Endangering Societal Growth
The pendulem swings on ESG rules.
“𝘛𝘩𝘦 𝘤𝘭𝘰𝘴𝘦𝘳 𝘵𝘩𝘦 𝘤𝘰𝘭𝘭𝘢𝘱𝘴𝘦 𝘰𝘧 𝘵𝘩𝘦 𝘌𝘮𝘱𝘪𝘳𝘦, 𝘵𝘩𝘦 𝘤𝘳𝘢𝘻𝘪𝘦𝘳 𝘪𝘵𝘴 𝘭𝘢𝘸𝘴 𝘢𝘳𝘦.” ― Marcus Tullius Cicero
I guess the irony would be complete if the EU would move its headquarters from Brussels to Rome - but I will make do with the fact that it is the Italian "technocrat" Mario Dragi who had the unenviable task of pointing out the obvious. Namely, that the EU is losing competitiveness thanks to various factors (including my old chestnut - high energy prices) but also lack of innovation and excessive regulations. Unsurprisingly, Dragi's report was given short shrift in many areas due to concerns over funding, deregulation, and potential threats to workers' rights.
Nowhere is the trade-off of regulation vs. action more clear than in the broad context of ESG. Let's be clear, without checks and balances the animal spirits of capitalism would run roughshod over workers rights, governance, enviroment etc. That said, how much regulation is too much?
Luxury Beliefs
In the 2015-2019 era - before the European energy crisis, before the invasion of Ukraine, before Covid, before the cost of living crisis - the comfort of stability and growth lulled people into thinking that good intentions were never enough. Nobody wants children mining critical minerals so they can drive their EV - so corporations should be made to consider human rights abuses not just in their operations, but all the way down their supply chains. CO2 emissions should be audited all the way down the chain…
The intention is unassailable, but this raises two questions - how far down the rabbit hole do you go and what is the cost?
Obviously, the N-1 subcontractor can be audited and pressure can be applied to them to ensure good ESG compliance - but push this logic to the extreme - how about the company that makes the pencils that your subcontractor uses? Do they ensure that the wood used in the pencils is sustainable, the graphite has no toxic waste issues? How far down the rabbit hole? What is reasonable.1
The Rabbit Hole
The European Corporate Sustainability Reporting Directive (CSRD) requires companies to report on sustainability impacts, risks, and opportunities across their entire value chain, which includes both upstream and downstream activities. However, the directive does not specify a fixed number of tiers or levels of subcontractors that must be included, such as "first-tier" or "second-tier" subcontractors. Instead, the extent of reporting depends on the concept of materiality, meaning companies must include subcontractors at any level where their activities are deemed to have material environmental, social, or governance (ESG) impacts, risks, or opportunities relevant to the reporting company.
This materiality is determined through a double materiality assessment, which evaluates both how sustainability issues affect the company (financial materiality) and how the company's activities, including those of its subcontractors, impact people and the environment (impact materiality). For example, if a subcontractor's operations significantly contribute to Scope 3 greenhouse gas emissions, human rights violations, or other material ESG issues, those impacts must be reported, regardless of how far down the chain the subcontractor is.
Open-ended and open to interpretation - coupled with massive potential fines. No wonder companies with clout are pushing-back.
The intention is good - to ensure accountability, the impact is clearly harder to ensure in the real world.
The Cost
An army of consultants will provide an ESG score-card that investors will use to judge, many of the same consultancies will offer services (at a healthy cost) to help you improve that score card. Al Capone would be proud - much of this business is oddly reminiscent of gangsters getting protection money. On top of the cost of consultants, there is the in-house cost of resources being tied up in data gathering, reporting and legal compliance. To be clear, much of this is good sense and is typically done anyway - the problem arises when the requirements become excessive and onerous and disproportionately affect the ability of a company to do its core business.
Not surprisingly, people who are not in business - the classic NGOs - “Non-Governmental” but also usually “not-for-profit” - are those most vocal about the need for the regulations. When money is free (and most of these NGOs are grant funded, many ironically by governments…. but I digress) it is easy to be utopian in one’s views, and see the need for regulation without considering the (unintended) impact(s).
“If confirmed, this is reckless," Maria van der Heide, head of EU policy at NGO ShareAction, said on Saturday. "Sustainability laws designed to tackle the most pressing crises — climate breakdown, human rights abuses, corporate exploitation — are being crossed out behind closed doors and at record speed. This is not simplification, it’s pure deregulation." (Politico)
Taken to the extreme, the only way to be compliant is to close your business. Indeed, it sometimes appears that the unstated objectives of some of the regulations is “death by a thousand cuts” to anything that doesn’t have the Green Dream stamp of approval. This, of course, trips up because there is no such thing as zero impact in E, S or G., so eventually every business has some “impact”.
In the meantime, productivity and competitiveness are being destroyed by well meaning people “who produce nothing”.
“…when you see that in order to produce, you need to obtain permission from men who produce nothing—when you see that money is flowing to those who deal, not in goods, but in favors—when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you—when you see corruption being rewarded and honesty becoming a self-sacrifice—you may know that your society is doomed.” Ayn Rand
A Leaked Draft - A Ray Of Hope
According to a leaked draft obtained by Politico, the European Commission is set to propose significant reductions to the EU's environmental reporting requirements as part of an omnibus legislation aimed at reducing regulatory burdens and enhancing economic competitiveness.
The proposed changes would exempt many businesses from sustainability reporting under the Corporate Sustainability Reporting Directive (CSRD), limiting its scope to only the largest companies with over 1,000 employees and €450 million in turnover, delay its implementation by a year, and significantly weaken due diligence obligations by requiring companies to monitor only direct suppliers. This has, of course, prompted concerns from environmental groups about diminished corporate accountability as quoted above.
Whilst this is a necessary return of the pendulum from the “extreme” positions favoured back in 2019, it is only part of the work that the EU needs to do.
More on that in a subsequent post!
Excellent.
The EU is fast becoming obsolete. Out of touch with economic reality and destructive policy making are taking its toll. How long until member countries exit the group?