Carrot or Stick? What EU Investors and Startups Can Expect From New ESG Regulation
Highlighting the EU’s efforts to combat greenwashing and enforce the Corporate Sustainability Reporting Directive (CSRD), many are calling for clearer regulatory guidance to help investors and startups effectively integrate ESG principles.
As a representative of the Finnish fintech ecosystem, known for its deep commitment to the sustainability agenda, Lasse Mäkelä, chief strategy and IR officer at Multitude Group, promotes a purpose-driven approach to ESG implementation and suggests that clear regulation and standards can motivate companies to contribute positively to environmental and social goals, aligning ethical progress with business innovation.
It’s been a watershed few months for ESG and, more broadly, sweeping measures around environmental and social issues. Greenwashing is out, the Corporate Sustainability Reporting Directive (CSRD) is in, and both major pieces of EU legislation have sent major vibrations through a number of industries, including fintech.
The downside to this is that these legislations have arrived without a great deal of compliance guidance. What we need in addition to these pieces of legislation are not only measures to motivate companies to contribute positively to environmental and social goals (thus aligning ethical progress with business innovation), but clear standards around how to not run afoul of them to begin with.
More pressure, less clarity
With Multitude in the midst of annual report preparations, I’m even deeper than usual in the ESG world – and that’s coming from someone who isn’t even Multitude’s dedicated ESG Officer. But I’ve spent the better part of my career doing work that is always ESG-aware and often ESG-adjacent, and I’ve always believed in business and industry’s greater potential to generate profits for shareholders while saving the planet. This is something I’ve also seen prioritised by C-suites and leadership teams of businesses of all sizes. It seems nearly everyone wants to be on the right side of history on these issues.
This is a bigger-than-usual year for ESG-related concerns, what with the crossover concerning human rights and the escalating global conflicts in Europe and the Middle East, in addition to upcoming elections of enormous consequence in the United States and throughout the world.
Recent KPMG research has revealed that geopolitical concerns and political uncertainty have dethroned typical ESG issues on the top of the risk radar for chief executives worldwide. And that’s on top of the already world-shaking new frontiers around AI risks and controls, which recently took up serious airtime in the keynote address and space in the agenda at this year’s World Economic Forum in Davos.
It’s essential to recognise that the momentum behind ESG initiatives, especially in regions like Europe, is part of a broader and more organic trend that won’t be overhauled in any direction by individual policy decisions. The commitment to ESG principles will persist, continually reflecting a deep-seated recognition of the importance of sustainable development and corporate responsibility, despite the potential for policy fluctuations.
A critical observation is the increasing pressure not only on startups but on large investors too, who have stringent regulations requiring investments only in ESG-compliant companies. Some of these investors are looking at company-wide commitments, including in insignificant-seeming areas such as offering reusable cups instead of paper ones, sorting the trash in small office kitchens or keeping the lights out in office areas, where nobody has been for a minute or so. But in my discussions with them, they’ve also echoed something I’ve noticed in recent years: there’s a broader issue of understanding what constitutes an actually impactful measure. There’s a knowledge gap around precisely what actions will lead to significant environmental and social benefits. We need clearer inter-industry guidance on what constitutes meaningful ESG efforts.
New EU regulation on ESG: Greenwashing and CSRD
After years of increasing pressure to do so, the EU has at last handed down a piece of sweeping legislation banning greenwashing. Greenwashing – the deceptive marketing tactic in which goods or products are touted as environmentally friendly or sustainable without actually being environmentally friendly or sustainable – has been an escalating issue within consumer marketing for years now. That the EU has taken such a major step not only to address it but actually curb it is a net positive by any standard.
The legislation, which was announced last September and formally endorsed in January, takes aim primarily at what it refers to as ‘generic environmental claims’. It’s the consumer- and marketing-focused counterpart to another key piece of legislation within the scope of the EU’s green transition: the Corporate Sustainability Reporting Directive (CSRD).
The CSRD entered into force on 5 January 2024 year, with the first annual reports due in 2025. The directive aims to modernise rules concerning social and environmental information that companies are required to report. This includes large companies and all listed SMEs. The rules, according to EU publications, now “ensure that investors and other stakeholders have access to the information they need to assess the impact of companies on people and the environment and for investors to assess financial risks and opportunities arising from climate change and other sustainability issues”.
