US innovators and investor are closely watching the drama of the EU’s General Data Protection Regulations (GDPR) (Regulation 2016/679/EU), covering corporate responsibility for protecting personal data, which is scheduled to go into force in May of 2018.
There’s another EU directive for 2018, though, and it could have a far deeper impact on the lives of individuals, organizations, and nations well into the future. It’s the EU Sustainability Reporting Directive (Directive 2014/95/EU, an amendment to Directive 2013/34/EU).
In essence, the law requires large firms and their subsidiaries to begin reporting on material aspects of their non-financial performance related to environmental, social, and governance (ESG) issues. This new report will include disclosure on progress related to hot button issues like gender equality, the rights of workers, environmental impacts of operations, and compliance with local laws. The goal is to prevent adverse impacts whenever possible and mitigate the others as soon as they are discovered.
While there’s no equivalent reporting requirement for US firms yet, the directive does apply to some European subsidiaries of US firms. Public interest entities (PIEs) as defined by the EU and member states fall under the jurisdiction of this new directive and will need to declare where they stand on ESG issues.
In the past, ESG reporting too often got buried in financial reporting notes or glossed over in feel-good marketing projects. Corporate social responsibility issues were only addressed after misconduct was exposed. That’s changing because society itself has changed. People want to feel good about the brands they endorse and they expect companies to act more responsibly in protecting the planet for future generations.
Where companies stand on these issues help consumers know which brands align with their values, employees know where they want to work, and investors decide which firms are executing the smartest strategies for a better future.
That’s why now is the right time for US innovators to start producing their own versions of these reports and for US investors to ask for them. New global standards for ethical business practices are emerging, and US companies have a chance help craft them.
The Directive’s Minimum Requirements
At the very least, firms must disclose their policies, outcomes and risks related to:
- Environmental matters
- Social and employee aspects
- Respect for human rights
- Anticorruption and bribery issues
- Diversity in their board of directors
Individual member states have chosen to build on these and ask for more. Firms will also be expected to summarize their due diligence processes in assuring compliance by subcontractors and other partners within their supply chains.
Innovation for Change
Innovation is born of constraints. Radically new ideas often only appear after the old ones start to break down. In our research, we’ve found that innovations are more successful when they are introduced in clusters. They need support from a management team dedicated to thinking differently and championing new policies, processes and products working in tandem.
Many times, some of the best innovations don’t even make it to the market stage because they lack a dedicated leadership team and sufficient resources for working prototypes. They fail right on the edge of success.
Fortunately, the world’s most powerful companies – those large enough to be affected by new EU regulations – have the resources, the leadership and the drive to bring sustainable innovation to life as long as they understand the best approach to innovation. What they need most now is a strategic direction tied to sustainability and executed by a workforce trained to enact a culture of innovation.
Correcting for Oversimplification
In a recent blog, we dug into the common oversimplification known as “Culture eats strategy for breakfast” which has been wrongly attributed to Peter Drucker. In the real world, balancing real-time management, strategy and culture is much more complex than that.
We have seen many times over that an innovative culture without strategic leadership can only produce sporadic successes with a wealth of great ideas that go nowhere. At the same time, even the shrewdest leadership can’t execute an intelligent strategy without fully understanding what the organization does best. Misalignment of capabilities, culture, and strategy has resulted very bad outcomes, both for individual companies and for the global environment.
Additional Details on ESG sections
Topics that could be covered in Environment section could include:
- Foreseeable environmental impacts with suggestions on workarounds
- Original applications of renewable energy sources
- Trends in greenhouse gas emissions and sustainability practices
Topics in the Social section might include:
- Projects to ensure improvements in workplace health and safety
- Gender parity initiatives and safeguards for worker/trade union rights
- Outreach to local communities for shared protection and development
Topics in Governance could cover:
- Transparent accounting methods in compliance with local GAAP
- Firewalls for preventing conflicts of interest on the board
- Internal audits to identify potential bribes or political contributions in exchange for favorable treatment
As evident from the above list, an innovative approach to business practices on the grandest scale will be absolutely essential in the years ahead. In fact, one of the most positive aspects of this new directive is the wave of innovation and innovative thinking that it is likely to kick off all over the world.
Eliminating Bad Ideas
Companies that have failed to live up to commonly accepted ESG standards have typically acted not out of malice but expediency. They sought the most direct route to the achievement of financial or productivity goals without sufficient consideration of how their initiatives would impact others. Those same impulses can be harnessed by a culture of innovation to produce a more empowered workforce that implements better solutions using more sustainable business practices.
Innovative thinking also seeks out the most direct route to a specified goal, but factors in the elements of corporate social responsibility at the earliest stages. Although all sorts of ideas are welcomed and encouraged at the ideation stage, what matters most is the rational decision design that selects only the best ideas.
Plans can change but planning means everything. It will certainly take time for large enterprises to collect the data, retrain their teams, and generate sustainability reports for all ESG concerns. Companies everywhere can take advantage of a substantial advantage in terms of brand reputation and investor recognition by putting a sustainability plan into place now.
The Essential Takeaway
The most important takeaway is that US businesses can take the EU sustainability directive as a template for ranking organizations on ethical terms. This framework can identify the scope of an organization’s commitment to leadership on ESG issues, and then put pressure on low-ranking firms to review and address their service gaps through innovation.
The new directive is an effective reminder that the public sector does not have a monopoly on enforcing ethical behavior. The commercial sector actually has a greater potential for reshaping the world in a more positive light by combining the economic might of large enterprises with the innate human drive to streamline workflows. A culture of innovation led by strategic thinkers who follow the communal priorities set by EU regulation adds up to a practical blueprint for manufacturing a better world.