Preparing for SOX-like ESG regulations

Assessing and managing environmental, social, and governance (ESG) risk is a top priority in amplifying growth. Is your organization embracing ESG as a strategic business imperative?

In brief

• Is your organization ready for the ESG risks of today and tomorrow?
• Have you aligned enterprise risk management to ESG to enable effective oversight of risk?

The environmental and social challenges companies face today are vast, complex and urgent. It’s imperative that leaders take meaningful action to chart a sustainable path forward. Today’s CEOs perceive environmental, social and governance (ESG) factors as one of their top two considerations — 60% of CEOs EY teams surveyed expect to transact M&A deals this year, driven by an urgency to improve their company’s ESG footprint. CEOs say that climate change is the single biggest threat to growth, next to talent scarcity.

We are entering a time marked by exponential growth in the significance of climate impacts and the associated volatility and disruption they result in. This gives rise to the opportunity for governments and private sector organizations to be more sustainable and to create lasting social impact in the communities where they operate, while also delivering genuine financial value.

At EY, almost all our private equity clients are asking us to perform ESG diligence, partially fuelled by growing regulatory, institutional investor and rating agency expectations. Recently, this includes mounting pressure from the US SEC for publicly traded companies to disclose climate-related financial risks. ESG requirements globally are likely to increase in the wake of the commitments at the 2021 United Nations climate change conference (Conference of Parties or COP26).

It’s important to remember ESG is more than just a compliance exercise. A growing number of companies are embracing ESG as a strategic business imperative — including owners and operators of real estate — particularly as companies pursue net zero by 2050. The world is acknowledging the seriousness and scale of the risks posed by climate change, and business leaders recognize ESG’s potential to build long-term competitive advantage, enhance resilience to accelerating sustainability risks and to attract socially and environmentally conscious investors, talent and customers.

In view of the surge in sustainable investing and evolving investor stewardship practices, whereby employees and customers are demanding organizations stand for something beyond profit, companies see ESG’s value in accessing capital and proactively addressing matters that could attract activist investors or hedge funds.

One thing is clear: managing ESG risk is a top priority in amplifying growth. 

Crucial questions for boards and executives to consider: 

• How are my company’s strategy and risk management functions meeting the needs of key stakeholders, addressing financially material environmental and social factors, and driving competitive advantage? 
• How is the board learning about ESG-related trends and developments that could impact the business and affect shareholder support for the board and management? 
• How would a sustainability materiality assessment help inform the company’s strategy and strengthen relationships with key stakeholders? 
• Would assigning ESG oversight responsibilities to board committees enhance the board’s governance? 
• How do company communications increase the brand value of ESG initiatives and meet investor needs for decision-useful ESG information? 
• Is the company taking the same approach to nonfinancial data as it is to financial data in terms of disclosure processes and controls and obtaining external assurance?

A critical consideration for ESG reporting is that companies need to have robust disclosure processes and controls in place, including those related to data quality. Sustainability reports are often created by a different part of the organization than financial reporting, as the controls and degree of discipline may not be of the same rigour required to enable informed decision-making.

It is key to have ESG governance in place at the board, management, operations and supply chain levels, and to set a framework and understand comparable benchmarks to drive ESG performance. Involving enterprise risk advisors and internal audit to obtain internal and external assurance will help entities provide credible, quality ESG data to the marketplace and build stakeholder confidence in the reliability of this information.