April 18, 2024
6
minutes

Why ESG is Becoming More of a Concern for Vendor Assessments

The modern business landscape is getting increasingly complex. An example of this increasing complexity is how Environmental, Social, and Governance (ESG) considerations are becoming more of an interest in industrial partnerships and vendor management. As early as 2021, industry thought leaders began highlighting the role of ESG principles in enhancing B2B ecosystems.

ESG today, is an essential consideration in managing business relationships, mitigating risk, and promoting sustainable and responsible practices within the business community. It also reflects a growing recognition of the risks associated with poor ESG performance, including regulatory penalties and damage to reputation. But what macro factors are contributing to this increasing interest in ESG across B2B relations and vendor management?

Major Factors Driving ESG Interest

Regulatory Pressure

One of the more visible causes of increased ESG interest is the introduction of more stringent regulatory requirements across industries. Around the world, governments and regulatory bodies are implementing stricter regulations related to environmental protection, social responsibility, and corporate governance. Businesses therefore, are required to to ensure that their operations and those of their partners comply with these regulations to avoid fines, sanctions, and damage to reputation.

Some recent regulatory examples include:

Corporate Sustainability Reporting Directive (CSRD)

Introduced by the European Union (EU), CSRD makes it mandatory for all companies to disclose how environmental and social changes are handled. Officially implemented in January of 2023, it aims to standardize sustainability reporting, making it as rigorous as financial reporting. Additionally, the European Commission's European Sustainability Reporting Standards (ESRS), which was developed as a part of CSRD, provides detailed guidance on reporting around impacts to environment and society.

Sustainability reporting standards from International Sustainability Standards Board (ISSB)

ISSB aims to develop and promote globally consistent sustainability reporting standards. By developing these standards, the ISSB aims to ensure that investors have reliable and comparable information to make informed decisions.

Sustainable Finance Disclosure Regulation (SFDR)

SFDR aims to increase transparency in the financial market regarding sustainability. Implemented in March 2021, the SFDR requires financial market participants, including asset managers and financial advisors, to disclose the sustainability impacts of their investment products and decisions.

Singapore's Green Finance Action Plan

The plan is designed to guide banks, asset managers, and insurers with disclosure requirements. This initiative is part of a broader strategy to integrate environmental considerations into the financial sector, promoting sustainability across economic activities and supporting Asia's transition to a net-zero future.

California’s Climate Accountability Package

The package mandates that companies provide more detailed reporting on their greenhouse gas emissions and the financial risks associated with climate change. This introduces legislation aiming to provide greater transparency regarding the carbon footprint of major corporations and enforce accountability by making information publicly accessible. Companies are also required to report on financial risks posed by climate change.

Investor Expectations

Naturally, as new regulations are introduced on  how businesses operate and report, they have had implications on public and investor expectations. There is a growing demand from consumers, investors, and the public for companies to operate responsibly and sustainably.

Investors, in particular, are increasingly integrating ESG criteria into their investment decisions. This is a result of both regulatory developments and changing market perceptions of what contributes to long-term value creation. Ernst & Young notes that aligning shareholder and stakeholder priorities leads to sustainable value creation for both.

A PwC survey implies that simply investing in ESG isn’t enough. Companies must be able to prove the impact of their ESG initiatives through data-driven reporting. In the report, close to 80% of surveyed investors considered ESG factors significant in decision-making while around 50% were ready to divest from companies not adequately addressing ESG issues.

In 2020, Larry Fink (CEO, BlackRock) announced BlackRock’s intention to exit investments with high sustainability-related risks. BlackRock’s move is not merely a reactive one. Fink highlights the firm’s intentions, “BlackRock has joined with France, Germany, and global foundations to establish the Climate Finance Partnership, which is one of several public-private efforts to improve financing mechanisms for infrastructure investment. [...] In the short term, some of the work to mitigate climate risk could create more economic activity. Yet we are facing the ultimate long-term problem. We don’t yet know which predictions about the climate will be most accurate, nor what effects we have failed to consider. But there is no denying the direction we are heading.”

Market Competitiveness

Today, it is not just about how a company manages its own operations but also the partners and vendors it works with. With increased public interest and expectations, demonstrating a commitment to ESG becomes a differentiator for businesses, helping them attract and retain customers, partners, and employees who prioritize sustainability and ethical business practices. Consumers are increasingly interested in brands that prioritize ESG and reflect sustainability in their branding. Companies that engage with vendors and partners who adhere to high ESG standards can boost their own reputations by association.

One of the most popular examples of this might be the effects of sustainability focus on Patagonia’s brand loyalty. Known for its commitment to environmental sustainability and ethical practices, the brand differentiates itself by using recycled materials and donating a percentage of its profits to environmental causes. The company has cultivated a strong brand loyalty among a dedicated customer base.

Benefits of ESG-prioritization can also be seen elsewhere as a result of government incentives and policies. For example, Tesla became the automotive company that popularized environmentally sustainable electric vehicles as a viable means of transport. Their exclusive focus on EVs also resulted in substantial tax incentives and regulatory benefits. This, in turn, contributed to their market valuation and competitive edge over other manufacturers.

Perhaps more importantly, avoiding partnerships and third party vendors that have a poor reputation in terms of ESG could help businesses avoid negative impacts to their own reputation. Assessing ESG factors in the supply chain can also help companies anticipate and mitigate risks that could disrupt business operations. For instance, Nike assesses potential vendors on various ESG aspects such as labor practices and environmental impact to mitigate risks of regulatory non-compliance and reputational damage that could arise from negative practices in its supply chain. This proactive approach not only safeguards against potential business interruptions but also ensures long-term sustainability.

Conclusion

The incorporation of ESG considerations into vendor assessments and B2B relations is not just a short-term trend, but an evolution in the way businesses operate. Increased regulatory pressures, changing investor expectations, and the pursuit of market competitiveness are driving this shift. Companies that proactively integrate ESG factors into their vendor assessments not only mitigate risks but also enhance their reputation and contribute to sustainable and responsible business practices.

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Raunak Chaudhari
Marketing Manager