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The (geo)politicized environment around ESG is increasingly intersecting

Natalie Runyon  Director / ESG content & Advisory Services / Thomson Reuters Institute

· 5 minute read

Natalie Runyon  Director / ESG content & Advisory Services / Thomson Reuters Institute

· 5 minute read

As the political landscape continues to evolve, companies must navigate shifting priorities and potential regulatory changes in the ESG space, while also preparing for geopolitical risks and incorporating sustainability considerations into their strategic planning to ensure long-term success

Earlier this year, the Thomson Reuters Institute predicted that the politicized landscape around environmental, social & governance (ESG) issues would continue. As the second half of the year approaches, the political climate is likely to introduce varying dynamics that could affect ESG-related legislation and policymaking, according to the Thomson Reuters Practical Law Spring/Summer Outlook.

The European Union recently felt the impact of political discord as it advanced legislation related to ESG criteria; in particular, the scope of the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) was narrowed after Germany and Italy indicated they would abstain during the adoption process in February and March. One of the most significant changes that resulted from negotiations in the final CSDDD agreement was the dramatically reduced scope of impacted companies. And this is happening amid already varying regulatory approaches in the United Kingdom and the EU.

At the same time, pro-ESG and anti-ESG moves by some US states continue — and with elections in the US and UK on the horizon, it is likely that the pace of legislative progress will slow even further, and these political debates will likely intensify divisions.

If there is another President Trump administration, there is talk about a dramatic across-the-board movement of de-regulation, which could have negative implications for the impact of the extra-territorial pro-sustainability laws coming out of the EU.

Macroeconomic realities make consistent ESG policy unlikely

In fact, the sustainability policy agenda is likely to face considerable challenges globally due to a range of macroeconomic issues. Election years intensify the pressure on political candidates to address immediate economic concerns, which include combatting inflation, limiting growing federal deficits and debt, and managing unemployment. All of these challenges reduce the urgency of the sustainability agenda in the near term. And advances by the right wing in the recent European Parliament elections “will make it harder to pass ambitious EU climate policies, but the majority of Europe’s current world-leading green policies are likely to stay put.”

Further, business compliance costs are also a significant factor, with some resistance to ESG measures stemming from concerns over their financial implications. In fact, some companies are weighing the cost of non-compliance for the early years of the EU’s Corporate Sustainability Reporting Directive (CSRD) as a legitimate strategy. One recent report quoted a business executive saying: “From talking to peers in my sector, I know of several businesses debating how much the financial penalties might be [for non-compliance] when compared to the cost of compliance and weighing these up… and seriously considering not reporting against CSRD for a few years.”

Geopolitical factors add long term complexity

Long term, geopolitical factors — such as international trade relationships and global power dynamics — also can introduce ongoing challenges and uncertainties that could potentially impact the success of an ESG project or initiative. Countries that boast a historical record of prioritizing issues falling within the environmental and social sphere — or the E and S of ESG — are likely to emerge as more desirable trading counterparts. Conversely, high conflict areas in the global southern hemisphere may be less desirable. Unfortunately, those areas also are major sources of critical rare minerals, such as lithium, that are in short supply around the world because of the demand for use in mobile phones and smart vehicles.

What may be more concerning, however, is that markets around the world might not be accounting for today’s geopolitical risks. “Stock markets sometimes are underestimating the potential impact of geopolitical risks that are there,” said the European Central Bank Vice-President Luis de Guindos. Remarkably, despite numerous countries facing elections this year and the continuing conflicts in the Middle East and Ukraine, stock markets have climbed to unprecedented levels this year.

Many ESG proponents are hoping that these elections result in governmental leaders that are accountable, act ethically and with openness, and recognize that many of these principles are fundamental to attaining both national safety and economic prosperity. Hope is not a plan, of course, but there are actions that compliance & risk professionals can take now that might reduce the potential impact.

Get educated on geopolitical risk — Based on where their companies have operations, corporate risk professionals need to understand the local, national, and transnational policies and decisions, including territorial conflicts, that could impact their organizations.

Prepare for regulatory changes and uncertainties — As political climates shift, especially with upcoming critical elections in the US and UK, corporate risk professionals should prepare for a potential slowdown in legislative progress and the possibility of further deregulation. This preparation might include scenario-planning and the development of flexible strategies that can adapt to rapid policy changes. Companies should also be ready to respond to any increases in litigation or reputational risks that may arise due to investigative reporting or stalled legislative processes.

Incorporate geopolitical risks into sustainability planning — Potential impact of geopolitical factors — such as international trade relationships, global power dynamics, and conflicts over rare minerals — may impact the long-term success of many companies’ sustainability initiatives. Corporate compliance & risk professionals should incorporate these geopolitical concerns into their risk assessments and strategic planning processes to ensure that their companies’ sustainability efforts are resilient and adaptable to changing global dynamics.

It’s important to note that all of these actions should be tailored to the specific circumstances and priorities of each company and should be undertaken in consultation with relevant stakeholders and subject matter experts.

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