Disclosing ESG is one thing, operationally integrating sustainability to drive business transformation is another

Rarely a day goes by without the financial news reporting adverse reactions from businesses, investor groups, trade associations, lobbyists, think tanks and politicians around the world to requirements for business entities to file reports disclosing the extent to which their activities affect—or will affect – environmental, social and governance (ESG) issues in the national or global economic landscape.

Perhaps such sentiments are now strongest in the US following the issuance by the Securities and Exchange Commission (SEC) in March and May of this year of two sets of draft regulations for publicly held corporations and investment funds, respectively, for mandatory disclosure of the impact of ESG from their business operations. Of course, this phenomenon is not unique to the United States. Similar concerns are expressed by similar groups in Canada, Europe, the United Kingdom, Australia and many other places.

This is hardly unexpected. After all, these countries are generally anathema to such government requirements, insofar as they believe that reporting such actions (or inactions)—to the extent that they are judged to undermine the fulfillment of ESG objectives or contradict ESG principles— may adversely affect the profitability of their engagements with investors, customers, suppliers, employees, business partners and other stakeholders on whom they rely for their business.

From the public outcry over ESG reporting and disclosure requirements, it is fair to say that such outcomes are assumed to be prevalent.

But the reverse can also be true: government-required disclosures by companies whose activities are consistent with ESG goals and principles would likely win the market from investors, customers, suppliers and the like. The bet, of course, is that the probability of such a turn of events is considered much lower than the flip side.

This raises two fundamental principles about the course of action that underlies the rationale for pursuing government-mandated ESG reporting and disclosure requirements.

First, there is a presumption that the imposition of such requirements will in itself create the necessary incentives for the desired changes in the behavior of firms in the field of environmental and social management.

Of course, such changes will rarely, if ever, manifest themselves in the short term within a modern business; in fact, they tend to be complex, convoluted, and multifaceted endeavors. The process is evolutionary rather than revolutionary, especially in large multinational enterprises and especially those that provide multiple products or services.

But the central point is this: whatever reporting obligations are accepted, there is a strong belief—almost fervor—that mandatory disclosures and the reports they generate are themselves agents directly propagating fundamental business transformation resulting in increased corporate sustainability. After all, this seems to be the raisin of demanding such disclosures.

Yet, even if this line of reasoning becomes reality, the key takeaway is that mandatory ESG reporting and disclosure are simply NOT substitutes for both embracing and actualizing sustainability in business operations. Sustainability is a market action; is not a reporting action. In my view, within the many discussions about the pursuit of mandatory ESG disclosures among business associations, politicians, regulators, standard setters, activists – and even in the business literature – this equivalence is assumed.

To be frank, any back-slapping, hugging and hand-wringing among ESG advocates caused by such disclosure requirements becoming the rule of the day is misplaced – no matter how good they feel. This no mean that such requirements are not stable targets. Indeed, they must be prosecuted. However, this means that they are at best intermediate step to make sustainability practices an integral part of business operations. And many things can happen along the way to thwart such a departure from reality.

Second, is it not out of the question to believe that in some cases ESG disclosure commitments it is required to be reported by businesses, may already be found to be in the best long-term commercial and social interests of firms, investors, ‘workers’, ‘consumers’ and society?

Put another way, what should be the public policy position that requires ESG disclosure even in cases where businesses already undertake such reporting and disclosure voluntarily or unilaterally— which regulatory mandates lack — and whose market operations are already imbued with sustainability practices?

Arguably, the existence of such cases—which in some sectors are likely to be more pronounced than in others—means that government regulation of mandatory ESG reporting and disclosure should not be monolithic or one-size-fits-all. At the same time, government officials may wish to give due recognition to such cases so that counterparties in this sector or firms in different sectors can learn how best practice is implemented to achieve operational sustainability.

It is hard to overstate this point. It should not be seen as a heroic feat – nor naive – for the C-suite and boardroom of the modern corporation to fully embrace and execute sustainability as the core, perhaps the coreoperational mandate of the business for which they are responsible.

What does this mean in practice? As I have argued previously in this space, the pursuit of corporate sustainability implies entrepreneurship operative decisions which underpin the day-to-day functions of the business which, taken togetherserve to maximize business long term growth as well as evaluating theirs impacts on the firm’s long-term performance across a range of dimensions, both financial and non-financial.

The emphasis on which is placed taken together and long run is key. The companies that are most effective in operating sustainably are those that consistently and consistently make their decisions so as to maximize long-term commercial results and non-economic – that is, ESG-related – returns from the use of their assets, both human and non-human.

There is a big problem here – especially in the case of the US. Our prevailing market policies, institutions and expectations are embedded in the ‘short term’. The SEC’s quarterly financial reporting requirements create powerful incentives for myopia in business strategy and shareholder expectations. Absent the change on this scene that many of us are calling for, the momentum to overcome and embrace a long-term time horizon is both entrenched and awesome.

If you accept these propositions, two key insights should jump out.

First, successfully achieving ESG and sustainability goals requires a fundamental understanding of what ESG and sustainability are not only matters of engaging in risk mitigation, but also of pursuing growth maximization. In short, corporate executives, board directors and investors need to think of ESG and sustainability initiatives as opening new doors to opportunities for business growth, not as restrictions to be observed with as little effort as is necessary to fulfill them.

Second, a true embrace of sustainability means that C-suites and boards fulfill their missions through integrative a lens that cuts across core business functions; its markets, both on the input side and on the output side; and its geographic footprint. Thus, a firm’s Chief Sustainability Officer (CSO) should be located in C-apartment and his/her role should be really a globally integrated one—in every sense of the word: across product and raw material markets as well as across geographic markets. It’s not too far-fetched to think of the CSO’s role as a “chief integrator.”

Such should be the role of boards Sustainability committees, which, unfortunately, are perceived as novelties in the boardroom. Indeed, we in the US are a long way (very far, in fact) from requiring the SEC’s boards of public companies to have directors who are “qualified sustainability experts,” much like the SEC’s rule that boards have “qualified financial experts” created by The Sarbanes Oxley statute emerged from the financial crisis of 2007-8. Although it may seem unusual for US securities law to develop mandates for non-financial experts on boards, we may soon see one for cyber security.

The SEC’s proposed regulations for ESG reporting and disclosure by public companies and investment funds represent a watershed moment for the growing importance of sustainability in American business and markets.

But as significant as this development is for the world’s largest economy, it is really only the beginning of a long list of critical elements of the sustainability agenda that the US and other advanced countries must address:

· ESG reporting and disclosure are not substitutes for businesses engaging in meaningful action to improve the sustainability of their operations through enterprise transformation.

· At the same time, harmonization of the different sets of existing sustainability standards and reporting requirements around the world is becoming urgent.

· So is the need for executives and boards of directors to modify the systemic integration of financial and “non-financial” metrics and business performance – each of which is equally important to the bloodstream of the modern corporation and the ecosystem in which it operates.

· Equally critical is the global development and education of qualified professionals who are experts in monitoring and evaluating business progress in increasing sustainability, whose skills differ significantly from conducting financial audits, which focus on retrospective assessments, while progress in achieving sustainability is both retrospective and forward-looking and inherently interdisciplinary.

· The need for an impartial forum to promote the exchange of ideas, learning from each other and building consensus on ways to accomplish common critical tasks.

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