The ESG Risk Series: Managing Companies’ Growing Expectations Around Environmental Due Diligence

17 June 2022 00:00


Regulators increasingly require corporates and financial services firms to incorporate Environmental, Social and Governance (ESG) risks into their due diligence and reputational risk management processes. ESG also brings opportunity: asset managers and investment banks have enjoyed significant returns by moving assets into sustainable funds, while companies who are transparent about their ESG commitments have been profitable. In the second blog in our ESG Risk series, we break down the “E” in “ESG” by identifying the main factors companies need to consider when assessing environmental risks–and explain how Nexis® Solutions can cut through the noise to help surface and mitigate these risks.

Defining the criteria for environmental risk

Environmental factors are usually the best understood aspect of ESG because of the media and policy focus on the issue in recent years. It is often used as shorthand for climate emissions, which are important, but the environmental risks facing companies are even broader. Due diligence into environmental risks should look at three key areas:

  • Resources: Where do the materials used in a product come from? Do its manufacturing methods pollute the earth, and what is the process for waste and water management? Are investment firms putting their money into polluting firms, or green ones?
  • Sustainability: Does a company’s services and products leave a heavy carbon footprint? Or are they seeking to follow a sustainable circular economy model which promotes sustainable reuse with minimal environmental impact?
  • Climate emissions: What is the CO2 output and energy consumption of a company and its third parties? What commitments have they made to reducing carbon emissions, and do they disclose their environmental impact in their annual report and other communications? How have they delivered against their previous targets?

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Green pressure: why do companies need to understand environmental risks?

As part of the trend towards mandatory human rights due diligence legislation, regulators and enforcement agencies have focused specifically on companies’ environmental impacts. This is likely to accelerate after the United Nations’ COP26 summit in late 2021, where world leaders agreed to take further action to counter climate change. Recent examples include:

  • The United States’ Securities and Exchange Commission (SEC) recently proposed new rules which would mandate all publicly-traded companies to report the risks they face from climate change in their audited financial statements, and disclose their approach to “governance of climate-related risks and relevant risk management processes”.
  • The UK’s Competition and Markets Authority is investigating major fashion firms which are allegedly making misleading claims about their environmental credentials.
  • The Bank of England is warning banks and insurers that it will crack down on them if they don’t manage climate risks.
  • Growing pressure on asset managers to disclose whether they have considered ESG factors in when selecting their investments, following the EU’s Sustainable Finance Disclosure Regulation.

Environmental impact has also become a major driver of reputational risk for companies. Last year, when Greta Thunberg called on banks to “stop funding our destruction” by lending to companies that use fossil fuels, it led to negative headlines for the sector around the world.

Investors are increasingly moving their assets to companies that transparently disclose the risks to climate change from their third parties and supply chain, and seek to reduce their impact on the environment. In May 2022, a climate activist and investor acquired more than a tenth of an energy firm in Australia with the aim of reducing the company’s climate impact from the inside.

However, there are obstacles to companies’ efforts to determine the environmental impact of third parties or potential investment prospects. Greenwashing is a common issue in the sector. A recent study found that a third of 1,000 large US companies make no environmental disclosures at all. Companies therefore need to use a wide range of data sources and criteria to assess environmental risk.

Nexis Solutions: cutting through the noise to surface ESG risks and insights

Nexis Solutions helps firms to tackle the challenge of assessing environmental risk, and other ESG risks, head on and surface insights related to ESG risks across our comprehensive data sources, from our news archive to company data to PEPs and sanctions lists. This supports companies’ reputational risk management, due diligence, and data-driven investment decisions.

In addition to our existing data, we have recently added ESG content to Nexis Diligence™ that enables users to confidently incorporate an ESG risk assessment into their due diligence research and reporting workflow, within a single interface of content chosen specifically for fast, cost-effective, and comprehensive due diligence:

  • ESG Ratings is a new content type in Nexis Diligence, which displays an at-a-glance view of a company’s ESG profile. These ratings, provided by CSRHub, help customers understand a company’s reputational or ethical business risk. The ESG Ratings break down ratings for each ESG category into further sub-categories, as well as providing an overall rating for the company.
  • ESG Custom News delivers users a set of predefined search terms, enabling them to carry out ESG research within our extensive set of news sources, customized to their preferences.
  • ESG Factors Power topics allow users to post-filter all their news results using ESG specific topical indexing.

For more information about Nexis Diligence, click here.

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