ESG Is Over — As We Know It

Corporate sustainability continues to evolve, and keeping pace in 2024 means confronting five big questions.

For proponents of ESG (environmental, social & governance), 2023 might have felt like a big setback. Asset management giants scaled back their climate commitments and supported fewer ESG-centered shareholder proposals.

At least 14 states passed anti-ESG legislation prohibiting or restricting investors from considering ESG factors when investing public funds. This year’s class of new corporate directors was less diverse than last year’s in terms of both race/ethnicity and gender. Global fossil-fuel production rose despite pledges from world leaders to reduce emissions. Even vocal ESG evangelist Larry Fink of BlackRock declared that he would no longer use the term ESG due to its politicization.

In the run-up to the pandemic and through 2022, ESG as an acronym became widely used. But until 2023, this use was largely unchecked. The term evolved to mean everything to every company, which in turn led to it meaning very little to those trying to isolate the signal from the noise.

Countless companies — from corporate issuers to fund managers — jumped on the ESG bandwagon, claiming to be following ESG principles or selling ESG products, with few guardrails in place to ensure bold proclamations were not just feel-good statements divorced from business strategy (or reality).

Nevertheless, reports of ESG’s demise have been greatly exaggerated. Heading into 2024, the issues that the acronym actually represents, such as being a good steward to the planet, treating employees equitably and the supply chain ethically, and ensuring management teams and boards properly oversee their responsibilities, remain deeply important to consumers, shareholders, and regulators alike.

However, the way that these constituencies think about ESG issues — and how they talk about them — has evolved substantially, leaving companies with big questions to consider as they prepare for the year ahead.

Below, we present five key considerations for your business leading into the new year.

1. Welcome to the Hotel California: Have you already checked in?

Despite the blowback on ESG and some stakeholders pulling back on their ESG-related demands in 2023, California boldly pushed ahead with aggressive climate change action. This included passing new, aggressive climate disclosure laws that make the greenhouse gas “GHG” emissions reporting requirements of the Securities and Exchange Commission’s (“SEC”) climate-related disclosure proposal (and potentially its final rule) look modest in comparison.

California’s new climate disclosure laws will require large companies “doing business” in the state to disclose and verify their full scope GHG emissions (Scopes 1, 2, and 3) and prepare public reports on their climate-related financial risks and efforts to mitigate them. The first reporting required under the laws will be due in 2026.

Absent successful legal challenges, very few large companies — public or private — will be able to escape California’s new laws. While the laws do not define what “doing business” in California means, the legislative history indicates the term is intended to cover companies engaging in any transaction for the purpose of financial gain within California, being organized or commercially domiciled in California, or having California sales in excess of $610,395, or property or payroll in excess of $61,040.

Sound expansive? It should. One of the laws’ sponsors, Senator Scott Wiener, told Vinson & Elkins that the laws’ nexus requirements to California are intentionally broad. For companies of requisite size with relatively de minimis ties to the world’s 5th largest economy, it will be difficult to evade falling under these new legal frameworks. Companies should plan for an aggressive approach to implementation of these laws.

Beyond these climate reporting requirements, California also adopted a law creating new reporting obligations related to voluntary carbon offsets. The law takes effect on January 1, 2024, and applies to certain businesses regardless of their size, that market or sell voluntary carbon offsets in the state, purchase or use voluntary carbon offsets and make emissions-related claims (e.g., achievement of net zero emissions or that an entity or product is “carbon neutral”) within the state, or make emissions-related marketing claims within the state.

The law did not include a compliance deadline, but Assemblymember Jesse Gabriel, the sponsor of the bill, recently sent a letter to the Chief Clerk of the California Assembly seeking to clarify that the intent of the law was for the first reporting to be due by January 1, 2025.

The assemblymember also noted his intention to send a formal letter to the Assembly Daily Journal, a forum routinely used to express legislative intent (e.g., explaining ambiguities to a given law), when the State Assembly reconvenes on January 3, 2024.

Given the fast-approaching deadlines for compliance with California’s new laws, companies should undertake assessments to determine the applicability of the laws to their businesses. And for those companies that determine that they are already staying at the Hotel California, it will be important to begin gathering data and preparing for disclosure in 2024.

2. You can check out any time you like, but can you ever leave (ESG reporting)?

Even companies that seek to sever ties to California and run for the door may not find much relief. Macro trends are continuing to push companies towards ESG-related reporting, with many of the pressures coming directly from regulators.

For example, notable states like New York may soon follow California’s lead. And still, those voices are calling from far away: companies that operate in the European Union (“EU”) may soon be ensnared by the requirements of the Corporate Sustainability Reporting Directive (“CSRD”), which will obligate companies falling within its scope to provide a range of ESG-related disclosures (e.g., on environmental sustainability, human rights, and governance).

