A Shifting Regulatory Landscape
What Companies Need to Know about Sustainability
How the New York Fashion Act, SEC Environmental Disclosures and IFRS Sustainability Standards are reshaping a new normal for environmental regulations
Some may hear the word sustainability and think it’s just another buzzword – a passing fad for an impractical ideal. Up until recently, they may have been right. Now, however, with investors and end-consumers placing ever-increasing importance on the sustainability track record of companies and investment funds, a new regulatory landscape is taking shape.
In response, companies will need to enable reporting by increasing the range and quality of their data infrastructures and altering their operational strategies to meet targets, or else risk potential penalties, public backlash and impaired investor relations.
What are the Real Market Pressures and Risks Involved?
Consumer Demand: The increase in droughts, floods and other climate change issues – combined with media coverage and scientific research supporting their connection to human activities – is causing a growing demand for sustainable practices by the public. Recent research indicates that globally 85% of people have shifted their purchase behavior towards being more sustainable in the last five years. This trend has increased the importance of sustainability in marketing while also building support for heftier fines and penalties. For companies who rely heavily on branding for product differentiation, brand damage caused by an investigation or penalty may end up more costly than the penalty itself. Industry leaders will need to alter their companies’ sustainable operations to meet evolving requirements or risk losing market share to competitors that more rapidly evolving their sustainability strategies.
Company Valuation: Regulatory bodies such as the U.S. Securities and Exchange Commission (SEC) and the International Financial Reporting Standards (IFRS) recognize that sustainable practices and strategies have a significant influence on a company’s valuation – both in terms of how climate change can play havoc with supply chains and distribution channels, and in terms of how unsustainable practices could reduce end-consumer demand and brand value. Annual statements will soon require extensive environmental disclosures that map out a company’s environmental impact, sustainability strategies and ongoing impact remediation efforts. Public companies will have to rapidly expand the quality and extent of their data measurement, or else risk non-compliance through insufficient transparency.
Investor Relations: Investors represent an overlap between the two market pressures we just covered. On one hand, they are swayed by the same considerations that are driving the sustainability push at the end-consumer level. On the other hand, investors are recognizing that corporations who are not taking sustainability seriously will soon face devaluation and risk non-compliance. Already, investors in public companies such as Shell and ExxonMobil are holding boards accountable by firing and/or suing board members for failing to meet sustainability targets. Corporate leadership will need to have effective strategies and solutions in place or risk board turnover, bad press and damaged investor relations.
Examples of Regulatory Landscape Changes
The planned passing of the New York Fashion Act and changes in SEC disclosures and IFRS rules provide solid examples of how the regulatory environment is shifting. Chart 1 below outlines the anticipated timeline for these examples.
The New York Fashion Act
Perhaps the most talked about new policy in the RFA industry right now is the New York Fashion Act, which many speculate will be voted on by the end of Summer 2022. This piece of state legislation targets global and domestic apparel and footwear companies with revenues over $100 million that do any business in the state of New York. It represents a significant departure from the norm because of its relatively specific criterion for required environmental practices, its steep proposed penalty of up to 2% of a company’s global revenues (with a cap of $450 million) and its publication of offenders in an annual report.
To put that into perspective, if the top five retail and apparel companies in the industry were to be charged to the full extent of the fines, they would each hit the $450 million cap.
SEC Environmental Disclosures
The recent uptick in environmental sustainability regulations is not limited to any one industry. In March 2022, the SEC made history by voting 3:1 in favor of new proposed rules that require publicly listed companies to add environment-related disclosers to their financial statements and registration documents. These include documentation of climate-related risks and impacts, metrics on Scope 1, 2 and 3 emissions, and models, outlooks and strategy changes caused by environmental factors like climate change.
While this decision is controversial, the SEC stresses that they are not trying to play the role of the United States Environmental Protection Agency (EPA). Instead, they are acknowledging the impact that a business’s response to environmental stressors will have on the company’s valuation.
