Growing ESG regulation: What should businesses be prepared for?

Singapore

AS interest in environmental, social and governance (ESG) issues continues to grow, so have the expectations of corporate conduct in these matters - and companies need to be prepared for the increased compliance and regulatory obligations in the years ahead.

For businesses in Asia, such pressures are likely to come on two fronts: from rules enacted by jurisdictions elsewhere in the world that have an extraterritorial impact, and from increased regulation and enforcement domestically.

Global law firm Hogan Lovells, in its annual Global Bribery and Corruption Outlook, forecast an increased compliance burden on corporations in 2022, particularly as a result of heightened ESG expectations.

It noted a growing overlap between corruption enforcement and expectations around the environmental and social behaviours of large companies, and said that companies with good anti-corruption compliance procedures should be well-prepared for growing ESG-related compliance obligations.

"There is also a growing body of case law regarding corporate liability for ESG, data and technology risks," said Stephanie Yonekura, global head of investigations, white collar and fraud, at Hogan Lovells.

"Recent trends suggest the future sanctioning of misconduct in these areas may operate like existing ABC (anti-bribery and corruption) laws. Businesses would do well to review their existing compliance programmes to ensure they are prepared for these emerging risks," she added.

Extraterritorial reach

"Corruption is an ESG issue in its own right," said Liam Naidoo, partner in Hogan Lovells' investigations practice and co-editor of the report.

He explained that, under most OECD (Organisation for Economic Co-operation and Development) regimes, corporates can be criminally liable not only for their own acts of bribery, but also for acts of their employees, agents, and subsidiaries; and that these regimes tend to have extensive extraterritorial application.

"Some regimes go further, such as the (United Kingdom's) Bribery Act, where even non-UK companies can be criminally liable for 'failing to prevent' corruption by their business partners.

"There is a strong sense that this trend will be mirrored regarding corporates failing to prevent human rights abuses," Naidoo said. "My own view is that we will soon see legislation in the UK which creates some kind of liability for companies that fail to prevent human rights abuses carried out by their employees, agents and subsidiaries overseas. But at the moment that is not a legislative priority."

Paul Tan, partner and head of litigation for South-east Asia, Cavenagh Law, Clifford Chance Asia, has also noted how countries use their trade power to influence corporate behaviour. "For example, the US has the Slave-Free Business Certification Act, which compels companies as part of the supply chain of large US companies to meet labour and anti-slavery standards.

"The US Tariff Act also prohibits the import of shipments manufactured in any foreign country by forced or indentured labour. There have been high-profile instances of shipments stopped at US borders on grounds that they carry products that were produced by poor labour standards," he said.

Sandeep Biswas, partner at global management consulting firm, Kearney, said that any Asia-based business dealing with other jurisdictions - especially, the European Union (EU) - will need to plan for regulations in those markets; a higher carbon tax is a case in point. "This is inevitable and will happen in more jurisdictions. As more and more global players shift their focus to Scope 3 emissions, most Asia-based companies will have no choice but to plan their business around 'global' regulatory mandates," he said.

Scope 3 refers to all other indirect emissions that occur in a company's value chain, outside of Scope 1 (direct emissions from owned or controlled sources) and Scope 2 (indirect emissions from the generation of purchased energy).

Western influence

Growing ESG regulation in the West will also exert influence on legislative developments in the Asia-Pacific.

Hogan Lovells noted in its report that the US Securities and Exchange Commission's (SEC) Division of Enforcement has created a Climate and ESG Task Force to develop initiatives to proactively identify ESG-related misconduct, while the SEC is planning to propose new rules for disclosures over climate change, human capital management, and board diversity.

In Europe, Hogan Lovells has noted that various laws and legal campaigns have been coalescing around mandatory human rights and environmental due diligence regulation. For instance, Germany introduced legislation in June 2021 that imposes, for the first time, due diligence and reporting obligations on companies - including German subsidiaries of foreign companies - regarding potential human rights and environmental risks across those companies' supply chains.

And the European Commission is expected to publish legislation requiring companies to conduct environmental and human rights due diligence.

International law firm Linklaters in its ESG Legal Outlook said that this is likely to send a significant ripple across global supply chains: "The Covid-19 pandemic has brought into sharp focus the complex global interconnectedness of supply chains. The proposed EU regime will add an extra level of complexity which many economic operators are ill-prepared for."

Naidoo said, however, while environmental and human rights issues are creeping up the agenda of governments in the Asia-Pacific, the advent of "hard law" to the same degree as in Europe does not seem imminent.

"We don't foresee that happening in the short to medium term. We think that 2022 will see the previously recommended ESG disclosures and regulations tweaked and clarified. That will allow regulators to clearly identify, charge and prosecute ESG-related offences. But we are not aware of any legislative plans to criminalise a failure to prevent ESG violations in the same way as bribery legislation does in places like the UK.

