From commitment to action: Echoes of Basel’s legacy

In a bid to address the evolving landscape of sustainability regulation and its impact on businesses, DPAM organised its 7th sustainability seminar in Madrid. The event featured two panels – the Environmental Panel and the Social Panel – both addressing critical aspects of sustainability and corporate responsibility.

The analogy between Basel and ESG Integration

In 1988, the Basel Committee embarked on a mission to reshape the financial world, publishing a set of minimum capital requirements aimed at better regulating the banking sector. This journey began with the Basel Accords, commonly known as Basel I, which addressed capital, market, and operational risk to ensure that financial institutions had sufficient capital to absorb unexpected losses. Later, Basel II and III emerged, with Basel III being a response to the global financial crisis of 2007-2008. Earlier this year, in January 2023, Basel IV was introduced, marking a noteworthy 35-year transformation in the regulation of a critical sector of our global economy.

In this evolution of financial regulation, we see parallels with the journey towards a sustainable and responsible business world. Just as it took over three decades to refine the Basel Accords, the corporate world is now on a journey to align itself with environmental, social, and governance (ESG) principles.

Climate transition: moving from regulation to corporate action

As climate change has sounded the alarm, it is now clear that something significant must happen to prevent catastrophic consequences.

Stand-alone commitments are not sufficient; a credible transition plan is a must

Throughout the last couple of years, companies have been stepping up their climate ambitions, notably by moving from self-declared climate targets to validated science-based emission reduction targets. However, the conference began by reviewing some sobering figures from a report by the Climate Disclosure Project (CDP) on the current state of affairs. According to CDP assessments, companies are distinctly off course: out of all companies with a validated science-based target, only one fifth are meeting their goals, and many don't provide a clear roadmap to reach the target. Setting time-bound, science-based targets is a first step in the right direction, but real-economy, absolute emissions reductions must be the focus. Since climate change is impacting how companies operate, it presents financial, reputational, and regulatory risks. Panellists, representing both the corporate world and the wider stakeholders, agreed that to mitigate these risks, it is essential to scrutinise companies' transition plans for feasibility and credibility. In addition, investors are also keen to assess and compare companies' transition plans to protect long-term performance as climate change is a material and foreseeable financial risk. The panellists of the conference then shared how companies and other stakeholders are reacting to this demand.

The building blocks of a credible transition pathway

During the panel discussion, insights were provided on the work of The Transition Plan Taskforce (TPT), set up to advise UK regulators on their future Sustainability Disclosure Requirements framework and co-chaired by a CEO from the private sector and a UK Government minister. The TPT aims to provide a comprehensive framework for credible transition plans where key elements such as ambition, action, and accountability are considered. Ambition should be in line with a strategic target that positions the business to contribute to an economy-wide transition, most importantly the plan needs to be quantified. Short-term actions should focus on decarbonisation and should respond to climate-related risks. Lastly, for accountability, strong governance is warranted. Engagement is also a crucial indicator, ensuring that lobbying activities align with corporate ambitions. But is this aligned with other initiatives?

Investors’ expectations are central to lay the groundwork for regulation

To drive change, various investor initiatives are also making their voices heard and, based on what we’ve heard during the conference, they clearly share the conceptual views of the TPT. The Institutional Investors Group on Climate Change (IIGCC), for example, has published key expectations for companies. While many initiatives concentrate on heavy-emitting companies, adoption needs to be extended to the long tail of companies that might not have the means to disclose data or set quantitative targets. Investors are increasingly engaging with companies to drive change, thus having a real economy impact. However, nuanced approaches are essential to address diverse sectors and their respective decarbonisation plans. But an investor expectations framework alone will not be sufficient; regulation must follow and needs to be ambitious.

The reality of corporate reporting: commercial risk or opportunity?

As the pressure for disclosure mounts, a risk-based and continuous approach becomes necessary. While panellists from the corporate world testify that they are embracing ambitious targets, it puts significant pressure and additional workload on the companies, so the costs of achieving these targets are not negligible. However, authorities appreciate these ambitions. Several companies, amongst corporate representatives at the seminar, are not afraid of these additional disclosure requirements and the burden they represent because it is in line with how they operate. Nonetheless, transparency and the ability to assess suppliers through standardised data are vital for value chain approaches, as for some companies, the majority (up to 95%) of their emissions lie in their value chain. Therefore, they welcome disclosure frameworks as they anticipate a positive shift for the entire sector, where sharing specific verified ESG data will become an integrated part of doing business.

Navigating external risks and opportunities

Companies are not only dealing with environmental risks but also with legal risks. Litigation challenges the accuracy of green claims and commitments, next to the viability of transition plans, emphasising that litigation follows risk rather than the transition plan itself. However, the most significant risk lies in not taking action and failing to establish a credible transition plan. A company's failure to transition properly can become a business risk. This is exemplified by the fall of Kodak, though this was not linked to decarbonisation. Nonetheless, numerous opportunities await, including gaining market share in industries focused on decarbonisation. This, however, also requires proper disclosure to investors. Leading companies generally see the increased transparency and greater disclosure as an opportunity in this transformative era to outperform peers and create a positive movement in the sector.

