Why meeting ESG regulations remains a major challenge for any risk management function

The EY Global Integrity 2024 report highlights that ESG-related regulatory reporting and data integrity have emerged as the biggest risks for organizations. As climate-related goals shift from voluntary commitments to mandatory obligations, the conversation around net-zero emissions goals and broader ESG issues has changed significantly over the past two years.

This shift has been from ambitions to a focus on compliance, as explained by EY's global ESG leader Katharina Weghmann (pictured above).

Traditionally, many organizations established high-level goals, issued Global Reporting Initiative (GRI) audited reports, and disclosed their climate impact in accordance with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD).

However, in recent times, the discussion has focused on key challenges and risks related to ESG, especially those arising from evolving regulations, lack of consensus across sustainability reporting standards, and concerns about data integrity.

According to Weghmann, these challenges have caused many organizations to take a closer look at their approach. Faced with the increasing complexity of corporate disclosures and the need to publicly report on progress towards sustainability goals, some organizations are shifting their goals to focus on what is achievable and measurable or aligning their goals more closely with current regulatory obligations.

This trend towards less regulatory compliance is also being influenced by the political climate, with upcoming elections in more than 60 countries in 2024 likely to impact the strength and direction of ESG regulations.

Weghmann notes that while the purpose of stricter reporting requirements is to improve transparency and accountability, the unintended consequence may be that organizations shift their focus from ambitious but difficult ESG goals to ticking legal boxes. This approach may prove ineffective, especially as ESG regulations continue to evolve around the world.

Due diligence to meet ESG regulations

The EY report found that 37% of respondents identified compliance with new and changing ESG regulations in various jurisdictions as one of the most important challenges in meeting their ESG compliance obligations.

Weghmann points out that this challenge is compounded by the rapid spread of ESG-related regulations around the world. Between 2011 and 2023, more than 1,255 ESG regulations were introduced worldwide, further complicating the situation for organizations trying to meet their compliance requirements.

The report goes on to identify seven key areas where CFOs, chief sustainability officers (CSOs), and other senior executives face the greatest difficulty in addressing ESG challenges. One important area is mapping and measuring the sustainability journey.

According to the report, 34% of respondents agreed that they have limited reliable data to measure progress against performance goals. Weghmann highlights that the ability to measure and report against ESG ambitions and goals is critical and drives the need for better, auditable data at the group level, often across multiple markets, business units, and products.

Another area of ​​concern is the role of CSOs in key decision-making processes. The report notes that 29% of respondents are concerned that, without the appropriate level of influence or authority, CSOs may not receive adequate resources and budgets for ESG initiatives.

Weghmann suggests that ensuring CSOs have a seat at the decision-making table is critical to integrating ESG with the organization's core strategy, value creation, and culture.

The report also cautions against adding sustainability solutions just to meet regulatory requirements rather than building them into an organization's systems from scratch. This approach can create a perception, internally and externally, that ESG is an afterthought rather than an integral part of an organization's long-term strategy.

To meet the growing demand for control

Weghmann advises that organizations should focus on implementing appropriate processes, systems, and internal controls to strengthen transparency and reporting. As laws and regulations evolve, organizations will need to push ESG data to the financial reporting level and ensure it can withstand audit scrutiny — a requirement under some of the new ESG laws, including the Corporate Sustainability Reporting Directive (CSRD).

Building a robust risk management system for ESG activities is another challenge identified in the report. While there is an increased focus on what to report and how to report it, organizations often overlook the critical need to develop a risk management framework for their ESG activities.

Weghmann also points out that while organizations tend to manage financial reporting risk, they need to make the same effort in managing non-financial reporting risk. This is especially important given the increase in regulations and disclosure requirements, which now involve multiple business units and processes, requiring a multi-pronged approach.

The report also talks about the hidden dangers of green washing and green burning. Employees who were not involved in ESG reporting are now inundated with new requests for information, acronyms, and standards.

Weghmann notes that this added pressure can lead to errors or omissions in reporting, which could expose organizations accused of laundering, underreporting, or even fraud.

As ESG efforts become increasingly mandatory, the figures for organizations have never been higher. Weghmann concluded that while the challenges posed by ESG developments are significant, they also provide an opportunity for organizations to find a more mature approach to their sustainability efforts.

This means going beyond mere compliance and embedding ESG integrity at the core of their business strategy, balancing ambition with ethics, and focusing on long-term value creation rather than short-term benefits.

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