"That said, we should remember that international legislation of this nature is often extra-jurisdictional," he added.

Tan says that pressure from European and US investors making investments into Asia markets has exerted influence for many years.

"Investors want to know that companies are thinking about the appropriate material ESG risks and opportunities for their industry and incorporating those topics into their strategies. They also want companies to disclose their ESG efforts in a way that investors can gauge progress and use the information to compare companies within and across industries. And they want disclosures to be based on commonly accepted standards and be investor-grade quality."

Regional developments

Biswas said that, while there has not been as much focus on regulation yet in the Asia-Pacific as there has been in Europe, "it's a dynamic situation and we expect this to pick up in the future as many Asia-Pacific countries have committed to net-zero targets".

"The biggest focus is likely to be on emission-related regulation given that Asia-Pacific countries are major contributors to global emissions. Further, local stock exchanges also have disclosure requirements related to ESG, but these are still nascent and will likely be strengthened over the years."

Pointing to carbon tax as a good example of the region's approach to ESG regulation, Biswas said that, while many Asia-Pacific countries have introduced it, "the tax is very small as countries need time to adjust to the energy transition".

"It does, however, show that Asia-Pacific countries are already thinking of an appropriate regulatory framework to govern this sector. Japan is considering a border carbon tax similar to what the EU is considering."

Tan noted that interest in ESG regulation across the Asia-Pacific is not uniform, but that there is growing interest in it, with the increasing awareness and importance of ESG. And, similar to Naidoo's observation, Tan said that the approach in the region has generally been more "soft law", in terms of the guidelines and incentives adopted.

"However, as the market shifts towards accepting ESG regulation as part and parcel of good business practice, and as Singapore seeks to position itself as an international commercial hub, it is inevitable that some core of these guidelines will become mandatory."

For Singapore, in particular, Tan noted that a mix of soft and hard approaches have been used, though "there may be a trend towards being more interventionist for ESG issues".

For example, the Singapore Exchange's decision to mandate sustainability reporting for listed companies, on a "comply or explain" approach, illustrates this gradual shift from a softer, voluntary approach, to one with more prescriptive rules over time, he said.

He also cited the Monetary Authority of Singapore's (MAS) release in 2020 of 3 Guidelines on Environmental Risk Management for the asset management, banking, and insurance sectors: "These guidelines are notable in that they depart from MAS's previous 'carrot' tactics - that is, the use of incentives to encourage the adoption of ESG - in favour of a more prescriptive approach."

And, ESG-related enforcement in the Asia-Pacific is gaining pace, according to Naidoo: "A good example is in Indonesia, where our team is seeing a dramatic uptick in environmental enforcement. We expect to see more ESG enforcement through to 2023."

Managing risks

To manage the growing complexities and risks in the face of such developments, Tan said that companies must start mapping where their exposures - whether direct or indirect - will come from.

"Direct exposure is easier to appreciate - if a foreign regulation requires a company doing business there to be compliant, it is one thing to implement practices that comply; but, if the foreign regulation requires you to ensure that even the practices of your sub-contractors or suppliers are compliant, then you will have to acquire understanding of the practices of sub-contractors and suppliers, and ensure that your procurement processes are adequate and robust."

In this, he believes technology can play a useful part - for example, blockchain technology can be used to digitalise supply chains upstream and downstream to track and trace the use of environmentally friendly materials in the manufacturing process, or to authenticate that the materials themselves are ethically sourced.

Businesses will also need to determine which laws apply - that is, what is mandatory, what is not, and what may become mandatory, and what ought to be adhered to for the sake of good business practice and social responsibility.

Biswas added that some kind of scenario analysis will inevitably be required in this respect, given the significant uncertainty in this area.

"For businesses with material exposures to other jurisdictions, there is a need to stress test the economics of all business decisions under existing or proposed regulations in relevant jurisdictions. In particular, this has to be considered when deciding on major capital investment decisions, as the economics may change quite dramatically over the lifetime of the asset."

Naidoo believes that organisations' compliance teams should also be able to leverage existing procedures and infrastructure to address ESG issues - for example, existing whistleblower hotlines could be used to raise ESG concerns and risks. "One thing for companies to consider, in order to strengthen their preparedness, is to provide training to their compliance teams to help them identify such risk," he said.

Tan pointed out that some companies have started to establish ESG panels - comprising external legal and strategic advisers - to conduct "ESG audits" of their practices, make recommendations to bring them in line with prevailing best practices and regulations, and to monitor compliance. "This is a practical first step that companies can take to demonstrate their commitment to ESG norms, especially if they are or are likely to be subject to mandatory regulation," he said.