Due Diligence For Third Party Environmental Impacts

As environmental, social, and governance regulation is becoming a standard requirement--not only from government regulation but from shareholder representations, businesses need to think more about how they are incorporating it into their strategies. However, only 5% of the UK’s largest companies have published a ‘credible’ environmental plan that would comply with forthcoming regulations, according to a new report. This stark statistic shows the difficulties facing compliance officers seeking to assess the ESG impact of third parties and suppliers.

In this blog, we look at the regulatory requirements around environmental disclosures and explore three ways companies can overcome the challenge by improving their due diligence–with help from Nexis® Solutions.

New regulatory requirements on companies around environmental disclosures

Among the UK government’s announcements during the United Nations’ COP26 climate summit in November 2021 was a forthcoming piece of regulation around environmental compliance. It said that major UK companies would soon be required to publish plans for how they would “decarbonize” their activities. A Taskforce was set up and draft has since been published listing standards around environmental disclosures that firms will have to meet. The guidance is expected to be finalized this year, and the regulation to come into force soon. Moreover, the Financial Conduct Authority said in February that financial firms and listed companies should draw up their plans to transition to net zero even before the rules have been finalized.

Yet a recent review of companies’ activities by EY claimed that only 5% of FTSE 100 firms have published net zero plans that would be deemed “credible” under the government’s guidance. 78% of these companies have published partially developed plans that don’t yet address certain key requirements. By contrast, 80% of FTSE 100 firms have committed to becoming “Net Zero” by 2050. Although companies still have time until the regulation comes into force, this should remind compliance officers that there is often a gap between stated commitments and the actual data.

MORE: The US Foreign Corrupt Practices Act: What it means for your business

The challenges of ‘greenwashing’ and ESG assessments

The EY report illustrates one of the major challenges facing compliance officers today. They face ever-growing expectations to monitor and understand the environmental impact of their company and its clients and third parties. But while many companies have made ambitious commitments to reduce their environmental impact, it is more difficult to find concrete evidence of their real ESG record.

A related challenge is the rise of “greenwashing”, in which claims by investment funds to be environmentally sustainable have turned out to be false. This makes it difficult for compliance officers to accurately assess claims around ESG impact. The problem is such that most investors are now skeptical of companies’ environmental claims–a 2021 survey by PwC found that 87% of investors “suspect that corporate disclosures contain some greenwashing”.

Investors are increasingly moving their money away from companies which cannot demonstrate an understanding of their impact on the environment and other ESG factors. For example, in February 2023 the UK’s Local Authority Pension Fund Forum (which comprises 86 public sector pension funds) wrote to FTSE 100 companies calling for “disclosure of robust transition plans, and governance and accountability mechanisms that support their delivery”.

MORE: How to deal with negative ESG news coverage

Taskforce reflects a wider trend towards climate-related regulations

The UK government’s regulatory intervention is part of a wider global trend towards mandatory ESG due diligence and reporting. This adds an extra layer of legal risk to the existing reputational, financial and strategic risks of failing to understand ESG impacts of a company and its third parties. For example:

• Banks in Hong Kong must ensure they meet certain requirements for managing climate risk and make appropriate disclosures on their activity to the regulators, following a regulation which came into force in December 2022.
• The US Securities and Exchange Commission recently created a Climate and ESG Task Force within its enforcement division to identify ESG-related misconduct by companies.
• EU countries will have to introduce mandatory human rights and environmental due diligence legislation to comply with the forthcoming Corporate Sustainability Due Diligence Directive. Germany’s Supply Chain Due Diligence Act is an early example of legislation requiring companies to publish information on certain ESG-related activities, which came into force in early 2023.

As a result, we expect to see more examples of enforcement action against companies which fail to disclose their environmental impacts or carry out effective ESG due diligence. For example, in November 2022 a financial services company in the US received a penalty of $4 million to settle claims that it did not sufficiently assess ESG factors in some of the investment products it offered.

MORE: The global impact of ESG legislation

Three tips for identifying and mitigating ESG risks

How can compliance officers confront this twin challenge of greenwashing and expanding regulation? Three best practices around due diligence stand out:

1. Consider ESG screening a necessity: Companies can no longer treat environmental (and ESG) impacts as a “nice to have” in their due diligence approach. ESG should now be a core consideration of whether or not to do business with a third party. This is often a regulatory requirement, but even if it isn’t then demonstrating an understanding of ESG impacts can give firms a competitive advantage.
2. Get the right data: The move towards regulators mandating statements by companies on their ESG record and plan (like that required by the UK’s new Taskforce), will provide more evidence against which compliance officers can assess companies’ environmental records. But companies should also ensure they screen third parties against a wide range of other data sources for keywords like ‘environment’, ‘carbon’ and ‘pollution’. For example, news data can surface statements made about companies or claims about their environmental impact which do not appear in an annual report or regulatory disclosure.
3. Leverage technology: It is almost impossible to sift through vast datasets of news, company and legal sources manually. Instead, companies should use technology platforms which allow them to automatically screen a high volume of entities against a wide range of authoritative sources in one place. Artificial Intelligence applications also allow companies to detect new risks.

MORE: Stop the risk: Asking the right questions for complete due diligence

Assess ESG claims with data and technology from Nexis® Solutions

Effective due diligence is key to understanding a company’s true ESG impact. Nexis Solutions helps firms to implement a more efficient and effective due diligence process to identify and mitigate ESG risks by providing companies with authoritative data from the most relevant sources, including:

• News data to identify reputational risk of third parties.
• PEPs and sanctions data to identify third parties which may require enhanced due diligence.
• Extensive ESG categorization and tagging to effectively evaluate and navigate the vast universe of content on ESG related topics
• ESG ratings data to assess third parties’ compliance with growing expectations from regulators and the public around human rights and environmental due diligence.
• Company data to help to build a picture of a company’s structure, directors and beneficial owners.

We support firms to deploy technology across these sources to improve their approach to due diligence and risk management. For example:

• Nexis Diligence+™ supports an effective due diligence process with our extensive archives and news searches going back more than 40 years.
• Nexis® Data+delivers an unrivalled collection of licensed and web content, deep archives and data, through our flexible data API.

Don't neglect your ESG due diligence, and request a trial today.