Creating an ESG Policy: Key Considerations

ESG in context

Incorporating environmental, social and (corporate) governance (ESG) factors into corporate culture and management processes is a strategy increasingly being adopted by many companies seeking a sustainable management model. While conventional profit-maximisation models remain the dominant force, boards are being increasingly challenged by investors and other stakeholders expecting them to integrate ESG goals into their strategy, i.e. to achieve corporate growth while mitigating environmental and social impacts. 

While some global actors are retracting from environmental commitments, following a number of recent regulatory developments, the “noise” around ESG has become impossible for many to ignore, and an increasing number of companies are incorporating corporate sustainability obligations into their business processes.

Why do companies need an ESG Policy?

ESG policies document how companies address ESG risks, such as carbon footprints, modern slavery in supply chains and/or anti-bribery measures, and many companies therefore already voluntarily implement these policies for legal, commercial and strategic reasons. New legislation including the Corporate Sustainability Reporting Directive (CSRD), and the Corporate Sustainability Due Diligence Directive (CSDDD) will increase the relevance of ESG for international companies. This legislation requires more stringent reporting and monitoring of human rights and environmental impacts at both company and supply chain levels (notwithstanding simplifications proposed as part of the EU’s Omnibus I package). In particular, companies operating in global trade sectors such as shipping and commodities will need to pay closer attention to their carbon footprint, environmental impact, human rights and other ESG factors. Companies who fail to comply risk penalties such as large fines, or ‘naming and shaming’.

As a result, more and more companies are considering whether they need an ESG policy and, if so, what should be included.

ESG policy drafting process – steps 

It is important that companies take their time when developing a policy. There is no ‘one size fits all’ approach, and generic templates or AI-generated policies may overlook critical nuances and / or contain inaccuracies that could expose a company to greenwashing litigation or reputational damage if false statements are publicly identified.

There are normally four recommended steps for creating an ESG policy: (1) an initial scoping exercise; (2) a due diligence analysis; (3) key competitor comparison; and (4) a greenwashing risk analysis.

Step 1: Initial scoping exercise

An initial scoping exercise helps define the purpose and business drivers of the ESG policy. Early identification of ESG risks can help in developing strategies to mitigate them and protect the organisation from potential financial, operational, and reputational risks.

The exercise will involve reviewing current published policies and mapping out interactions to gain an understanding of where a new ESG policy would sit within current organisational and governance policy frameworks. It also helps determine the appropriate language for the policy, and the level of detail required.

We recommend that any scoping exercise should include consideration of a range of factors, including:

1. The ambit of the ESG policy and what it needs to cover;
2. The relevant corporate and/or commercial driver(s) behind having an ESG policy (including any pressure from internal or external stakeholders);
3. Identification of existing company policies that will need to intersect with the ESG policy and, any order of precedence applicable;
4. Identifying the policy’s intended audience and, where public-facing, whether steps have been taken to mitigate the risk of greenwashing (see Step 4 below); and
5. Identification of available data to underpin the policy, and any data gaps.

Step 2: Due diligence exercise

An ESG policy should be built on thorough due diligence to understand what legislation, regulations and policies apply to the company. The due diligence exercise should consider both mandatory and voluntary obligations in all the jurisdictions where the company operates. The company may choose to base its ESG policy on the jurisdiction where its headquarters are located or where it has the largest footprint, whilst also acknowledging the need to comply with any more onerous local requirements.

This exercise should be carried out by a suitably qualified advisor, as the application of laws and regulations often turns on points of interpretation or whether the company meets certain thresholds.

To future proof an ESG policy it is also advisable to consider whether upcoming laws or regulations not yet in effect may impact the policy once they are in force.

Step 3: Key competitor comparison

Companies may also find it helpful to carry out a key competitor analysis, to determine whether competitors have an ESG policy and any key issues and risks they identify. Benefits of this exercise include:

1. Benchmarking: companies can ascertain best practices, practical steps and actionable measures by comparing themselves with similar companies.
2. Competitive Advantage: Knowing competitors’ ESG strategies may help companies identify opportunities to differentiate themselves.
3. Risk Mitigation: Understanding ESG risks faced by competitors can help to anticipate and mitigate similar risks.
4. Stakeholder Expectations: By observing how competitors respond to stakeholder demands, companies can better understand and meet expectations of their own stakeholders.
5. Market Trends: Analysing competitors’ policies can reveal emerging trends in ESG that a company can leverage or use to establish itself as a leader in ESG practices.

Step 4: Greenwashing risk analysis

One particular risk that companies should be acutely aware of when drafting ESG policies, is the potential for climate risk litigation. Of this family of claims, greenwashing litigation is a key consideration. Greenwashing litigation is, broadly, a growing form of climate risk litigation in which claimants (including consumers, activists and shareholders) seek to hold private companies (among others) legally accountable for misleading, unsubstantiated and/or selective claims in relation to their environmental actions, products, services, investments or practices.

Legal and regulatory avenues for bringing greenwashing claims are numerous. Accordingly, the underlying causes of action and corresponding remedies vary, depending on the avenue pursued. Even where financial consequences of a greenwashing claim are nominal, reputational damage may be significant.

There have been several high-profile greenwashing legal proceedings in recent years in which companies were found to have overstated the positive environmental impacts of products or services, or set goals which were not realistically actionable or underpinned by any evidence or plan.

Companies may also be found to have engaged in greenwashing where they do not monitor and/or measure their actions as claimed, thereby being unable to verify any progress on their ESG goals.

This is relevant to an ESG policy because companies will need to think carefully about what targets and commitments the policy communicates. For example, a company should be cautious of making a broad claim that it will reach net zero by 2050 if it has not done any analysis of what its current emissions are, or has not developed a robust, science-based plan for reducing those emissions, or for tracking progress towards achieving a reduction.

Conclusion

Together, these four steps form the basic building blocks for producing a robust and comprehensive ESG policy. Companies may require assistance considering each step individually, and should obtain advice where appropriate, particularly if the policy will address ESG risk in specialised, or sector-focused areas.

HFW’s cross-sector sustainability experts have experience of working with clients to develop, assess and clarify ESG policies, and are well placed to offer comprehensive advice and further guidance on any of the issues raised in this briefing.