Environmental, social and governance (ESG) factors are no longer just buzzwords in the legal and compliance world — they're a business priority. Ignoring them can have serious consequences on both the finances and reputation of your company, so it's hardly surprising that 69% of respondents in the latest ACC Chief Legal Officers Survey believe ESG will garner more attention over the next few years.
So how can your legal team stay ahead? In this installment of "Conversation On Compliance," we delve into what responsible organizations need to know about ESG trends and their impact on contracts — plus helpful tips to plan accordingly:
The Evolution of ESG
Over the last decade, ESG has grown from a relatively niche concept to one of worldwide concern (and as of recently, a contentious topic in the U.S. Senate).
In the early days, ESG metrics and reporting were scarce. There were also fewer regulatory requirements for ESG disclosure, so there was less incentive for companies to update their policies and stick to following them.
But today, investors, customers, employees, and shareholders are making more conscious decisions to work with companies whose values align with their own. This means it's no longer enough just to have a written policy in place; stakeholders want tangible evidence that businesses are holding true to their values and living up to expectations.
In fact, 76% of consumers say they will stop buying from companies that treat the environment, employees, or the community in which they operate poorly, clearly indicating that ESG compliance is more than an afterthought now — it's a necessity.
Three Trends Driving ESG Compliance Urgency
From wooing investors to meeting regulatory demands, the stakes for ESG compliance have never been higher. Let's look at a few of the major trends that are driving urgency in this area:
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Investor Pressure: Venture capital and private equity investors aren't just studying balance sheets and analyzing returns for potential investments anymore — they're analyzing ESG programs, too. ESG factors not only provide insights into a company's commitment to sustainability and risk management, but also supply essential information on stakeholder engagement and long-term value creation potential. These valuable details can help savvy investors protect themselves from financial losses as well as damage to their reputation. Expect questions from investors not just about whether or not you have an ESG program in place, but if you also can demonstrate spend in financial and/or contractual terms.
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Supply Chain Transparency: Nowadays, stakeholders expect both your company and its suppliers to adhere to ESG commitments. This means you need to establish solid ESG standards and expectations for suppliers, including guidelines on sustainability, responsible business practices, human rights, labor practices, and environmental impact. And if a supplier falls short, consequences — like terminating contracts or imposing financial penalties — should be enforced.
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Increasing Regulatory Scrutiny: Many countries around the world are considering, or have already introduced, regulations that mandate organizations to divulge how they're faring in terms of environmental sustainability, human rights issues, and diversity initiatives — or else face potential fines. Last year, the U.S. Securities and Exchange Commission (SEC) fined BNY Mellon Corp. and Goldman Sachs Group Inc. over $5 million collectively over "ESG misstatements and policy failures within their investment management units." This marked the first time a regulator fined a financial institution for ESG-related failings, but it sent a very clear message: greenwashing and other misleading ESG claims won't be taken lightly.
ESG-Related Contract Clauses to Pay Attention to:
Your contract language plays a crucial role in ensuring your company is compliant with environmental and social standards while averting any potential legal liabilities.
Here are some clauses to pay extra attention to as you crack down on ESG compliance:
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Environmental standards: Contracts may require suppliers or service providers to comply with specific environmental standards, such as those relating to carbon emissions, waste management, or sustainable sourcing.
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Social responsibility: ESG compliance may also require the inclusion of social responsibility clauses in contracts, particularly in relation to labor practices, diversity and inclusion, and human rights. Such clauses may require suppliers or service providers to adhere to certain labor standards, such as fair wages, non-discrimination, and safe working conditions.
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Governance standards: Governance clauses may include commitment to diversity, employer relations, executive compensation, and shareholder governance. For example, contracts may require suppliers or service providers to have certain governance policies in place, such as anti-corruption policies or codes of ethics.
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ESG representations and warranties: These clauses include representations and warranties about your company's environmental impact, social policies and practices, and governance structures.
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ESG performance metrics and targets: These clauses include targets related to the reduction of greenhouse gas emissions, the use of renewable energy sources, or the promotion of diversity and inclusion (e.g. subcontracting 25% of your business to women- or minority-owned companies.)
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ESG due diligence requirements: These clauses require suppliers or other partners to provide information about their ESG performance and to comply with certain ESG standards.
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ESG indemnification and liability provisions: These clauses may provide for indemnification if a supplier or partner breaches ESG obligations or create liability if a company fails to meet ESG standards.
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ESG termination rights: These clauses may allow a company to terminate a contract if a supplier or partner breaches ESG obligations or fails to meet ESG standards.
The ABCs of ESG Compliance: Tips to Stay Ahead
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Audit your contracts. Periodic contract reviews afford businesses the opportunity to understand exactly how many of their documents have relevant language and if the obligations contained within them reflect current standards. Review your contracts on a regular basis — quarterly, annually, or as often as your policy dictates — to ensure your ESG provisions are accurate and up-to-date. Look for two things: quantity, AKA how many contracts have ESG-related obligations; and quality, AKA how many contracts have unique ESG-related obligations.
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Be aware of the ESG landscape. Clients rely on you to keep up with ESG regulations, so vigilance is key. Consider reading ESG-specific legal blogs, signing up for webinars, seeking guidance from consulting firms, or joining professional associations to learn about the latest developments. Examples of great resources: professional organizations like the Association of Corporate Counsel (ACC), blogs like PracticalESG, and virtual events like this one hosted by the World Commerce and Contracting Association (WorldCC).
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Collaborate with other departments. Connecting with other departments within your organization, like human resources and procurement, can help you keep tabs on ESG trends and identify potential risks and opportunities in your contracts. You can also tap into the power of your sales and marketing teams, who can evangelize your policies through blogs, testimonials, internal communications, and more. This is especially important if you're looking to attract prospective investors.
How AI-Based CLM Software Eases ESG Compliance
AI-based CLM platforms make it easy to streamline your ESG compliance process. Here's how:
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Instant Risk Identification. Manage ESG risks by using machine learning algorithms that read and analyze contract attributes, like ESG performance metrics. If a vendor fails to meet carbon footprint reduction metrics, for example, the platform will flag the suboptimal terms so you know to renegotiate.
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Streamlined Storage and Reporting. Protect your business from costly compliance issues with a centralized contract repository. Not only can you store, search, and monitor your contracts, but you can also quickly report on key metrics — like how many documents adhere to certain ESG criteria — for audits.
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Higher-Quality Contract Creation. With legal-approved templates and a clause library full of ESG terms, you'll give yourself peace of mind that all contracts align with your values. Both features ensure consistency in your contract language and reduce the risk of non-compliance.
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Automated Approval Workflows. Contract approval workflows are completely customizable, so you can ensure that ESG-related clauses are approved by the appropriate stakeholders, such as legal, compliance, and human resources teams.
As ESG continues to gain traction, it's more important than ever for businesses to stay informed and refine their policies. Stay tuned for our next quarterly installment of “Conversation on Compliance” as we focus on diversity, equity, and inclusion (DEI) — and in the meantime, check out our blog for more contract management trends and tips.
