Over the past few years, environmental, social, and governance requirements have evolved from "optional but recommended" to "start preparing." Now, they're quickly becoming fully required. A set of guidelines that currently exist as informational disclosures, ESG requirements are meant to measure and account for a company's impact on the broader world. They're useful for investors and consumers to see how companies are performing in terms of their environmental and social impact, governance, and compliance with regulation.
Earlier this year, the European Union's
These are only a few of the regulations that have been developed and approved across the globe, showing the movement has most likely hit a critical mass. Now, with ESG reporting trending toward becoming a non-negotiable across the board, it's past time that companies start thinking about how these regulations will impact them and the steps they need to take to ensure their business is compliant.
Breaking down new regulations
While the CSRD and future SEC rules impact different types of companies, both were ultimately created with the same goals in mind: to link companies' broader mission and goals to their investor reporting, and to hold companies accountable for their environmental and social impacts.
The CSRD requires thousands of companies to disclose financial results, risks and opportunities connected with their value chains, and define how they will align their business model and strategies to achieve carbon neutrality.
While a majority of impacted companies are in the EU, CSRD is also affecting U.S.-based companies that have activities in the EU. In fact, at least
Proposed SEC regulations, on the other hand, would require publicly listed companies to disclose ESG-related risks (primarily those that are environmentally related) that are likely to have an impact on their operations and financial conditions, as well as information on their greenhouse gas emissions and net-zero transition plans. These rules are not set in stone yet, but will provide a baseline of financial reporting disclosure rules and empower the markets to determine how sustainable a company needs to be.
Between these two regulations, most companies — regardless of whether they're private or public — will need to begin shifting their reporting and compliance strategy.
Facing ESG reporting challenges
Despite the critical need for companies to begin their ESG journey, there are a few challenges at hand. First and foremost, the new regulations put the reporting burden on the reporting entity. Second, there is no room for compromise around non-compliance, with limited assurance being mandatory in many cases. Lastly, non-compliance consequences are murky.
These obstacles are creating both a reporting issue and a compliance problem for organizations, especially those who are just getting started.
There are five challenges, in particular, that stand out:
- New and underdeveloped framework. Since the regulation landscape is changing constantly, with new regulations replacing old ones, it's difficult for inexperienced teams to determine scope and jurisdiction.
- Data collection. Due to the new supply-chain-specific regulations, companies will be scrambling to collect data from third-party vendors. This data can be more of a challenge to collect, particularly as it gets further away.
- Certifications and validation. Additionally, this third-party data needs to be certified and accurate. This can be a challenge for companies as they have little experience executing these new processes.
- Compiling and reporting. This plethora of new data can become disparate and siloed both internally and externally, making the compilation of data difficult and nebulous.
- Workflow automation to support reporting and compliance. Companies already struggle with their reporting and compliance burden and, now, teams will require new checklists and automation to support this new initiative.
In order to navigate these challenges and comply with incoming ESG regulations, companies must act fast to operationalize a compliance program for reporting.
Starting the compliance journey
As companies begin structuring — or in some cases, restructuring — their compliance efforts to follow the new rules, there are three important steps to take:
First, they need to determine whether or not their current compliance function is truly prepared to cover a wide variety of ESG reporting demands. Auditing existing processes and workflows will ensure alignment with regulations and standards while also streamlining and driving overarching strategy. This is an important foundational step that is often missed.
Second, they should begin building out an ESG reporting unit, including developing frameworks, collecting data, achieving certifications and verifications, reporting, and hiring. Specifically, they should consider whether or not the organization needs to recruit new talent or train existing talent. They should ensure that whatever staff they hire have the appropriate ESG literacy, as many compliance program professionals score poorly in financial literacy.
Lastly, they should make sure they provide their team with the right tools and resources to support an effective ESG compliance program. With staff shortages and technical literacy challenges, teams are already struggling. Ensuring teams have the right compliance tools that minimize work, ensure accuracy, and provide clear visibility into work is key. This will make a compliance program nimble and agile to face ever-developing regulations.
Creating an ESG-compliant future
The growing importance of ESG reporting and the implementation of new regulations, such as the CSRD and potential SEC rules, signify a pivotal moment for businesses worldwide. In order to see success in this changing landscape, companies must carefully navigate compliance and ensure they have the right teams and tools to navigate this shifting environment.
Embracing these steps will not only ensure regulatory compliance but also pave the way for a more sustainable and responsible future in finance and accounting.
