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The dynamic change sweeping through Environmental, Social, and Governance (ESG) means that even on governance – a well-established aspect of corporate life – a new era is emerging. New regulations require higher standards of governance for almost all companies, not just those listed on public markets.
While we often see new regulatory burdens, ESG is increasingly ‘shining a light’ on the governance ‘trifactor’ of transparency, monitoring, and communication. Strategic forward planning is becoming increasingly important. The incoming CSRD changes in Europe are a reminder that re-engineering governance should be high on the corporate agenda.
Covering new ground
As an example of the new governance context, CSRD introduces more detailed reporting requirements on the environmental impact and societal and human rights from 2024 onwards. Sustainability reporting appears to have been put on an equal footing with financial reports, with a focus on consistency and comparability that aims to end greenwashing. Current EU non-financial reporting rules apply to a mere 11,700 companies; with CSRD, this will catapult to almost 50,000 companies.
To meet these new expectations, a far clearer and more thorough picture of operations must be brought into governance scrutiny. For example, on supply chains, most firms today have only a partial view of upstream and downstream activities. This is no longer sufficient: a new risk management approach is needed and, while governance doesn’t present the value creation opportunities available in environmental or social areas, it is an enabler for these opportunities.
Transparency: operational clarity
In the governance trifactor, transparency has a new meaning today. Companies need to ensure visibility throughout their supply chains, not just their Tier 1s. As we explored in our article focusing on the social pillar, awareness of any negative social impacts at any stage of the supply chain requires action.
Supply chain mapping is therefore essential to be able to detect all critical risks. An ESG supplier map guides transparent work, identifying high-risk suppliers further along the chain than Tier 1 – for example, regions where animal welfare standards are lower, where corruption is more widespread, or where human rights violations occur. Supplier relationships become much more important, including elements such as payment practices and the supplier’s worker protections.
The next step is to build the ESG dimension into supplier visits. This must take place with Tier 1 suppliers but also ideally beyond and below this tier – at least for suppliers deemed to be a higher risk – ensuring that priorities move beyond the traditional focus of quality, costs, and delivery performance.
Monitoring: Review and act
With greater transparency, monitoring almost naturally becomes far more effective – although careful KPI creation is needed to ensure that robust, actionable ESG information is captured.
Are your KPIs really measuring what you need to know? And what are the tools, sources, and methods you need to effectively collect environmental and social performance?
Multi-stakeholder materiality analysis helps structure and target KPI definition; for example, determining where publicly available information stands up or where structured interviews are needed. The value creation opportunity here is to identify and mitigate risk through robust assessment, from timing, severity, and likelihood scoring through to priority questions focused on operational activity such as:
- How does the risk impact operational efficiency?
- How does the risk impact continuity?
- How significant and how likely is the risk and the potential knock-on effects to our partners?
Communication: Re-write your reporting routines
By its nature, non-financial reporting has communication at its core. Historically this has been one-dimensional and mandatory.
An emerging communications challenge from CSRD is the need for comprehensive and accessible reporting on standardised, pre-defined topics – in addition to existing regulatory frameworks and standards that companies must comply with to do business. In the EU, REACH or Use of Conflict Materials regulation are just two examples.
Tackling the communications challenge will involve tracking and avoiding potential duplication and over-response in information gathering and reporting. Critically, however, businesses must deeply consider how they are telling their ESG story, how they are mobilising and engaging their employees around the huge ESG effort that is required, and how they are convincing external stakeholders of the credibility of their corporate action.
In essence, a shift is needed far beyond box-ticking or top-level statement making: you need to think about your storytelling strategy and associated capabilities.
Get to grips with governance
New and updated approaches to governance will affect a growing number of companies around the world. For firms based in the EU, or with operations in the EU, our AlixPartners analysis of CSRD readiness shows that many industries are far behind where they should be today and will likely face many challenges in their preparations as the CSRD directive comes into force.
Assessing the steps to take on transparency, monitoring and communication requires a fundamental shift in the organisational structure of businesses and we see these needs continuing to evolve throughout the remainder of this decade, in order to ensure companies are ‘fighting fit’ for the new ESG era and rapidly evolving regulatory landscape.
You can also read earlier articles from this series below:
