Why U.S. Businesses Should Prioritize ESG in 2024 — and How to Get it Done

INTRODUCTION

In the current landscape of societal divisions U.S. businesses find themselves caught between the gravitational pull of opposing forces. On the one hand, the need to address critical issues like inequality and the objectively troubling deterioration of the environment has led to growing calls for increased activities and reporting around Environmental, Social, and Governance (ESG) principles. On the other hand, there is a growing aura of skepticism. Nevertheless, the impending regulatory landscape and escalating consumer and investor interest underscore the significance of ESG initiatives. Projections indicate a substantial increase in institutional investments focusing on ESG, reflecting a broader trend toward sustainable practices.

Significant new regulations and reporting requirements are fast approaching for U.S. entities, and the underlying sense of urgency is only heightened by the rapidly growing popularity of sustainable business models among both consumers and investors. ESG-focused institutional investments are projected to soar by as much as 84% by 2026, with 85% of global investors believing that ESG work is not only necessary but leads to "better returns, resilient portfolios, and enhanced fundamental analysis," according to a recent survey published by Bloomberg Intelligence.

In this white paper, we'll take a more in-depth look at exactly why U.S. business leaders and investors should be approaching ESG work with an increased sense of urgency in 2024, including the rise in ESG-related regulations and reporting requirements, as well as a continuously growing demand for more sustainable, socially conscious business practices from both consumers and larger partners and investment firms. Additionally, we'll lay out some specific steps that businesses can take to establish and reach their goals, particularly those that may be just getting started on their ESG journey.

AN EVER-EXPANDING REGULATORY LANDSCAPE

While still relatively new and constantly evolving, there have been a number of strict and sprawling ESG-related regulations emerging in recent years, virtually all of which will have an impact on most businesses based or doing business in their corresponding regions. This is particularly true in the EU, where fine-tuned environmental impact and reporting requirements will begin to be enforceable as early as this year. More specifically, the EU's Corporate Sustainability Reporting Directive (CSRD) represents the most significant set of non-financial reporting requirements introduced for businesses to date. An expansion of the existing Non-Financial Reporting Directive (NFRD), the CSRD aims to "ensure that investors and other stakeholders have access to the information they need to assess the impact of companies on people and the environment and for investors to assess financial risks and opportunities arising from climate change and other sustainability issues." According to the new rules, more than 50,000 business entities, including both large corporations and some small and medium-sized enterprises (SMEs), will need to begin reporting (and verifying) information related to environmental impacts, social issues in the workplace, human rights, corruption, and boardroom diversity.

Officially passed in 2023, the CSRD's new rules have already become enforceable for large public interest entities (PIEs) with over 500 employees as of January 2024 and will extend to all other PIEs in 2025 and impact publicly listed SMEs in 2026 - across the entire EU. The rule applies to companies even if the parent company is not EU-domiciled. The parent-level reporting might not kick in until as late as 2028 but the sub will have to report as early as next year. Moreover, CSRD reporting has also become mandatory for businesses in the UK, who also must comply with standards outlined in the recently disbanded Task Force on Climate-Related Disclosures (TCFD), the continued oversight of which will be managed by the International Financial Reporting Standards Foundation (IFRS). But the U.S. may also not be as far behind as previously thought, and in fact, there have been many regulatory developments to emerge at both the federal and state levels in just the past year, indicating the introduction and enforcement of more comprehensive ESG-related regulations akin to those mentioned above.

For example, last October the U.S. federal government finalized its new Principles for Climate-Related Financial Risk Management for Large Financial Institutions, which encourage the disclosure of information related to carbon emissions to potential lenders: the principles are intended to support efforts by financial institutions to focus on key aspects of climate-related financial risk management. The principles cover six areas: governance; policies, procedures, and limits; strategic planning; risk management; data, risk measurement, and reporting; and scenario analysis. The principles also describe how climate-related financial risks can be addressed in other risk categories including credit, liquidity, other financial risk, operational, legal, compliance, and other nonfinancial risk.

On March 6, 2024, the Securities and Exchange Commission (SEC) implemented long-awaited regulations aimed at improving how public companies communicate information regarding climate-related concerns. The rules will require disclosures in registration statements and periodic reports, such as Form 10-K for domestic issuers and Form 20-F for foreign private issuers, and encompass disclosures concerning the risks associated with climate issues and how companies manage these risks. They also cover the governance practices of boards and management in relation to such risks. Furthermore, the rules call for the disclosure of financial impacts stemming from severe weather events and other natural occurrences in the audited financial reports. Larger companies will additionally need to disclose details regarding their greenhouse gas emissions, with a gradual introduction of assurance requirements for this information.[1]

At the state level, California also recently made waves with its passing of new climate legislation SB 253 and SB 261 in late 2023, which will impose companies doing business in the state to begin disclosing information related to greenhouse gas emissions and other climate-related risks by 2026 as part of their annual reporting.

Of course, these developments represent only the beginning of strict ESG-related regulations and reporting requirements for U.S. entities, and investors and business leaders in the states would be wise to recognize the parallels between the new climate reporting rule and the introduction of the Sarbanes-Oxley Act (SOX) of 2002, which significantly increased the financial reporting burden on publicly traded companies and at no small cost. In other words, now is the time to reflect on the impact of SOX and any missteps made in the process of meeting compliance, and the takeaways from such a reflection should be used toward the integration of ESG-related reporting standards — such as those laid out by the IFRS — into existing processes and strategies.

UNPACKING SEC CLIMATE RULES

The new SEC rules mandate disclosures in registration statements and periodic reports, including Form 10-K and Form 20-F, focusing primarily on the impact of climate-related risks on business strategies and operations. Pursuant to Exchange Act Section 25(c)(2) and Administrative Procedure Act Section 705, the Final Rules are currently (since April 4, 2024) stayed pending the completion of judicial review of the consolidated Eighth Circuit petitions[2]. The stay highlights the controversial nature of SEC efforts for climate disclosure. Given the amount and depth of final regulatory climate disclosures in Europe, the Final Rules are unlikely to be substantially revised, moreover suspended companies in scope should take notice and get ready for compliance:

• The rules draw from the Task Force on Climate-related Financial Disclosures (TCFD) framework but do not include equivalency provisions for disclosures under other frameworks, requiring companies to adhere strictly to the SEC's guidelines.
• Disclosures must detail both actual and potential impacts of climate-related physical and transition risks, specifying the geographical areas of assets and operations affected and whether these risks are short or long-term.
• Companies are asked to describe management's role and the board's oversight in assessing and managing climate-related risks, but they no longer need to disclose directors' specific climate-related expertise.
• The rules simplify the requirements for describing processes for identifying and managing climate risks, moving towards a principles-based approach for transition plans.
• Disclosures related to climate-related targets or goals will now include material expenditures and impacts on financial estimates, but with a focus on materiality to reduce the burden of reporting.
• Greenhouse gas (GHG) emissions disclosures (Scope 1 and 2) are necessary for larger companies, with specific methodological details needed; Scope 3 emissions disclosure has been removed.
• The attestation of GHG emissions for large, accelerated filters will phase in, starting with limited assurance and progressing to reasonable assurance over several years.
• Financial statement effects from climate-related events must be disclosed if they meet specified thresholds relative to equity or pre-tax income, with detailed reporting of impacts from severe weather and other natural conditions.
• The rules introduce requirements for tagging financial data with inline XBRL, with compliance dates starting in 2026 for large filers and 2027 for others, highlighting the ongoing adjustments companies must make to meet these new standards.

GROWING DEMAND AND INCENTIVES FOR ACTION

Beyond regulatory and compliance concerns, there is a growing number of reasons why U.S. businesses and investors should be prioritizing their efforts toward ESG-related reporting and sustainable business practices.

First, the rising demand among consumers across the globe for more sustainable, ESG-conscious brands and products has become clear in recent years. In fact, according to a 2021 survey by The Economist, global consumers largely attribute as much responsibility to brands as they do to governments when it comes to fighting climate change, and online searches for sustainable products have seen a 71% increase over the past five years. This corresponds with a more recent study published by McKinsey, which revealed a "clear and material link between ESG-related claims and consumer spending," with differentiated growth being achieved by ESG-friendly brands of all sizes and across industries.

This is in addition to arguably the single most compelling reason why U.S. businesses need to increase their focus on ESG-related issues and practices: demand from institutional investors remains incredibly strong and is only expected to pick up steam in the coming years. More specifically, investments in sustainable brands represented nearly 13% of assets under management in the U.S. at the end of 2022 (around $8.4 trillion). And demand for sustainable investment opportunities is still outstripping supply, with close to 90% of institutional investors hoping for a near-term increase in the development of ESG-focused products.

There are also some less obvious yet equally compelling benefits to ramping up ESG-related efforts and outcomes, such as the fact that U.S. companies are increasingly tying executive compensation to ESG performance. In late 2022, Forbes reported on a survey which found that this practice is not only common but is utilized by "the vast majority of S&P 500 companies," with incentives disproportionately correlated with Diversity, Equity, and Inclusion (DEI), but also increasingly linked to a company's efforts toward reducing its carbon footprint and emissions. Critically, this is in addition to a more recent study, which found that nearly 40% of all companies globally are leveraging some variation of this incentive scheme to improve performance on ESG-related criteria.

Put simply, between managing compliance risk and boosting revenue and investment performance, there is currently no shortage of reasons for ESG transformation to be top-of-mind for U.S. businesses and investors in 2024. The only real question that remains, particularly for those who have fallen behind the curve in recent years, is exactly how to get it done.

