Why ignoring ESG could cost your business more than you think 

In the evolving landscape of corporate governance, ESG (Environmental, Social, and Governance) compliance is no longer a “nice-to-have” — it’s a must. From financial penalties to lawsuits, the legal consequences of non-compliance are growing increasingly severe. In this blog, we’ll look at the changing regulatory landscape, explore the legal risks of non-compliance, and discuss the latest updates in the world of ESG. 

The growing ESG regulatory landscape

As ESG becomes more integral to business operations, governments around the world are implementing strict regulations to enforce transparency and accountability in ESG practices. The takeaway is clear: Companies must comply, or they risk facing substantial consequences.  

Let’s take a look at the most recent changes in global ESG regulations: 

The European Union (EU)

The EU has been a pioneer in ESG regulation, rolling out several ambitious directives:  

• Corporate Sustainability Reporting Directive (CSRD): The CSRD came into effect in 2023 and “the first companies will have to apply the new rules for the first time in the 2024 financial year, for reports published in 2025,” according to the European Commission, an official website of the EU. This directive requires companies to report extensively on sustainability, covering everything from carbon emissions to human rights in global supply chains. Penalties for non-compliance, according to the World Economic Forum, include fines of up to 5% of a company’s net worldwide turnover. 

• Sustainable Finance Disclosure Regulation (SFDR): Financial institutions must disclose how ESG factors influence investment decisions. According to the European Commission, the SFDR is also “designed to allow investors to properly assess how sustainability risks are integrated in the investment decision process.” 

The United States (U.S.)

ESG regulations in the U.S. are rapidly changing, with the Securities and Exchange Commission (SEC) pushing for more stringent climate disclosures.  

• SEC’s proposed climate disclosure rules: In March 2024, the SEC proposed new rules requiring publicly-traded companies to disclose climate-related risks. According to the Boston Consulting Group, the SEC approved a major directive – the Enhancement and Standardization of Climate-Related Disclosures for Investors rule – which “aims to have companies that are listed on US stock exchanges disclose climate-related information that may materially affect their business and, in turn, investors’ decisions.” 

• State-specific regulations: Many states, such as California and New York, have enacted or are considering ESG-related laws, including climate disclosure mandates. In California, a recent bill was passed this October requiring large companies to disclose their value chain emissions and provide reporting on climate-related financial risks. 

The United Kingdom (UK)

• UK Corporate Governance Code: Established in 2019, the Code requires companies listed on the London Stock Exchange to be transparent in ESG reporting. Previously, the Code only applied to premium-listed companies. Now, as of January 2024, companies that need to follow the Code include all those listed in the commercial category or the closed-ended investment funds category, according to the Financial Reporting Council.  

• UK’s Sustainability Disclosure Requirement (SDR): This requirement sets regulations for UK companies and financial institutions to report their ESG impacts. With an estimated launch by 2025, the SDR aims to increase sustainability within corporations.  

More and more companies are being asked by investors to disclose their ESG data. In fact, a Deloitte study found that 80 percent of U.S. institutional investors use sustainability information when they make investment decisions. 

The top 3 legal consequences of ESG non-compliance

Failing to comply with ESG regulations can lead to hefty consequences. Penalties now include significant fines, lawsuits, reputational damage, loss of business opportunities, and even jail time (in some states). 

1. Fines and penalties

Whether it’s the EU’s CSRD or the SEC’s new rules, fines for non-compliance can be substantial. For instance, the EU mandates fines, with countries like Germany mandating fines of up to €10 million or 5% of global turnover for companies that fail to report as required. Similarly, the SEC has proposed fines in the millions for violations. Last month, the SEC fined WisdomTree Asset Management $4 million for greenwashing and failing to comply with its ESG investment strategy.  

2. Litigation risks

In the U.S., shareholder derivative suits related to ESG issues are on the rise. In 2023, investors in Enviva Inc. filed a derivative suit on behalf of the company, “alleging that Enviva’s management made false and misleading statements regarding the sustainability of the company’s wood pellet products as a replacement for coal and its cash flow from operations” (Browning v. Alexander, et al). Companies failing to disclose ESG in accordance with their country’s regulations may find themselves at the center of costly legal battles.  

3. Loss of market access and capital

As institutional investors increasingly prioritize ESG, companies that fail to comply risk being excluded from portfolios. In fact, investors representing $25 trillion (USD) in assets plan to double ESG assets within five years, according to BlackRock’s 2020 report. Companies that don’t align with these standards could face higher costs of capital or difficulty attracting investments. 

The bottom line

The legal risks of failing to comply with ESG standards are no joke. We’re talking about everything from hefty fines and lawsuits to angry shareholders, and these are just the legal consequences of ESG non-compliance; there are also significant reputational and social risks that can impact your business. As ESG regulations evolve around the world, businesses can’t afford to sit back and hope they stay under the radar—they need to get serious about compliance. 

The good news? By staying ahead of changing regulations, working with your legal teams, being transparent in reporting, and creating a culture of ethical responsibility and sustainability, companies can steer clear of these risks – and Contract Lifecycle Management (CLM) software can make that even easier. A CLM can help you track and manage ESG-related clauses and requirements in contracts, ensuring compliance and transparency across your entire supply chain. If your company hasn’t yet made ESG a priority, now’s the time to act.  

Not sure how to get started? Read our blog, “5 Steps to building a successful ESG program in 12 months.“