Environmental, Social, and Governance Risks within Organizations
How Implementing a Contract Management Tool Can Improve Performance
In this age of information accessibility overload, every company is under the microscope. The court of public opinion is stronger than ever, and with this added pressure more organizations are hyper-conscious of their business practices. Striking a balance between overly optimistic (and potentially misleading) statements of change and true implementation of sustainable practices is difficult, but not impossible. This balance is essential, however, to protect a company from the risks associated with ESG factors.
What is ESG?
ESG stands for Environmental, Social, and Governance. ESG is a framework of belief that sustainability goes beyond environmental concerns. Organizations can use these criteria to determine the sustainability and ethical impact of operations. These standards are becoming common considerations for investors.
The environmental factor refers directly to the impact an organization has on the physical environment with which it interacts. This encompasses an organization’s risk management practices relating to greenhouse gas emissions, resiliency to climate fluctuations, and natural resource stewardship.
The social factor encompasses the relationships between the organization and its stakeholders. This pillar includes a company’s practices around wages; employee engagement; commitments to Diversity, Equity, and Inclusion (DE&I); and the communities they interact with on all operational levels.
The governance factor includes how a company is run. This covers all levels of operations, including the rights of shareholders, incentive programs within the employee base, and to what level leadership is open internally.
ESG risks and market challenges
ESG practices are scrutinized more than ever in business relationships given the ever-increasing priority from consumers and the public. It’s a mainstay topic at marketing and public relations conferences, focusing on climate change, sustainable sourcing, and societal impact putting company practices under a microscope with increasing importance that’s on par with financial performance and brand reputation.
Greenwashing is one of the most common accusations against companies who are seen to use ESG as a publicity gain as opposed to an authentic governing practice for the greater good. It’s one thing to say a company only sources sustainable materials, but it is another when procurement contracts require minimum spend without termination provisions for vendors violating ESG requirements. Companies cannot authentically commit to ESG goals if customers and vendors are not required to do so without risk of relationship termination or financial penalties.
An example of greenwashing risk comes from a Bloomberg report, where Tesco (the UK’s largest supermarket chain) recyclers, were repeatedly moving plastic waste from subcontractor to subcontractor, tracking waste to Poland and Turkey, where it was ultimately illegally dumped rather than recycled. Despite advertising the removal of over a billion pieces of plastic, reporters found truckloads of plastic in distant countries, increasing the carbon footprint of plastic waste transport that was not recycled as advertised. With a proper legal framework, Tesco should be able to withhold, or even terminate payments to their primary vendors for providing services that fall short of their ESG commitments.
Bloomberg reporters also identified misleading carbon credits purchased by major Fortune 100 companies from The Nature Conservancy. Some preservations where carbon credits were applied already had protection in preserved areas and were not at risk without the credits. These credits lack additionality: the concept that credits must provide an additive benefit when compared to inaction. Companies purchasing these credits should have legally protected themselves to demand refunds, especially when misleading statements concerning the lack of carbon offsets compared to inaction were discovered and publicized.
Stronger legal frameworks in situations like these can help companies stay ahead of greenwashing accusations, demonstrating a deeper commitment to ESG with a proactive approach to terminate relationships and enforce financial penalties to disincentive non-compliant counterparties.
The benefits of incorporating ESG practices into your processes
Building in ESG legal protections not only reduces financial burdens from early termination penalties and lawsuits relating to severing agreements, but also demonstrates a higher awareness of ESG consciousness. It becomes a competitive differentiator proving every business decision considers ESG and distancing the firm from greenwashing accusations. It proves that ESG is more than a publicity campaign: it is a focal point of corporate culture.
Higher ESG scores can become a competitive advantage in the marketplace. Consumers increasingly prioritize ESG in purchasing decisions, which leads to companies enforcing ESG standards in procurement and operations. Regardless of whether a company is business-to-commercial (B2C) or business-to-business (B2B), the requirements will only increase in time, meaning scrutiny will as well.
Governments have also embraced ESG in regulation and procurement. From diversity scorecards to carbon cap-and-trade programs, compliance requirements will only increase as politicians appeal to climate- and social-minded constituents. The operating environment is constantly shifting on all sides, and the cultural, social, and political pressures are being felt in every industry.
How to incorporate ESG practices through your contracts
One way for companies to adhere to a social contract with stakeholders is through legal obligations that dictate what counterparties must do to uphold and comply to ESG standards, as well as protect the ability to exit a relationship when standards are not met or are violated. Ultimately, the legal department empowers organizations to truly be ESG compliant by providing the legal framework to enforce and exit relationships as they relate to these standards.
The legal department plays a critical role in empowering companies to honestly market themselves as ESG conscience. The ability to audit, confirm, and publish counterparty ESG key performance indicators (KPIs) plays a crucial role in avoiding greenwashing accusations, especially when the charge is shifting the blame or turning a blind eye. The consumer goods industry knows all too well the ramifications of the negative reputational impact from publicized undesirable practices from raw material suppliers or contract manufacturing plants. These instances have become not only more widespread for other industries and their vendors, but with customer relationships as well. Hosting an event for a controversial figure or group, cutting ties with a client due to an executive accused of heinous acts, and exiting an entire division due to geopolitical events—these all become actions a company must have the legal right to terminate, even if laws were not technically violated.
Legal departments can implement policies, processes, and technologies to ensure ESG is a part of the department’s culture. Steps such as due diligence checklists, provision requirements, ESG-focused clause libraries, and multi-departmental approval reviews empower leadership to track KPIs and obligations—continuously evaluating and determining the future of business relationships (both customer and vendor) to mitigate reputational damage. Legal provisions obligating ongoing audit rights, verifiable reporting, and dictating termination triggers are examples of deciding factors for whether a company fully controls their ESG journey.
Where contract management tools come into play
At Conga, we understand that ESG practices are more important than ever in an organization. With our contract management solutions, you can seamlessly incorporate ESG messaging and processes into existing procedures. This format of procedure and process automation ensures your top priorities as a company stay front and center in employees' day-to-day activities. Conga can help you accomplish this by arming your legal team with the ESG standards and practices they need while negotiating contracts.
ESG practices can be layered into any of our contract management solutions, taking your processes to the next level in terms of liability protection. You can implement the inclusion of ESG protections in the same way you currently execute other risk and protection clauses.
Contract management data can also be integrated into downstream systems to inform the business, risk, and compliance of the obligations mandated and protections afforded by ESG-minded contracts. Combined with other operational tools, the entire ESG lifecycle can be managed in a digital framework for ease of tracking, adherence, and reporting to all stakeholders.
While companies will always remain in control of internal practices, the public has begun to look toward business relationships to determine which companies align with their ideals holistically. It’s becoming less acceptable to operate with vendors and customers who are averse to those ideals. Whether it’s procuring from a raw material supplier with poor labor practices or selling to a customer with a negative environmental record, these relationships, governed by the contracts from which they originate, have increasingly become part of the assessment concerning ESG principles and a reflection on how serious a company is about those principles.
In the court of public opinion, how does your company want to be assessed?