ESG is coming, and it’s time for midmarket manufacturers to prepare
To avoid being caught off guard, it’s essential that you understand how the changing ESG landscape might impact your business in the months to come.
The changing regulatory environment
The SEC is currently evaluating rule changes that will mandate disclosures pertaining to GHG emissions. Among other things, these regulations will require public companies to disclose information about their governance of GHG risks and their risk management processes. As public companies build out their ESG programs, many are requiring disclosures from their supply partners, and some are even requiring that certain ESG thresholds and scores be met to stay active as a supplier. If you’re a public company or you supply into one, it’s critical to understand that GHG — and potentially other nonfinancial disclosures — may soon be mandatory.
What are middle-market manufacturers being asked to disclose?
In many cases, OEMs and other large business partners are asking suppliers to disclose “Scope 3” data — data that’s related to the GHG emissions that the suppliers create or emit. The larger organization relies on the supplier to know what falls under Scope 3 and how to go about gathering it. This data could include emissions from vehicle fleets, the electricity for buildings, and any number of things that could be a material component of what you’re generating.
The requests often come in the form of a questionnaire generated by a recognized industry standards organization such as CDP, EcoVadis, or Manufacture 2030. But suppliers may also receive requests to provide data related to GHG emissions that fall outside of set standards.
How difficult it is to gather the data will depend on your operations. Large organizations typically know what they’re generating and how to count it, and many are already doing so. But many middle-market operations don’t even know where to start. Many don’t have the financial capacity to make major investments in technology and infrastructure to gather the necessary data, nor do they have the engineering expertise to perform the necessary calculations. It’s particularly challenging for those required to measure methane gas emissions — a large contributor to GHG.
Looking over the horizon, the disclosure requirements may expand to include an assurance component. For example, European regulators are currently considering expanding existing disclosure requirements and including the need to obtain third-party assurance. If this trend is adopted in the United States as part of the SEC’s proposed rule changes, disclosures could quickly go from a “check-the-box” type of a program to “data verification” by a third party.
While not directly ESG-related, the Inflation Reduction Act (IRA) provides a carrot for companies interested in investing in more sustainable operations. Financial incentives are available to help make your business more efficient, make it more attractive to do business with, and ultimately make it more valuable as going concern. IRA incentives include tax benefits, grants, and other initiatives to help middle-market companies improve energy efficiency within their operations. These are worth considering if your company is anticipating relevant upgrades and you’d like to make this a part of your wider ESG story.
All of these factors provide significant business reasons and opportunities to consider when evaluating an ESG program. As you decide on an approach for your company, make sure you view it from all angles to see what fits with your business and level of risk tolerance. Any one or combination of these factors could be enough to conclude that now is the time for your company to act.
Options for starting an ESG program
With change on the horizon, what ESG options are middle-market manufacturers considering at this time? The approach you choose will vary according to your industry, the nature of your operations, your stakeholders, and your level of risk aversion. However, most midmarket manufacturers are opting for one of the following alternatives.
The approach you choose will vary according to your industry, the nature of your operations, your stakeholders, and your level of risk aversion.
- Being an early adopter: Some companies are choosing to get out in front of it now and build out a formal ESG program. This may be a good option if you’re deeply rooted in the supply chain of a public company. If your business partners are making ESG disclosures that will in turn require disclosures from you, starting a program now may be a wise choice. Another consideration is future staffing of your organization. If you’re in a competitive environment for recruiting younger talent, a robust ESG program may be a significant determinant in where they choose to work.
- Wait and see: Some manufacturers are waiting to see what regulations ultimately come to pass and what their business partners will require before deciding on a path. In the meantime, they’re adopting a reactive approach and doing the minimum required. Depending on your industry and level of business risk, this approach may work. The caveat here is whether your organization will be able to ramp up quickly enough if the requirement to disclose comes unexpectedly.
- Start the planning process: A third alternative some manufacturers are considering is a middle-of-the-road approach that involves making some initial investments now to get a plan in place in anticipation of mandatory disclosures. This option can save some initial expense — such as implementing dedicated systems for gathering data — while still getting a baseline program in place to be ready to move when necessary. The extent of the plan depends on your individual risk factors and how nimble you are to respond quickly if need be.
A good way to approach these alternatives is to consider what will happen if you’re asked to make disclosures — or if you’re forced to. Will you be in a position to react? Many middle-market manufacturers are hedging by taking the third option — starting a plan now and building out their program over time. This choice helps spread out the investment and provides a reasonable starting place for companies that currently lack staffing capacity, the tools to aid in collection, or the know how to gather the data and ensure their computations are correct and accurate.
What does a minimalist program look like?
Setting up a full ESG reporting structure in line with strategic priorities typically involves a phased approach. But if you’re looking to start a minimalist plan now, you can get started with these three steps:
- Define your goals: What are you trying to accomplish, and how does it align with your strategic priorities?
- Identify your stakeholders: Who’s your target audience and what do they care about? These are the stakeholders you’ll keep in mind at each stage of developing your plan.
- Identify what topics are material to your organization: What ESG topics are relevant to your industry, size, and audience? Once you’ve identified your topics, you’ll do a gap assessment to understand what data you’re already collecting and what you’ll need to gather in the future. For example, if you’re focusing on GHG emissions you’ll want to know where your emissions are coming from, whether your company has a mechanism in place to track and count them, and how you’ll interpret the data once you have it.
When setting up your plan, start with an analysis of your business operations, then set targets and goals for disclosing, identify areas for improvement, and outline the specific actions necessary to build an ESG program over time. What your plan looks like will depend on your industry and organization. Focus on what you think will be critical to your company in the years to come — whether it’s responding to regulatory changes or the need to recruit the best talent, etc. — and go from there.
Whatever your approach, start thinking about it now and ensure you have the basic provisions in place to create a program. Even if you don’t push the start button now, what’s most important is being prepared in case you need to move quickly.