Companies are continuing to fail in their efforts to improve environmental, social, and governance (ESG) reporting, while compliance functions are finding it tough to keep up with demands for better assurance in the area, according to experts.

Speaking at Compliance Week Europe in Edinburgh, Scotland, in late October, panelists told attendees ESG reporting is still “immature” in many companies.

Peadar Duffy, global ESG practice lead at tech vendor Archer Integrated Risk Management, said “most companies make the mistake of treating ESG as one issue when it is actually three separate issues—environmental risk, societal risk, and corporate governance” and added that “they rarely have the resources or expertise to tackle them properly.”

Duffy said 11 recommendations from the Task Force on Climate-Related Financial Disclosure (TCFD) can help with ESG reporting based on the four core pillars of governance, strategy, risk management, and metrics and targets, which he called the “the North Star that every company should follow.”

But he added trying to comply with the spirit of them becomes a problem when companies are asked to “discuss” what steps they are taking to address some ESG risks.

“Where you have metrics, you have guidance about how to follow the spirit of the recommendations when reporting,” he said. “However, for those recommendations where you are invited to ‘discuss’ how the business is managing other ESG risks, it simply leads to confusion and very diverse approaches, which is unhelpful.

“There is a tremendous gap between what is a good TCFD report and what is a bad one,” Duffy said. He added only 4 percent of those companies that report in line with TCFD actually attempt to comment on all 11 recommendations. More than 80 percent report on just a single recommendation.

Other experts agreed ESG reporting is not as developed as it should be.

FCA proposes rules to prevent greenwashing

On Oct. 25, the U.K.’s Financial Conduct Authority (FCA) proposed a series of measures to prevent “greenwashing” by financial services firms, especially the way they use terms like “ESG,” “green,” and “sustainable” as misleading—but effective—marketing tools for products and services that do not measure up to such claims.

 

The regulator wants consumers to maintain trust in goods and services that are advertised as “green” or “sustainable” and plans to introduce a labeling system, as well as restrictions on the usage of such terms, so the public has more assurance marketing claims are backed up with evidence and better disclosure.

 

The measures are among several potential new rules that will protect consumers and improve trust in sustainable investment products under the FCA’s ESG strategy and business plan.

 

Following consultation, the FCA plans to introduce different categories of sustainable investment product labels, including one for products improving their sustainability over time.

 

There will also be limits on the future use of sustainability terms so that only products that qualify under the FCA’s definitions can use them. The regulator wants a more general anti-greenwashing rule covering all regulated firms to avoid any further misleading marketing of products.

 

There will also be more easily understandable disclosures to help consumers understand the key sustainability-related features of an investment product, as well as more detailed disclosures suitable for institutional investors or retail investors that want to know more. Product distributors, such as investment platforms, will need to ensure any labels and/or consumer-facing disclosures are accessible and clear to consumers.

 

The FCA warned the new rules will be backed up with enforcement action.

 

The consultation is open until Jan. 25, 2023. The FCA intends to publish final rules by the end of the first half of 2023.

Maria Lancri, partner at law firm Squair, told attendees ESG reporting was bad because ESG efforts were bad.

“ESG reporting requires the company to have actually done something to merit reporting on it. If the company has not done anything, such reporting is simply greenwashing,” she said.

Douglas Hileman, president of Douglas Hileman Consulting, said one of the key problems of ESG reporting is it relies heavily on historic data to provide a view of what the company will do in the future.

“If a report is published in 2022, it relies on data from 2021, based on recommendations or agreed areas of review from 2020. This is meant to inform what the company is aiming to achieve in 2023. There is little wonder, therefore, that ESG reporting is often regarded as poor,” he said.

In a session on corruption, human rights, and supply chains, Lloydette Bai-Marrow, founding partner of Parametric Global Consulting, told attendees companies were placing too much faith in suppliers agreeing to punitive clauses in their supply chain contracts, as well as putting too much trust in suppliers providing full and accurate information about where they were sourcing goods and services from in their supply chains.

“Getting suppliers to sign a supply code saying their contract can be terminated if breached and thinking that’s all they need to do to comply with laws like the Modern Slavery Act is not effective due diligence,” said Bai-Marrow. “Companies need to properly monitor the relationship and carry out site audits and checks for possible human rights abuses. Also, relying on these same suppliers to act on your behalf and conduct the kind of checks you should be doing on their supply chains is fraught with risk.”

She said research suggests the risk of violations occurring in the supply chain increases by 18 percent among Tier 2 suppliers, and that the risk of a possible violation increases further through subsequent tiers.

However, experts were concerned that while compliance functions have an opportunity to get more involved in providing better assurance around ESG risks, they may become overwhelmed by the amount of work involved.

“Compliance functions can’t do all this work on their own—other assurance functions like internal audit and risk management need to help,” said Asha Palmer, senior vice president of compliance solutions at U.S.-based educational tech firm Skillsoft.

She also pointed out since many of the rules and reporting requirements around ESG and human rights issues like slave labor in supply chains are relatively new, “It is still unclear just how organizations are meant to report what they are doing to prevent such abuses in their supply chains or correctly measure the impact of their efforts. These are also reasons why compliance can’t do this stuff on its own.”

Neil Hodge is a freelance business journalist and photographer based in Nottingham, United Kingdom. He writes on insurance and risk management, corporate governance, internal audit, compliance, and legal issues.

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