IFRS & European Organizations
In many ways, international – particularly European – sustainability legislation can give us a glimpse of where US policies are heading. Many of these organizations are focusing on one of the most daunting tasks of environmental regulation: creating standardized and quantifiable metrics which can objectively measure environmental impacts. For the last decade, the European Commission has conducted industry pilots (PEF/OEF) to better define industry-specific environmental footprints. More recently, the IFRS has created the International Sustainability Standards Board, which plans to use existing research to establish and publish climate-related disclosure standards by mid-2022.
These new standards, which will create quantifiable benchmarks in a wide range of industries, will serve as the basis for regulatory compliance policies in the years to come. While standards evolve, indicators and drafted legislation can be used as the baseline for upcoming regulatory changes.
Exploring Sustainable Solutions
In terms of planning for the future, companies should realize these regulations are likely only the tip of the iceberg. As standards solidify, rulings will cascade from state to state and escalate to nations and global organizations. Sustainable solutions will become an increasingly vital part of corporate strategy. Leaders considering sustainable solutions will inexorably face two interdependent problems:
- Does my company have enough of the right metrics to meet disclosure requirements and establish the company’s goals?
- What does my company need to change to reduce its environmental footprint and meet regulatory standards and sustainability goals?
The answer to the first problem will be found in the assessment and establishment of data and technical architectures, while the answer to the second will be found by using new strategies and approaches to make ongoing operations more environmentally friendly.
Data & Technical Architecture Considerations
The first step companies should take is to understand the as-is state of their business. What data is already available? What data is still needed?
Once this information is known, companies can begin the process of developing standard data models that can be applied to an intersection of different regulatory requirements before they begin to explore solutions. Examples of this would be for companies to apply current ISA-95 data hierarchy structures consistently for the better enablement of greenhouse gas emission calculations.
Regardless of where a company focuses its sustainability strategy, improving enterprise data quality is a key foundational element for compliance. Data collection, analysis and reporting capabilities will mark the difference between a compliant, highly-regarded brand and one that cannot verify product lifecycle and production data related to sustainability targets. The quality of the data that underpins the reporting will be key to this effort. To better assure quality, companies seeking to take advantage of automated transaction processing and source data closer to the automation layer will be rewarded with more reliable data quality and less variation in reporting.
When considering the enterprise technology architecture, a convergence of Information Technology/Operational Technology (IT/OT) will empower some brands to launch forward into advances like emissions prediction and closed-loop controls while others trudge through manual collection and reporting. This means companies that have sorted their Industrial IoT backbone infrastructure and associated sustainability and energy management application suite will benefit from having the data hierarchy embedded across the IT/OT landscape. This allows for a smoother integration, enabling seamless reporting and providing a foundation to optimize through applied machine learning control and artificial intelligence.
Each enterprise affected by sustainability regulations will craft its own unique solution; however, the most successful approaches will integrate into operational strategy.
One example of strong sustainability and operations overlap is in energy management. Energy management involves using effective strategies and digital technologies to improve bottom-line performance and achieve sustainability goals through connected energy operations, smart facilities and product innovation. Successful program roadmaps not only work towards emission reduction goals, but also reduce operational costs through more efficient energy use.
On a more macro level, companies should reconsider standard disciplines like supply chain through a sustainability lens. Aspects of supply chain include:
- Planning and inventory management
- Product innovation and development
- Manufacturing and order management
- Distribution logistics and networks
Each impacts the sustainability of an organization. In addition to targeting performance optimization for the objectives of financial outcomes, companies should challenge themselves to consider sustainability objectives such as a reduced carbon footprint. Often, we have found that these objectives are complimentary, rather than conflicting.
The Time for Action is Now
Assuming these regulations are enacted, companies will have to reach regulatory compliance in the next two to three years. Like a runner starting a 100-meter dash 2-seconds late, companies who haven’t yet started building out an effective sustainability data, technology architecture and operations infrastructure will need to work hard to catch up or be left behind. A sustainable future is no longer some far-distant goal. The establishment of its foundations are being fostered now. It’s time to put on a burst of extra speed to become a market leader in practical sustainable solutions.