The greenwashing ban as it relates to marketing has gotten a bit more attention, just by virtue of its more public-facing nature. But the CSRD is its essential counterpart, and just as important. In the case of both new sets of legislation, which also means as it concerns both ESG compliance officers and marketing teams, regulatory clarity from the EU will be nothing short of essential. Unfortunately, it’s already lacking.
The scope of the CSRD is massive, covering everything related to environmental matters, social matters and employee treatment, human rights, anti-corruption and bribery, and company-board diversity (encompassing age, gender, educational and professional background). The stakes around successfully navigating the waters in terms of accountability are now incredibly high.
No one is opposed to the greenwashing ban or the new CSRD requirements on their own merits. Addressing both of these issues head-on is a progressive, ethical step forward aimed at making our planet liveable for generations to come. But in doing so without establishing guidelines as clear as they could be, the EU has created a regulatory minefield for companies that are otherwise ready and willing to be as ESG compliant as possible. The investments to create new ways of collecting data, verifying it and auditing it with new compliance functions are costly and these decisions are difficult to make until it is clear how CSRD will be enforced.
Big mess in ESG measurement
I’ve witnessed firsthand the high level of frustration among business leaders whose aims to contribute positively to the planet seem to run contrary to their business operations and interests. They often express a desire for a unified standard or a clear directive on what exactly needs to be focused on, whether it’s solely carbon footprint or other aspects of the environmental, social, and governance factors that comprise ESG. The sheer scope of ESG tends to breed confusion, even among companies that genuinely want straightforward instructions to ensure compliance.
The first challenge is accurately measuring ESG compliance. There are many ESG agencies, often under the umbrella of risk assessment companies like Fitch, Standard & Poor’s, and Moody’s. These services nevertheless remain distinct; Multitude, for instance, is rated by Fitch with a bond rating that includes some (but not all) aspects related to ESG.
Obtaining a dedicated ESG rating would require engaging with their separate ESG service, essentially investing in a comprehensive assessment. Various ESG rating agencies have conflicting standards and recommendations, creating confusion among companies about which guidelines to follow and whether the cost of compliance is justified by the benefits. These agencies offer different funding models and business models, which can affect a company’s visibility in ESG rankings.
Adding to the complexity is the impact of global conflicts on ESG perceptions, particularly regarding investments in the defence sector. Previously, ESG principles typically discouraged investments in military equipment, but current events have shifted opinions, suggesting a need for more nuanced ESG considerations. This evolving situation has led some companies to reassess their stance on ESG, especially on defence investments, reflecting the dynamic and often confusing environment surrounding ESG compliance and reporting.
Driven by passion, not by enforcement
From the regulators’ perspective, I think the carrot is more important than the stick when it comes to ESG implementation. The current state of regulations appears somewhat chaotic, creating a scenario where there’s a strong desire to engage in sustainable practices, yet there’s uncertainty on how to proceed.
Early-stage startups usually embrace these values instinctively, already driven by a passion to effect positive change in the world without the need for stringent regulations. These startups, along with more established companies, seek straightforward, actionable targets and a coherent regulatory framework. If the guidelines were clear and feasible, companies would be lining up to meet these standards. The key is ensuring that these frameworks are sensible and practical for businesses to implement.
My stance leans towards encouraging companies to voluntarily adopt ESG principles, particularly in the startup and growth company sectors, where a strong sense of purpose is both vital and already present. This sense of purpose is not only crucial for motivating teams, who often work for lower salaries, but also for the company’s overall commitment to making a positive impact. A compelling example is a company named Naava, known for creating green walls that purify air within office spaces, serving both as a functional and aesthetic addition. These green walls symbolise bringing nature indoors, highlighting how businesses can integrate ESG values into their core mission without necessarily seeking formal ratings from ESG agencies. Such companies demonstrate that adopting ESG principles as part of their culture can drive both purpose and profit.
The concern for maintaining a strong reputation and appealing to potential investors often outweighs the deterrent of regulatory fines – put together, it’s hugely motivating. Even so, there remains a significant need for clearer guidelines on what constitutes impactful ESG initiatives. With assessing ESG contributions across sectors in disarray, it’s a complex challenge by any measurement. But change begins with clarity.