As of the date of publication, the SEC has yet to finalize its climate-related disclosure rule and it is not certain how the final rule will differ from the proposed rule; however, the Chair of the SEC has indicated that the SEC may collaborate with the EU to streamline the process for companies to comply with the overlapping climate reporting requirements of the SEC’s rule and the CSRD.

Note that the SEC recently updated its Fall 2023 Regulatory Agenda to reflect an estimated deadline of April 2024 for the adoption of the climate-related disclosure rule, but the agenda dates do not represent strict deadlines and a final rule could be dropped before or after next April.

Furthermore, while the ESG acronym may be falling out of favor in some circles, investors are continuing to call for ESG-related disclosure, even if by another name. For example, despite walking away from the term “ESG,” Larry Fink stated that BlackRock has not changed its stance on ESG reporting expectations.¹

Additionally, the volume of ESG-related shareholder proposals submitted in 2023 remained at an all-time-high, with the number of environmental-related proposals trending up, and we expect a similar number of ESG-related proposals during the 2024 proxy season. In fact, we have already seen a number of proposals this winter asking companies to make disclosures around methane and Scope 1 and 2 GHG emissions.

While support for ESG shareholder proposals has generally trended downward since peaking in 2021 (despite the number of proposals trending up), companies should continue showing appropriate responsiveness and engagement with their shareholders, lest they be caught on the wrong side of a proxy vote and be faced with potential repercussions on subsequent director votes.

Finding a passage back to the place before ESG-related reporting became mainstream won’t be easy. At the state, national, and global levels, the web of ESG-reporting frameworks continues to grow, with each addition often conflicting with the last, and California’s new climate laws add yet another layer of complexity. So, however a company may feel about ESG, getting its house in order for ESG-related disclosure is a must in 2024.

Companies will need to report ESG-related data that is accurate, complete, and precise. Companies will therefore need processes for collecting, verifying, and disclosing ESG-related data, as well as managing the associated risks. Implementing robust internal controls will be essential, as will collaborating across departments, conducting rigorous due diligence, and negotiating supplier agreements to ensure that validation and indemnification are in place.

Amassing these capabilities is an expensive and time-consuming endeavor that requires substantial investments in education, upskilling, and tools at every level of the organization. Many companies don’t know where to begin, and even some that have the contours of a plan in place are unprepared to implement it.

It is therefore important that companies start thinking as soon as possible about how they will get properly settled into Hotel California, because there’s plenty of room and we’re all going to be here for a while.

3. Decoding SCOTUS: What now for corporate DE&I programs?

When the Supreme Court struck down race-based affirmative action programs in college admissions this summer, many wondered how the ruling would affect corporate diversity, equity, and inclusion (“DE&I”) programs. The short answer is that it doesn’t (directly): the legal framework governing affirmative action in higher education doesn’t apply to companies’ employment decisions. Yet, the Supreme Court’s opinion has sharpened scrutiny of DE&I programs and emboldened their opponents, including activist investors, state attorneys general, and private litigants, to challenge them.

In 2024, companies should review their DE&I policies and programs to ensure that they comply with applicable employment anti-discrimination laws. Companies should also consider the priorities of their investors in undertaking such reviews, as institutional investors continue to emphasize the importance of DE&I goals and initiatives to the creation of long-term shareholder value.²

The focus here should be on avoiding practices that look like quotas or making preferential employment decisions based on protected characteristics, and instead should tie DE&I policies and programs to the company’s strategy and bottom-line enhancing outcomes (e.g., boosting employee engagement or delivering more relevant products or services to customers). Expanding diversity strategies beyond numeric targets — and leaning into concepts like inclusion, accessibility, and belonging — will be important in the new year.

4. Going green(washing): Where will the FTC land?

Companies have long sought to promote their green bona fides, but in recent years their claims have seen significant scrutiny. Such critiques include allegations of greenwashing in nearly every major industry. With the Federal Trade Commission (“FTC”) likely to update its Green Guides in the near future (public comments on the guides closed in April 2023), look for greenwashing scrutiny to intensify — and for greenwashing allegations to rise — in 2024.

Last updated in 2012, the Green Guides describe the types of environmental claims that could be deemed unfair or deceptive, and plaintiffs rely on this guidance to bring greenwashing lawsuits. If, as is widely expected, the new updates more directly sweep in enterprise ESG commitments like net-zero goals and other sustainability initiatives, companies could find themselves in jeopardy not just in terms of legal liability, but also for serious harm to their brands and reputations.

Many companies have yet to fully vet their ESG-related statements — many of which appear in nontraditional marketing materials such as sustainability reports. It would be wise for such companies to have their counsel give these statements a comprehensive review. Indeed, the FTC’s recent assertive posture suggests that it may take a prescriptive approach with the revised Green Guides, one that could strengthen the hand of private plaintiffs and expand the FTC’s latitude to bring enforcement actions.

