Rules and regulations on sustainability are proliferating
Unsustainable companies beware. A net of sustainability is closing in, which over the next few years will become almost impossible to avoid.
The net is made up of statutory obligations, standards, stock-exchange listing requirements, procurement criteria and conditions attached to trade deals. Many strands of the net rely on companies taking voluntary action, but there is an increasing trend towards mandatory requirements. The net is global, and its overall effect is to require companies to be more accountable for their environmental and social impacts. Unsustainable companies are finding it harder to hide.
The emphasis is on getting companies to report more on environmental, social and governance issues. This is based on the premise that “what gets measured gets done”, says Alan McGill, a partner in the Sustainability and Climate Change practice of the financial services firm PwC. The net of sustainability “will get companies to have a better understanding of their impact” as the crucial first step in acting to minimise that impact.
For example, the European Parliament agreed in April to a European Union directive that will require all listed companies with more than 500 employees to disclose information on environmental and social matters, human rights, anti-corruption and bribery. Companies will also have to publish information on treatment of employees and diversity in the boardroom.
The directive will probably take effect from 2016 and will impose the non-financial reporting obligation on about 6,000 companies. It will augment existing rules in a number of countries. Denmark, France, Sweden and the UK, for example, already require some form of non-financial disclosure from large companies.
But the effect will be to spread the sustainability net wider and catch many more companies. According to the European Commission, only about 10% of companies that will be covered by the new directive currently systematically report on their non-financial performance.
Some companies will have a clear advantage when new rules come in. Pioneers such as Marks & Spencer and Unilever are already reporting comprehensively and reorientating their businesses to be more sustainable. But others will have a rude awakening.
“There are other companies that are coming to it much later,” McGill says. Those late-comers “are tending to struggle with the collection of the data”.
Companies are also increasingly required to report non-financial information under laws that impose on them direct environmental or social obligations.
For example, companies covered by emissions-trading schemes must calculate and report their emissions – and will pay a financial penalty in terms of an obligation to buy carbon permits if they do not keep their emissions under control. Such schemes convert environmental performance directly into financial data, which is reported by a company in its financial report, even if it does not disclose non-financial information.
Another example of a reporting obligation inserted by lawmakers into an environmental law is the EU Timber Regulation, which took effect on 3 March 2013. This law requires companies importing wood and wood products into the EU to do ‘due diligence’, meaning they must certify that the timber has not been illegally harvested – in effect, to identify risk in their supply chains.
The timber regulation “is really very good. It sets a good minimum basis,” says Richard Holland, chief conservation officer for WWF. Holland traces an overlap between such regulation and voluntary codes. He notes that Forest Stewardship Council certification has increased from 9% of global production to 16% in the past seven years – still a low number but nevertheless an “amazing success”, Holland says.
Companies are also being made to look at their supply chains by rules on minerals such as gold, tantalum and tungsten, which are used in products from mobile phones to light bulbs. The US Securities & Exchange Commission adopted in August 2012 a rule that companies should disclose use of these minerals from the Democratic Republic of the Congo or adjoining countries – areas where revenues from the sale of the minerals might be used to fund armed groups.
The EU in March proposed a similar rule – though it would be voluntary rather than mandatory. The effect is that companies can no longer turn a blind eye to dubious operators in their supply chains. Holland says such rules on sourcing can have “perverse effects” because in the short term they encourage companies to stop buying from high-risk areas, potentially penalising legitimate suppliers as well as dodgy dealers. But “within a few years that will have sorted itself out” and the end result will be a more responsible supply chain, Holland says.
The European Union has recently moved to adopt a number of rules designed to make companies more transparent and accountable. To a certain extent, the rules have been motivated by the idea that corporate irresponsibility contributed to the economic and financial crisis. As well as the directive on non-financial reporting, requiring listed companies with more than 500 employees to disclose a range of environmental, social and governance information, the EU has adopted a requirement for women to take 40% of boardroom positions in listed companies by 2020, or for companies to explain why not, and for major oil, gas, mining and logging companies to disclose on a country-by-country basis their profits, taxes paid and other financial details.
The objective of this rule is to make natural resource extraction in developing countries more transparent. In the United States, listed companies are required to disclose “material” issues that could have an impact on investment decisions. This should include “trends, demands and uncertainties that have a material impact on financial results”.
The understanding of what is material in this context is increasingly being broadened to include sustainability-related information. The non-profit Sustainability Accounting Standards Board (SASB) has taken on the job of defining what is material from a sustainability point of view on a sector-by-sector basis.
SASB’s next challenge is to get companies to take up its standards. US listed companies also have ethical and corporate governance obligations arising from the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act. This includes chapters requiring companies to disclose, among other things, the ratio between chief executive and average employee pay, the use of conflict minerals and payments made to governments in pursuit of oil, gas or mining concessions.
In the United Kingdom, the 2013 update to the Companies Act requires listed firms to disclose their carbon emissions, and to publish a “strategic report” that should describe the company’s strategy and business model, and should also include information on human rights policies, and on gender balance.
