Sustainability Regulatory Horizon: regulation’s role in the race for sustainable change

Sustainability has been rising up the corporate agenda in recent years. Business leaders are recognising both their responsibility to build more sustainable companies and the commercial benefits of doing so, with consumers increasingly favouring corporations with strong sustainability credentials. 

At the same time, international accords such as the Paris Agreement, pressure from some of the world's biggest investors, the shareholder/stakeholder debate and concern among central banks over the impact of climate change on financial stability are creating further impetus for change.

While it would have been easy for sustainability to take a back seat in the rush to repair economies damaged by COVID-19, the pandemic has strengthened the resolve of governments and corporations to ‘build back better’. The EU’s recovery plan is designed to boost sustainable technologies and business models, while the election of Joe Biden is already re-establishing the US as a key player in the response to the global climate emergency.

Regulators, especially in Europe but also across the world, are devising ways to incentivise more sustainable practices. For instance, biodiversity protection – protecting nature and reversing the degradation of ecosystems – is now recognised as important in building our societies’ resilience to future threats such as climate change, forest fires, food insecurity and disease outbreaks (including by restricting the illegal wildlife trade that can cause global pandemics). Accelerated by the recent pandemic, biodiversity protection has climbed up the agenda of regulators: the European Commission has for example recently launched a consultation to develop a legally binding instrument (Biodiversity strategy for 2030), which sets ‘concrete actions’ and EU targets to restore damaged ecosystems.

Measures have also been introduced to incorporate sustainability standards into global trade agreements, competition law, corporate finance, M&A and supply chain management, with further developments on the horizon.

How does sustainability regulation affect business?

Regulators will play a key role in accelerating the transition to a low-carbon future. Rules introduced in response to the Paris Agreement and the UN Sustainable Development Goals, coupled with growing investor interest are influencing relative asset values, making some fossil fuel reserves uneconomic to exploit and driving investment towards transformational technologies such as hydrogen fuel cells. These measures are another incentive for businesses to innovate (including by acquiring new technologies), with sustainable financing instruments – and in some cases state assistance – helping to provide the necessary capital.

Laws and regulations are also being used to protect human rights and the environment. Companies are now obliged to report what they are doing to identify human rights risks in their supply chains, and in some jurisdictions disclose the steps they are taking to address any issues they find.

Deforestation is another priority. The UK and the EU are considering how to address supply chains that contribute to deforestation, which, for business, places a premium on sophisticated due diligence, both to mitigate regulatory risk and to safeguard hard-won reputations.

Cross-border trade, too, is in the spotlight thanks to protective regulations like the EU's planned carbon border adjustment mechanism and because more free-trade agreements now include ambitious sustainability provisions. Even in the recent Brexit deal, both parties reaffirm their 'ambition of achieving economy-wide climate neutrality by 2050', among other sustainability-related commitments.

How can corporate leaders assess sustainability risk?

This fast-evolving landscape presents corporate leaders with a challenge. Not only do they have to track regulatory developments across the world, they must also understand how different sets of rules with national and extraterritorial reach apply across jurisdictions.

In addition, the lack of standardisation between the multiple mandatory and voluntary sustainability reporting systems requires careful judgement: striking the right balance between ensuring enough information is disclosed to counter accusations of greenwashing, but not disclosing so much that the business is exposed to additional risk.

And risk is not limited to specific sustainability regulations. Tackling global issues such as climate change requires collaboration, potentially between businesses in the same sector (horizontal collaboration). However, this type of co-operation is limited by competition law. In response, some authorities (including the European Commission) are considering whether their antitrust frameworks can be adapted to boost progress towards climate goals without disrupting markets.

Responding to sustainability regulation

Businesses should be assessing which regulations affect their business, and how. But there is also an opportunity to shape the direction of regulation through dialogue with regulators (for example by public consultations). Global players must also keep in mind the worldwide scope of some regulations.

Our Sustainability Regulatory Horizon is a framework to understand the fast-paced regulatory change that will be a hallmark of the race towards a sustainable future. Multiple Freshfields teams have collaborated to offer answers to the sustainability-related questions our clients are asking us, including on:

• policy and regulatory development and the impact of regulation on global trade;
• opportunities to finance the transformation, including state aid but also sustainable finance;
• the impact on M&A and collaboration projects;
• the social dimension of the transformation, including post-pandemic working; and
• environment and human rights related questions.