KPIs to assess a credible transition

The conference concluded with a final question to all panellists: what mandatory metric or KPI should be made available by all and should be used to assess transition credibility and impact?

According to some panellists, credible transition plans should focus on long-lived capital stocks, avoiding carbon lock-in that hinders the shift towards sustainability. Furthermore, the way a company deals with stranded assets or the amount of Paris-aligned capex can be key indicators. It was also agreed among panellists that the focus should lie on absolute reductions, with a clear methodology and alignment with scope definitions. However, taking only one single metric to assess companies’ ambitions would go against the aim of sustainability as it takes into account different aspects like carbon emissions, biodiversity, water use, human rights, workforce diversity, business ethics, and so on.

Moving from regulation to corporate social responsibility

Current and upcoming regulation on social topics and human rights

The Social Panel delved into global regulatory efforts with a focus on the EU, emphasising the need for companies to consider social risks more comprehensively. Given the complexity of the current regulatory framework, there is an increasing need for a cohesive approach towards a sustainable economy, advocating for a common baseline for responsible business conduct to ensure consistency across legislation and guidance. Currently, different regulatory mechanisms can be defined, such as the company-focused mechanism (Corporate Sustainability Reporting Directive - CSRD and its standards, proposed Corporate Sustainability Due Diligence Directive - CSDDD) and the finance-focused mechanism (SFDR, Green Taxonomy, potentially upcoming Social Taxonomy). These mechanisms require companies to act on human rights and environmental risks by considering due diligence and engagement, climate and transition plans, and disclosure and transparency requirements.

In parallel with these developments, the OECD guidelines on Responsible Business Conduct were also updated, showcasing the evolving nature of responsible business conduct and the incorporation of new elements such as a more specific definition for climate and environment, just transition, stakeholder engagement, and a focus on downstream due diligence on top of the upstream one. Other initiatives have emerged in certain countries such as the Mandatory human rights due diligence in Brazil, South Korean acting on Human Rights and Environmental Protection for Sustainable business management, and the Japanese government setting human rights due diligence guidelines for companies. This newfound regulatory tsunami demonstrates the broadening of the regulatory lens towards social and human rights topics.

The World Benchmarking Alliance (WBA) plays an active role in shaping policies to propel the Corporate Sustainability Due Diligence Directive (CSDDD) forward, making it a practical and effective regulation for companies to implement. For this purpose, the WBA leverages existing frameworks, such as the OECD guidelines, and analyses how companies currently perform to find gaps and areas that require improvement, emphasising the necessity of the CSDDD as a fundamental baseline to set collective expectations for all companies.

The role of entities like the WBA becomes increasingly crucial in driving accountability, transparency, and responsible practices across the corporate world, especially given the continuous evolution of the regulatory frameworks. The WBA ensures that companies integrate the evolving regulatory expectations into their corporate governance, enabling third parties to utilise WBA's research to assess companies' adherence to the new regulatory frameworks.

The regulatory frameworks may form a persistent challenge, including the burden of regulatory disclosures, especially for smaller companies. A good practice to address the disclosure bias between larger and smaller companies is to prioritise engagement with the most sustainability-driven companies, dedicating more time, effort, and resources to foster meaningful interactions, with the aim to maximise sustainability outcomes and mitigate the disparities arising from the disclosure.

The impact of this regulation on companies’ operational strategies:

Despite the disclosure burden that some small companies may face, many companies still view these new regulatory requirements as catalysts for positive change, driving continuous improvements in their corporate culture, with a focus on avoiding negative aspects while fostering positive outcomes.

Some companies took the regulatory framework as an opportunity and were proactive in setting a business conduct and managing human rights risks. Ahold Delhaize, for instance, a global food retail giant, has been a pioneer in adopting responsible business practices. In 2018, the company initiated a thorough human rights due diligence, a crucial step setting the stage for subsequent efforts. Notably, Delhaize showcased transparency and proactivity by publishing their first human rights report in 2020. For Borregaard Group, which operates one of the world's most advanced and sustainable biorefineries, it is not merely about reporting but about fundamentally aligning their practices with the principles of respect for human rights. Their strategy involves ensuring that the individuals responsible for specific topics and departments are also accountable for KPIs and measures pertaining to human rights. This inclusive approach extends accountability to various stakeholders within the organisation, fostering a culture of transparency and responsibility.

Acknowledging the severity of human rights risks within the supply chain, companies are strategically shifting their focus to this vital area. They strongly believe in diligent scrutiny through a comprehensive due diligence process to evaluate and address human rights concerns across operations and supply chains. The role of boards of directors, as high-level governance bodies, remains necessary to ensure this responsibility and accountability and drive the incorporation of human rights considerations into a company's strategic decision-making processes.

Back to Basel

In conclusion, the journey towards a sustainable future mirrors the evolution of financial regulation, requiring corporations to set ambitious targets, implement actions, maintain accountability and have a due diligence process to evaluate and address human rights concerns across operations and supply chains. With the pressure for disclosure mounting, companies must navigate these challenges, but the opportunities for innovation and growth in the just transition to a low-carbon economy are undeniable. Ultimately, the corporate world's transition to a more sustainable future will have far-reaching implications for the global economy, much like the transformation of the banking sector under the Basel Accords.