Environmental, Social, and Governance (ESG) issues are impacting increasingly on corporate governance agendas. The EU has been particularly active in this area. The pressures are not all positive. In recent times, there have been attempts to downgrade ESG issues. Both former US Vice-President Mike Pence and business magnate Elon Musk have made negative statements about ESG. This blog looks at both the negative comments and the positive developments on the ESG front.
What are the emerging ESG issues?
Environmental, Social and Governance (ESG) are issues that affect the sustainability of companies. Traditionally companies focused on profits. In recent years, however, ESG criteria were beginning to impact on companies’ agendas. These criteria were an addition to traditional financial criteria. with separate characteristics:
- Environmental criteria look to examine how companies respond to environmental challenges. These challenges include climate change, pollution, and greenhouse gas emissions.
- Social criteria look at how companies treat people. These criteria embrace human capital management, health & safety, work conditions, diversity, and equal opportunities, and
- Governance criteria have regard to the way companies are governed. These criteria embrace pay and remuneration, tax practices and strategy, corruption and bribery, and board diversity and structure.
The EU has recently been active on the ESG front. Last February, the European Commission adopted a proposal for a Directive on what it calls ‘corporate sustainability due diligence.’ This proposal aims to foster sustainable and responsible corporate behaviour throughout global value chains. At the launch of the proposal, the European Commission pointed out that companies – “… will be required to identify and, where necessary, prevent, end, or mitigate adverse impacts of their activities on human rights, such as child labour and exploitation of workers, and on the environment, for example pollution and biodiversity loss.”
The new Directive, once adopted, will apply:
- To all large private companies with over five hundred employees and €150 million turnover in the EU, and
- Two years later companies with over 250 employees, €40 million turnover and with at least 50% of this generated from operations in high-impact sectors, such as manufacturing of food and textiles, wholesale of agricultural raw materials and live animals, extraction of minerals and others, will be expected to adopt the new rules
- However, the due diligence obligations will not apply to Small and Medium-sized Enterprises (SMEs).
Box 1 shows the likely impact of the forthcoming EU legislation on large companies.
At the launch of the EU initiative, Věra Jourová, European Commission Vice-President for Values and Transparency, said: “This proposal aims to achieve two goals. First, to address consumers’ concerns who do not want to buy products that are made with the involvement of forced labour or that destroy the environment, for instance. Second, to support business by providing legal certainty about their obligations in the Single Market. This law will project European values on the value chains and will do so in a fair and proportionate way.”
The EU proposal will next come before the European Parliament and then to the European Council. Once adopted, Member States will have two years to transpose the Directive into national law and communicate the relevant texts to the Commission.
Impact of the EU Directive on Ireland
The draft EU legislation on corporate sustainability due diligence will not apply to SMEs. To that extent, if the Directive is adopted by the EU, it will only apply to a small number of companies in Ireland, given that over 99 percent of all enterprises in Ireland fall within the SME bracket, according to the CSO. Although SMEs will not fall under the scope of the Directive, it will have an impact on SMEs. In this regard, Níall Fitzgerald FCA, Head of Corporate Governance & Ethics at Chartered Accountants Ireland, has pointed out that – “… the Directive does provide for supporting measures for those likely to be indirectly affected as part of the supply chains of larger companies, for example a requirement for a larger company to bear the cost of any third-party assurance required from a SME to verify compliance with its code of conduct or measures to prevent adverse human rights or environmental impacts in its supply chain”. https://www.charteredaccountants.ie/Governance/Home/eu-proposal-for-new-directors-duties-and-rules-on-corporate-sustainability-due-diligence
It seems clear that Ireland’s SMEs will be indirectly affected by the new rules because of the effect of large companies’ actions across value chains. Accordingly, the EU sees need for specific support to be provided for SMEs. The briefing referred to – “…guidance and other tools to help them gradually integrate sustainability considerations in their business operations.” In addition, EU Member States will be required to provide further technical support and may even have to provide financial support to SMEs to facilitate adaptation.
Regulated financial services providers in Ireland have already been reminded of their ESG responsibilities. Specifically, Governor Gabriel Makhlouf wrote to them on 3 November 2021 to highlight the statutory obligations and related supervisory expectations relating to climate and sustainability issues.
Pushback on ESG Policies
However, there is evidence of a pushback against the inclusion of ESG criteria in the range of responsibilities of company boards. Two influential voices have recently made negative comments.
Firstly, the former US Vice President Mike Pence looked for a reining-in of ESG, in a speech about energy policy in Texas on 10 May 2022. According to the Los Angeles Times, Pence – “criticized investor-activist campaigns to force companies such as Exxon Mobil Corp. to follow socially conscious investing principles, saying they elevate left-wing goals over the interests of businesses and their employees.”
Secondly, Elon Musk of Tesla pulled no punches in a recent tweet regarding ESG. His full tweet is in Box 2.
ESG is not a political football to be kicked around the political spectrum. The focus needs to be on how individual companies implement the criteria. While the forthcoming EU legislation will not impact immediately on companies in Ireland, they will have an impact in the future. Accordingly, it makes sense that Irish companies, regardless of size, now examine what the implications of ESG criteria are for them.
Tom Ferris, Consultant Economist.
Tom Ferris is a Consultant Economist specialising in Better Regulation. He lectures on a number of PAI courses and blogs regularly for PAI. He was formerly the Senior Economist at the Department of Transport, Ireland.