The reporting requirements in the EU and US are part of the trend for developed countries to increasingly adopt sustainability-related rules and regulations. But rich-world companies should not be complacent. “The success of the western countries is based on the premise that companies operated in a period of abundance. Those operating conditions are now changing,” McGill says.
This means that large, developed- world companies might face a tough adjustment to put themselves on a path to sustainability, whereas developing world companies more intuitively understand the constraints – the need to operate within environmental limits while benefiting social development. “All developing nations are looking for growth, but they know they need to do it in a different way,” McGill says.
One example of this is the provisions in India’s Companies Act 2013 that require about 8,000 large companies in India to spend 2% of their average net profits on corporate social responsibility. The Companies Act also includes various disclosure provisions, such as a requirement to publish the ratio of executive salaries to the average employee’s salary.
Anthony Miller, a researcher on corporate responsibility and responsible investment for the United Nations Conference on Trade and Development (UNCTAD), says that India’s 2% rule “is really about philanthropy”. But it does require companies to make a contribution to broader social development in India, and to consider how they can help the country and not just help themselves.
Emerging countries are increasingly using stock-exchange listing criteria to push companies to greater transparency and sustainability. India’s Companies Act also requires the top 100 companies on each of the country’s stock exchanges to publish a sustainability report. Other stock exchanges that have started, or are preparing, indices that rank companies on their environmental, social and governance performance include Egypt, Turkey and Vietnam.
However, the “poster children” for stock exchange-mandated sustainability, says Miller, are South Africa and Brazil. In March 2010, the Johannesburg Stock Exchange became the world’s first to require listed companies to produce an integrated report that includes non-financial information, or to explain why they are not doing so. The Brazilian Securities, Commodities & Futures Exchange – the world’s 13th largest – similarly has a “report or explain” rule for its listed companies for sustainability information.
UNCTAD is one of the overseers of the Sustainable Stock Exchange Initiative, which brings together exchanges to promote sustainability. The initiative currently has 10 stock exchange partners, including London, which signed up on 2 June 2014. Miller says stock exchanges and governments can work together to catch companies in the sustainability net, depending on the specific circumstances in different countries. In South Africa, for example, “there’s really no need for the government to come in” to mandate sustainability because of the stock exchange listing requirements, he says. France, by contrast, has no sustainability related listing requirements, but it does have laws obliging French companies to carry out extensive non-financial reporting.
“There is no one size fits all,” Miller says, on the balance between regulation and stock exchange listing requirements. “To some extent it doesn’t matter, as long as there are binding rules and some capacity to enforce them.”
Laws and stock-exchange requirements force companies to at least think about sustainability, but rule-makers also have other tools at their disposal that have the effect of punishing unsustainable companies.
Public procurement requirements are one example. Speaking at an event in Brussels in June, John Bazill of the European Commission’s directorate-general for trade said: “It used to be the case that the public authority had to choose the cheapest bid, full stop.” But this has changed, he said. EU procurement rules now allow public-sector buyers to factor in environmental and social criteria.
WWF’s Richard Holland says the impact of this should not be underestimated. In the Netherlands, for example, public authorities are the largest single purchasers of tropical hardwood. In terms of ensuring sustainability, “by working with them, you get further than you would with all the DIY chains put together”, Holland says.
Sustainability is also starting to become a feature of trade agreements, with sustainable development chapters included in recent EU trade deals with Central America, Columbia and Peru, Singapore and South Korea.
These chapters require, for example, partners to ratify International Labour Organisation commitments or global agreements on trade in endangered species and biodiversity, to give workers a greater say, to strengthen inspections of companies, or even to favour “green goods” in trade between the partners. “There is some interesting language in these agreements. The challenge is now to put it into place. It is a task that is only just beginning,” Bazill says.
Voluntary becomes mandatory
Ioannis Ioannou, assistant professor of strategy and entrepreneurship at London Business School, says the growing net of sustainability rules and regulations “boils down to the greater demand for transparency and accountability”. At the heart of this is the idea of fairness – if huge private profits are to be made, it should at least be demonstrated that they have been made cleanly, without riding roughshod over the wider public interest.
But companies also benefit. The evidence shows that “companies become increasingly sophisticated”, as they respond to the demands, and this results in a greater focus on material issues and improved business performance, Ioannou says. He adds that sustainability is no longer an add-on that follows on from development. “You don’t become sustainable because you are wealthier, but in the long term you become wealthy because you are sustainable,” he says.
This is the prize that regulators are pursuing, and companies should not ignore voluntary standards – they have a tendency to turn into binding rules. “You can see this pattern in a number of areas,” UNCTAD’s Miller says.
In terms of the move from voluntary to mandatory non-financial reporting, he adds: “We expect this trend to expand to almost all countries.” The “big game”, thorough to the middle of the century and beyond, Miller says, is “aligning market signals with public policy signals” – in other words, ensuring that the environmental and social price is right and companies are forced to operate within the bounds of sustainability. In this situation, companies that move towards sustainability ahead of the regulators will undoubtedly have the advantage. Unsustainable companies: you have been warned.
enforced responsibility EU requirements reporting standards sustainability reporting