An accelerating focus on doing business responsibly will force changes to wide-ranging aspects of business operations and strategy
Societal expectations of businesses have shifted fundamentally over the past five years. These new expectations for how businesses relate to people and the planet will be reinforced and accentuated in the years ahead through voluntary, legislative and regulatory measures in jurisdictions across the globe. Businesses have long owed a legal duty of care to their shareholders, but societal perceptions of their responsibilities have expanded beyond the maximization of shareholder returns and to include a wide range of stakeholders. While perceptions and expectations have been changing gradually, recent developments are accelerating and formalizing these new relationships between business and society.
Factors shaping the trend
This transformation began in response to growing consumer expectations that businesses have obligations to local, national and global communities. While some businesses have long embraced these obligations, only more recently have markets and regulators begun to transform these expectations into legal obligations for all businesses. Today, while publicly traded companies continue to owe primary fiduciary duties to shareholders, they also face a growing array of formal obligations regarding their impacts on society and the environment.
The formalization of these expectations through regulatory commitments includes both due diligence obligations—notably, expanded corporate risk assessment—and transparency obligations—notably, both voluntary and mandatory disclosures. These new expectations and obligations overlap with risks related to environmental, social and governance (ESG) issues but are broader, with far-reaching implications for business strategy and operation.
Many of these obligations are based on the principle of double materiality, which requires businesses to consider both how ESG issues may affect their financial performance and the impact their business operations may have on people and the environment. These new obligations often require businesses to contemplate, and even assume responsibility for, impacts that reach across the value chain, including their own direct actions (Scope 1) and their indirect actions both up (Scope 2) and throughout (Scope 3) the value chain. Ultimately, this drive toward responsible business involves a fundamental transformation of a business organization's identity, duties and purposes. Beyond government regulation, access to capital is being reshaped as banks and investors focus more on financed emissions, and opportunities arise that align with climate and energy transitions goals.
Key regulatory developments
The European Union (EU) has taken the lead in formalizing new compliance obligations driving responsible business, largely as part of its Green New Deal. New EU regulations have an outsized impact and extra-jurisdictional reach, altering both the due diligence and reporting obligations of EU firms and many of those that market products and services in, or seek access to, the EU market. Other jurisdictions (including the US) are following suit in their own ways by expanding due diligence and transparency obligations of covered business enterprises.
EU Sustainable Finance Disclosure Regulation (SFDR)
As of 2021, the SFDR has sought to reorient financial flows toward more sustainable growth consistent with Europe's Green New Deal. The regulations mandate large financial institutions in the EU, including asset managers and investment advisors, to provide sustainability-related disclosures for financial products. More specifically, the SFDR requires disclosure of adverse sustainability impacts of investment decisions and disclosure of how sustainability-related events could materially impact investments. Heightened disclosures apply for financial products that market themselves as sustainable investments.
EU Corporate Sustainability Reporting Directive (CSRD)
The CSRD, adopted in 2023, requires certain companies that fall within its scope—large EU public companies and smaller EU public companies listed in EU exchanges, as well as non-EU parent companies with large EU-subsidiaries—to report on sustainability impacts, including climate and human rights. Specifically, companies covered by the CSRD must report on established sustainability reporting standards addressing the resilience of their business models to sustainability risks, plans to ensure compatibility of business operations with the Paris climate goals, risks to the company related to sustainability, and efforts to mitigate those impacts and risks. These reporting obligations apply throughout a company's operations and value chain.
EU Corporate Sustainability Due Diligence Directive (CSDDD)
Adopted in 2024, the CSDDD will introduce mandatory human rights and due diligence requirements for companies of a certain scale either based or operating in the EU. As the CSDDD progressively comes into force over the next five years, covered businesses will be required to engage in the "identification and, where necessary, prioritization, prevention and mitigation" of "adverse human rights and environmental impacts connected with companies' own operations," and those both up and down the supply chain. Companies will need to adopt a risk-based approach to environmental and human rights due diligence, address potential adverse impacts and publicly communicate these efforts. The regulation requires businesses to strive to avoid such harms by implementing risk prevention plans, changing operations, and even modifying business strategies and operations. The CSDDD establishes legal enforcement remedies, including through supervision by EU member state regulatory authorities, direct financial liability and exclusion from public procurement.
US Securities and Exchange Commission (SEC) Climate Related Disclosure Rules
In March 2024, the US SEC issued final rules on climate-related disclosures for investors. While narrower in scope than the EU equivalents, the US regulations will require substantial disclosure by registered entities relating to risks and opportunities to their business from climate change. Presently subject to a voluntary stay by the SEC of the effective date of the rules and pending judicial review, when the regulation comes into force, public companies will need to disclose material climate-related information, such as climate-related goals and targets, activities to mitigate material climate-related risks, and Scope 1 and 2 emissions. While the final SEC rules do not require the kind of Scope 3 disclosures now mandated in Europe, they directly engage one of the world's most powerful regulators in the drive toward responsible business.
Strategic litigation seeks to compel change
Strategic litigation is reinforcing these regulatory pressures. Litigation by governmental enforcement agencies, shareholders, and consumers has long been used to compel corporate changes. Today, a new era of strategic litigation seeks systemic realignment of business with environmental and human rights goals. In the past five years, stakeholders have identified novel (and often effective) legal bases for action in jurisdictions across the globe. Recent examples of such strategic litigation include shareholder derivative suits to advance diversity, equity and inclusion; workplace sexual harassment and gender discrimination litigation; climate change-related actions by state attorneys general; and tort claims against companies for purported violations of various duties-of-care. Most recently, greenwashing litigation has gained steam, with class action litigation challenging the veracity of climate-related disclosures and creating new risks for how companies frame sustainability progress.
Global business must evolve
As businesses advance toward a more responsible future based on these shifting societal and stakeholder expectations, new regulatory obligations, and the increased threat of litigation, new risks and opportunities are emerging. This journey toward responsible business may involve changes to a corporation's business model, governance, supply-chain, manufacturing, products or services, and marketing, among other shifts. Businesses will face increased regulatory burdens with reporting obligations in multiple jurisdictions. They will need to prepare and implement new compliance plans to meet new and evolving obligations. Ultimately, this journey will likely alter many businesses' identities and values.
Amid growing pressure to conduct business responsibly, corporations need to think differently about risk and governance. Changing societal expectations create new consumer risks; new regulatory requirements generate new compliance risks; due diligence requirements may lead businesses to see previously hidden risks; and strategic litigation imposes new financial risks. In response, corporate governance may need to change. Businesses will face pressure to create and formulate new sustainability-focused policies, establish new C-suite positions related to risk, compliance and sustainability, increase regulatory capacity, consider new insurance and hedging strategies, and develop new ways to coordinate, share information and engage with stakeholders.