5. Generative artificial intelligence: How can you keep up?

Just as companies may have begun to feel like they’re getting their arms around the complexities of environmental and social issues, along came machine learning and its incredible ability to disrupt every industry. Generative artificial intelligence (“AI”) made a big splash in the mainstream consciousness in 2023.

Less than a year after many of the now well-known generative AI tools debuted in late 2022, McKinsey reported that 79% of business personnel surveyed have had at least some exposure to generative AI either for work or outside of work, with 22% reporting that they are regularly using generative AI in their work.³

The same survey found that one-third of respondents reported that their organizations are already using generative AI. Furthermore, a September 2023 survey of public companies of varying sizes and industries found that the majority of respondents were focused on or considering AI usage in some area of their businesses.⁴

While this technology may feel mysterious and overwhelming, what is clear is that it will continue to take hold in corporate America. And with these powerful tools comes risk: AI tools have been linked to risks relating to intellectual property, data privacy and confidentiality, inaccuracies, cybersecurity, bias, and reputational damage.

Given the rapid pace of development in this space, it is also likely that many AI-associated risks are not fully understood at this time, and there will likely be other types of risks associated with AI usage that we haven’t even imagined yet.

The AI revolution is unlikely to slow down, with AI spending expected to surge in 2024. As generative AI continues to advance and proliferate in the coming year, companies should consider how generative AI tools fit into their business strategies and how the risks associated with use of these tools can be managed. For some companies, this may mean formally adopting AI policies and procedures (including employee-facing AI policies), as well as ensuring that their boards understand and are prepared for the impacts of AI on their business — all matters that fit under the traditional umbrella of ESG.

ESG: A means, not an end

In recent years, many companies started to see ESG as an end in itself: ESG practices and goals were seen as an unquestioned win-win-win for investors, the planet, and society-at large, worthy of companies’ time and energy. Heavy on ambition but light on detail, ESG initiatives often drew robust stakeholder support, even if their ambitions were untethered from the applicable business’s long-term strategy.

Those days are gone.

As rising interest rates and geopolitical tensions have produced unsettling economic headwinds, companies’ near-term financial prospects have come into sharper focus, making ESG for ESG’s sake a tougher sell. The upshot is that, even if the headwinds subside, 2024 will be about approaching ESG (and the concepts that underpin that shapeshifting acronym) as a means of creating value. Yes, the “right thing to do” rationale still matters, but it has become a more nuanced part of the ESG mosaic.

Companies will need to think about ESG initiatives and goals in terms of the opportunities that they can generate and the risks they can mitigate. Indeed, companies must consider how ESG efforts can be linked to the creation of long-term value for investors, to whom the management and boards owe fiduciary duties under the law.

For those companies that have been less aggressive in pursuing ESG-related efforts in the past, the calculus is equally clear: take care of business now, but make a plan for the future. Understanding how consumers, regulators, investors and other key stakeholders think about ESG (or whatever they wish to call it) will be critical for long-term commercial viability, and the companies that aren’t attentive to these matters may be doing so at their peril.

 ¹ BlackRock’s 2023 Investment Stewardship Proxy Voting Guidelines for U.S. Securities call for, among other things, companies to disclose “short-, medium-, and long-term targets, ideally science-based targets where these are available for their sector, for Scope 1 and 2 greenhouse gas emissions (GHG) reductions and to demonstrate how their targets are consistent with the long-term economic interests of their shareholders.” Additionally note that State Street Global Advisors (“SSGA”) provided in its 2023 Proxy Voting and Engagement Guidelines that it may take voting action against companies in the S&P 500 that fail to provide sufficient disclosure regarding climate-related risks and opportunities related to the company, or board oversight of climate-related risks and opportunities, in accordance with the Taskforce on Climate-related Financial Disclosures (“TCFD”) (which calls for disclosure of Scopes 1, 2, and, if appropriate, 3 of GHG emissions and the related risks)).

² BlackRock, Vanguard, and SSGA each provide certain expectations regarding board diversity disclosure and membership in their 2023 proxy voting guidelines, with consequences for companies that do not meet their expectations (e.g., SSGA may vote against the nominating chair of all companies that do not have at least one woman director, Russell 3000 companies that do not have at least 30% women directors, and S&P 500 companies that do not have at least one director from an underrepresented racial/ ethnic community).

³ Survey, The state of AI in 2023: Generative AI’s breakout year, McKinsey & Company (2023), https://mck.co/3v06AP2.

⁴ Natalie Cooper, Bob Lamm, and Randi Val Morrison, Board Practices: Artificial intelligence, Harvard Law School Forum on Corporate Governance (2023), https://bit.ly/3Td7zpr.