GETTING STARTED WITH ESG

While we have frequently stressed the urgency with which ESG-related activities should be addressed throughout this paper, it's important to note that there is not a one-size-fits-all solution to improvement here. The truth is that different companies operating in different industries will have varying needs and requirements, and those just starting will be better off tackling ESG through strategic management of their expectations.

Here are three high-level tips to keep in mind when getting started on your ESG journey in 2024:

EVALUATE YOUR CURRENT PERFORMANCE

You can't make improvements without first knowing exactly where your organization stands in relation to each of the three ESG principles. For this reason, it's critical to begin with a comprehensive analysis of your current performance against expectations and benchmarks in all categories.

To do this, however, it's important to be familiar with existing ESG frameworks, including the Global Reporting Initiative, as well as standards laid out collectively by the TCFD and Sustainability Accounting Standards Board (SASB), under the management of the IFRS, the latter of which is not only instructive for preparatory compliance efforts, but which we expect will eventually be incorporated into U.S. reporting guidelines. Additionally, at some point, companies may need to consider assessing not only these direct impacts on you or impacts on your organizations that may exist within your supply chain, potentially severing ties with suppliers who may not be in alignment with your company's core values.

Plan Extensively Around Clear, Specific Goals.

Once you've uncovered your various strengths and weaknesses regarding environmental and social impacts, as well as governance policies and execution, you'll want to start developing a concrete plan that includes the identification of clear goals and a timeline for achieving them. Importantly, such a plan should involve the integration of ESG-related issues into your broader corporate strategy, but we also want to reiterate here that it's equally crucial to manage your expectations at this stage so as not to set yourself up for failure or make unreasonable promises to stakeholders.

Working directly with stakeholders, be they investors, employees, or customers, should also be a part of your initial performance evaluation and planning processes. Having serious, and even difficult conversations with those who matter most to your organization's future will help reveal areas that need improvement and will aid in the gradual refinement of your overall decision-making process.

INVEST IN INNOVATIVE ESG REPORTING TECHNOLOGIES AND EXPERT SUPPORT

Finally, one of the most beneficial decisions any organization can make is to take advantage of the increasing availability and advancing capabilities of ESG reporting technology, particularly those being offered alongside access to expert guidance in both ESG best practices and investor relations. One of the most common reasons that businesses today fail to implement ESG strategies is that it's often an incredibly costly, time-consuming, and resource-intensive process. However, as the additional cost of non-compliance looms considering new regulatory developments, many U.S.-based organizations and investors that continue to delay action are bound to find themselves in a lose-lose situation.

The good news is that solutions for streamlining your ESG planning and reporting initiatives are both cost-effective and readily available. More specifically, by leveraging advanced service providers that combine interactive software solutions with expert consulting, you can reduce or eliminate the inherent complexity that comes with developing and executing your ESG roadmap.

To put it into even further perspective, this means you'll be greatly simplifying the processes involved in both the evaluation and planning stages, in addition to acquiring a core solution to guide the execution of your overall strategy. This includes everything from the tracking of greenhouse gasses in compliance with SEC suggestions to the ability to identify and adopt the most relevant reporting standards to your business and even generate automated reports in alignment with those corresponding standards. Such capabilities not only make it easier for investors and other key stakeholders to learn about and verify your progress but also make your organization far better positioned to receive positive reviews from prominent ESG rating agencies.

CONCLUSION

In conclusion, now is the time for U.S. businesses to prioritize ESG. As highlighted throughout this paper, regulatory shifts, growing consumer and investor demand, and the potential for enhanced brand reputation underscore the importance of ESG integration. By evaluating current performance, setting clear goals, and implementing practical strategies, organizations can navigate the complex ESG landscape and emerge as leaders in sustainability.

As we embark on the journey towards a more sustainable future, let us seize the opportunity to embrace the ESG imperative and drive positive change for businesses, society, and the environment alike.

ABOUT B. RILEY ADVISORY SERVICES

B. Riley Advisory Services' ESG practice advises clients on a range of initiatives aimed at promoting sustainable practices, responsible investment, and positive impact. We work closely with our clients to integrate ESG considerations into their business strategies, risk management, and decision-making processes. Whether it's assessing environmental risks, evaluating social impact, or ensuring strong governance practices, our experienced team is committed to helping our clients drive meaningful change within and outside of their organizations.

B. Riley Advisory Services is an integral part of B. Riley Financial, a diversified financial services platform that delivers tailored solutions to meet the strategic, operational, and capital needs of its clients and partners. Through its affiliated subsidiaries, B. Riley provides end-to-end, collaborative financial services across investment banking, institutional brokerage, private wealth and investment management, financial consulting, corporate restructuring, operations management, risk and compliance, due diligence, forensic accounting, litigation support, appraisal and valuation, auction, and liquidation services. B. Riley does not offer legal advice and the content in this paper is not intended to serve as legal advice, any legal questions or legal decisions should be made with private legal counsel.

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