8 ESG Legal Risks to Consider in Transaction Documents
According to the consulting firm Bain, “Covid-19 was a dress rehearsal for climate change”. Unfortunately, this statement stands true, and we can’t deny the impact of the pandemic on the lives of millions around the world.
But while 2020 was a year of pandemic and a havoc situation, it was also a time when the environmental, social and governance (ESG) agenda became an essential topic of discussion among businesses worldwide.
ESG is a complex topic that covers various areas. But majorly, it revolves around a primary aspect: the identification and mitigation of ESG legal risks.
If you haven't come across such risks before, this article will help you understand them. So, dig in to explore eight main ESG legal risks to consider in transaction documents.
What is the Environmental, Social and Governance (ESG) Agenda?
Only a few years back, initiatives like corporate social responsibility were championed by consumers and employees in most organizations. Simultaneously, problems such as ethical supply chains and carbon footprints were under strict scrutinization.
Yet, many companies never considered such factors as a vital part of their business objectives. Moreover, most organizations never seriously regulated these issues.
But today, perceptions have changed, and ESG has taken a center table in most boardrooms. Thankfully, many stakeholders have finally realized the impact of environmental, social and governance risks on their profitability and business reputation.
ESG is a combination of business standards that many investors use to screen upcoming investments. The environmental, social and governance aspect in ESG stands for the following:
Environmental: These measures highlight the way in which a company responds to problems related to greenhouse gas emissions, climate change, green products, and water conservation. Environmental measures also help evaluate all kinds of environmental risks that an organization might face.
Social: These benchmarks assess the relationships of a business. Additionally, these factors measure the organization’s responses against stakeholder interests, safety, privacy, and diversity. This and governance are commonly known as corporate social responsibility.
Governance: This aspect refers to a business’s focus on transparency regarding its financial reporting and communication. Moreover, it also highlights the independence of senior management, executive compensation, and proxy access. Besides, governance measures confirm the business's legal dealings and absence of conflict of interest while selecting board members.
8 ESG Legal Risks to Consider in Transaction Documents
When dealing with an organization as a customer or a supplier, these are some of the ESG legal risks that you should consider before signing the transaction documents:
Increased Severity of Unfortunate Weather Events
It is a physical risk that revolves around climate change. The risk of extreme weather conditions can alter business activities in many ways.
For instance, severe flooding can disrupt technology and automotive supply chains. As a result, many organizations can face substantial economic damage and a hit to their profitability.
It is imperative to consider this risk in transaction documents so that all the employees, stakeholders, and suppliers can take measures in their own ways to reduce this risk.
A New Technology Failure and a Loss in Investment
This ESG legal risk is related to the wrong implementation of a new technology. To improve their structure and work ethics, many organizations introduce technologically advanced systems in their companies. But, unfortunately, not all of these are successful.
The failure often results in the loss of significant investment that many organizations fail to pay off. As a result, they either have to file for bankruptcy or take loans from banks that create further issues for their financial position.
Change in Customer Preference or Perception
If you run a business and often perform regular market research, you should have noticed that customer preferences and perceptions change with time. This is one of the ESG legal risks you can’t control but may manage to meet consumer demands.
However, many businesses stick to their product portfolio regardless of what their consumer wants. And as a result, they suffer a loss in their sales and build a negative reputation for themselves.
Cost Incurred While Transitioning to Technology with Lower Emissions
Shifting from one technology to another involves lots of risks. For instance, initial investment, installation of new technology, maintenance, and training costs of people managing the new system are some of the major costs. And if unfortunately, the shift doesn’t work for the organization's benefit, the loss comes as a burden rather than a learning experience.
Moreover, sometimes a shift to lower emissions products reduces the sale of existing products. While this is great for the environment, businesses may suffer a massive loss with this demand change.
Increased Temperatures in Oceans
This environmental risk can result in a significant loss in biodiversity. In addition, it negatively impacts fish stocks that, as a result, affect the well-being and livelihood of the fishing communities.
Increased Raw Material Costs
Inflation is a considerable risk to businesses, and it not only impacts their profitability but also harms the quality of their production. Unfortunately, many organizations do not foresee this risk and plan their costs according to the current scenario.
But when hit by inflation, businesses often reduce or even stop their employees' pays from meeting their profit targets. This action is not only ethically wrong but also harms the livelihood of many poor individuals.
A Failure to Comply with Human Rights
One of the social risks associated with business is a failure to comply with human rights. This includes an inability of the organizations to pay minimum wages and provide safe and secure environments to their employees. If not mitigated, this risk can harm the reputation of the organization and may also affect employee retention rate.
Dangerous Levels of Water Contaminations
In 2011, Flint, Michigan, faced an extreme water crisis. The domestic water supply was contaminated with high levels of metal, resulting in costs of more than $1.5 billion.
In addition, since relevant companies did nothing to reduce this risk on time, it led to various health complications within the community. This again is a primary environmental risk that most water companies face.
Why Is it Important to Consider ESG Legal Risks
There are many benefits of considering ESG legal risks in your transaction documents. This consideration helps identify, manage, and mitigate the factors that can negatively affect your business plans.
Here are some ways your business can benefit from managing these risks:
Experience Enhanced Sustainability
With a clear view of risks associated with environmental, social and governance aspects, you can allocate your resources in a better way. This means that you can prepare your business to fight against a rise in material prices, poor employee retention rates, and non-compliance with legal obligations.
Enjoy Increased Profitability
A business that effectively identifies and mitigates its risks is better positioned to achieve its profitability goals. Therefore, people looking to invest in sustainable funds find ESG-conscious businesses quite attractive.
Moreover, such organizations also grab the attention of customers looking for environmentally friendly and sustainable products.
Improve Employee Productivity
ESG legal risks such as a change in technology can have a significant impact on employee retention. However, one can mitigate this risk by creating an environment with purpose throughout the organization.
In addition, many employees take an ESG-focused business as a means of giving back, which then creates an enthusiasm to work for the betterment of this planet.
Increased Investor Interest
Organizations that work towards mitigating their ESG legal risks often succeed with attracting attention from top investors. It is because investments in ESG-focused organizations generate good returns and make investors feel good about their stocks.
If you plan to run a business or an organization, considering ESG legal risks is as important as identifying financial risks. Discussing and implementing the environmental, social and governance plan plays a significant role in achieving your business's objectives.
This article has listed some of the primary ESG legal risks that you may face within your organization. If you do, curate a plan to mitigate and manage them before things get out of control.