross-border, Praxity Alliance members have been refining their processes, with audit and reporting processes pre-empting legislation by many years.
Mature Markets and Emerging Economies
There is a difficulty in establishing “one rule for all” and context needs to be considered when targets are laid out. For example, there has been a lot of debate about the ecological impact of emissions from developing countries, whose rate of use of fossil fuels has increased exponentially in the last few decades. On the other hand, emissions continue to be a global problem that is neither region-specific nor respects international borders and political divisions.
This is not to say that economies outside the traditional powerhouses are not incorporating ESG into their strategies. With an awareness of how developing countries have been impacted by exploitative business practices, the focus is shifting to sustainable development and redressing the balance.
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There are some interesting aspects to navigate; how does a government establish what is appropriate and what is legislative overreach? How does the urgency of action on climate change stack up against the longer-term business cases for ESG reporting? How do we define success over such a broad swathe of industries and territories?
Energy Security in Europe
In the face of conflict and political instability, there have been increasing calls for developed countries to shore up their energy supplies. Western Europe has been particularly affected by an energy crisis, with conflicts affecting major suppliers and transit routes.
Governmental price caps on Russian oil have undoubtedly made fossil fuels more expensive commodities, especially in Europe, driving up prices across the board. There have also been issues in developing nations with the traditional breadbaskets of Europe – Ukraine and Southern Russia – becoming unavailable or only sporadically accessible. This has globally increased prices of crucial goods, leading to high inflation in even the most stable economies, and potential famines in less developed nations.
One effect is that longer-term environmental concerns may have slipped down the list of priorities, in favour of short-term fixes to an ongoing crisis. However, it can also be argued that hastening transition to green energy and renewable sources would have prevented this crisis from happening in the first place. There may be an improved business case for relying on renewable energy, or from limiting the use of imported goods, both of which would have knock-on effects for an ESG report. It’s impossible to ignore the business reputation and public relations aspect to this too, as these are emotive matters to both the public and to stakeholders.
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The Politicisation of ESG
The ESG space is contested, with priorities, political positions and ideologies competing over what the scope and importance of ESG measures should be. Social media, and the posture that generates engagement, has aided polarisation and encouraged cynicism in politics and among the public. There have also been concerted efforts to misrepresent the ESG conversation, in an attempt to appeal to broader concerns about societal direction.
Some industries may feel unfairly legislated against. For example, fossil fuels and heavy industry remain important cornerstones for many economies, including highly developed ones. While clearly any fossil fuel or heavy metal extraction would have a high environmental cost, it can be argued that it is unfair for these industries to be targeted when the modern world still relies upon their products and their businesses succeeding.
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Crosscurrents in North America
The US has seen significant pushback against attempts to make ESG reporting mandatory, or to bring in legislation with teeth on a nationwide basis. As of February 2024, there were around 61 anti-ESG bills stuck in the US Congress. Tit-for-tat boycotts and counter-boycotts are also an ongoing concern -
Apart from legislation, certain states have also compiled restricted lists, which target financial institutions that allegedly boycott industries like fossil fuel and firearms. Several states such as Kentucky, Oklahoma, Texas, and West Virginia have enacted these anti-boycott laws in the last two years, maintaining a list of restricted financial institutions that will be barred from doing business with the state.1
Dr Jörn Obermann, General Representative, Tax Advisor and German Public Auditor, FIDES
Political polarisation has played a part, with much political posturing along the perceived party line. In their turn, states with Democratic majorities have been aggressive in pursuing legal avenues to inscribe ESG in law. For example, The Climate Corporate Data Accountability Act (SB 253), signed into law by California Governor Gavin Newsom, is the first-of-its-kind mandatory climate emissions disclosure rule in the United States2
Pushback in Europe
This friction has spread across Europe and the EU too, with the debate framed along similar lines. With ESG legislation in Europe having found its teeth, there is inevitable pushback as new realities begin to bite. For example, while European territories tend to be in close step with each other, there is a (somewhat justified) fear that not every major economy is bound by the same rules, especially in reference to the giants of the USA and China -
The European Banking Federation (EBF) says lenders in the region won’t be able to compete with their US rivals if regulators continue to pile on environmental, social, and governance (ESG) rules that Wall Street remains free to ignore. The warning from the bloc’s main bank lobby comes as the European Central Bank (ECB) puts pressure on lenders to capture ESG risks, including in loan-loss provisions, marking a new frontier in ESG reporting standards.3
Dr Jörn Obermann, General Representative, Tax Advisor and German Public Auditor, FIDES
Investing trends can unfortunately be a case of reality following perception and not the other way around.
Edward Olson,
CPA, CA, CIA, GCB.D, Partner, Enterprise Risk Services, National Leader, Environmental, Social & Governance, MNP
Look to the lawsuits against ESG and understand this is all about how companies don’t want to be told what to do. However, changing legal and regulatory environments are squeezing those who purposely set out to do nothing. Eventually they will have to act, which is strategically a bad move; being forward-looking is a key tenet of good corporate leadership. The topics embedded across the ESG paradigm need to be considered; a failure to do so is a failure to understand the numbers.
Jorn Obermann,
General Representative, Tax Advisor and German Public Auditor, FIDES
Look to the lawsuits against ESG and understand this is all about how companies don’t want to be told what to do. However, changing legal and regulatory environments are squeezing those who purposely set out to do nothing. Eventually they will have to act, which is strategically a bad move; being forward-looking is a key tenet of good corporate leadership. The topics embedded across the ESG paradigm need to be considered; a failure to do so is a failure to understand the numbers.
Ed Olson, Partner and ESG Leader, MNP
Ed Olsen,
Partner and ESG Leader, MNP
Hostility to ESG comes from many sources; whether businesses want to be free to make their own profit decisions, whether they feel that their sectors are unfairly maligned, or whether they see it as social justice window dressing. Despite this, ESG as a holistic assessment seems to be here to stay. Not only does ESG accounting place a firm in its broader context, it also seems to be helping businesses make more profit. The social and environmental cases seem to be self-evident going forward, and if the business case is currently proving itself even under increasingly stringent rules, then the review of a firm’s governance almost writes itself.
The area is clearly a rapidly developing one, which is why Praxity’s most recent ESG reports are so radically different from one another. Perhaps the real question is whether unity can be found, without compromising to the point of meaninglessness. As the business case proves itself more and more, those who simply ignore the problem and pretend it doesn’t exist may be quickly reminded of financial realities.
1https://www.thomsonreuters.com/en-us/posts/esg/anti-esg-legislation/
2 Thomson Reuters, ESG – Navigating Past the Noise, 2023
3https://www.businesstimes.com.sg/companies-markets/banking-finance/bankers-europe-push-back-ecb-conducts-new-esg-risk-review