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What Middle Market Companies Should Know About ESG and Sustainability in 2023

Mar 31, 2023

As part of the Solutions InSight series, the EisnerAmper team spoke with Maram T. Salaheldin, Senior Associate at Clark Hill, in January of 2023 about how middle-market business leaders can turn an effective ESG program into a competitive advantage, particularly during the rise of ESG-related enforcement and lawsuits.


Favor Lee:Hello everyone. Thank you so much for joining us for this session. What middle market companies should know When it comes to ESG. My name is Favor Lee, Director of Business Development at EisnerAmper, and I'm honored to be moderating this session today. I'm joined by two wonderful panelists, Lourenco and Maram, and we're here for a rich conversation about ESG. So before we get started, I would like to have our panelists introduce themselves. Let's start off with you, Lourenco, then Maram.

Lourenco Miranda:Thank you very much, Favor. My name is Lourenco Miranda. I'm managing director of ESG and sustainability for EisnerAmper and my job is to help our clients to improve their ESG and sustainability performance.

FL:Perfect. Maram?
Maram Salaheldin:Thanks Favor, and thanks to EisnerAmper for having me. Happy to be here with you all. My name's Maram Salaheldin, I am an attorney with the law firm of Clark Hill based in our DC office. I focus on environmental health, safety and sustainability issues for our worldwide clients. And these days I'm heavily focused on ESG and sustainability where I help co-lead Clark Hill's advisory practice in that space. And I'm looking forward to the conversation today.

Thank you, Lourenco and Maram. So let's get started. So looking at the macro level, let's start off with that, and what are some of the ESG related trends that you're seeing? So Maram, if you want to kick us off on that, that'll be awesome.
MS:Yeah, absolutely. It's new year, and we're all excited to see what's coming and to learn more about what's happening in the ESG space, of course, and hopefully get some clarity. I know that's a big question for a lot of people. What does it all mean? How do we manage it? What are we supposed to do? And so hopefully today we can get into some of that a little bit. But big picture as far as trends, it's a little bit of the same as what we saw in 2022. Frankly, we're going to just see an evolution of a lot of the things that already started last year or even the past few years really. And specifically that's going to be an increase or a continuation in a lot of ways of enforcement activity, litigation, lawsuits related to ESG as well as regulatory activity, as different government entities try to give us some clarity on what it all means and how companies can make sure that these initiatives are compliant and that they aren't being either subject to enforcement actions or lawsuits.
FL:That's a great point. Yes, it's going to be harder and stricter in a way as far as the regulations go. So that's a really good point. Lourenco, what are your thoughts on ESG related trends in 2023?
LM:Yeah, so on what Maram just said is, I think 2023, you are going to be a continuation of 2022 in terms of and after COVID, where ESG reminded us that we are thinking about environment, thinking about the social part is important, is extremely relevant. And now going into 2023, all the energy discussions that I'm having happening in the world, especially in Europe, all the energy prices, the inflation, all of these elements are related in a sense with ESG. So you have to think about how you position yourself in order to become competitive in this environment and an environment that is increasing in terms of regulations, in terms of expectations from the general public, from your shareholders, from our stakeholders in general.

So all of these are going to permeate the agenda of CEOs, CFOs, CEOs of firms, whatever industry sector they are playing, and also regardless of the size, we are going to talk about this today related to supply chains and the opposition in your supply chain of bigger companies. If you're a middle market, you have to start paying attention to that, something that was not on your agenda before now because all of these new trends in terms of regulations and supply chain changes will start getting more and more important for you as a middle market manager. So that's a trend for 2023 and the near future.
MS:Lourenco, that's a great point as far as the complexity goes, because specifically for middle market companies that we're talking to here today, in the past, sometimes the conversation's been very focused on larger companies, public companies, EU companies, but for middle market, US companies that may have customers or contacts or any part of their supply chain that is either a US public company or a larger company or an international company with an EU presence, for example, or in other parts of the world, that web of requirements that applies to them is rapidly expanding and becoming more complex, whether it's directly or indirectly through flow down provisions and things, requests that are being sent to them through their contracting, their contracts or their agreements with customers and the rest of their supply chain.
FL:I think that's a great segue into this. So like you said, I mean there's a lot of focus around larger enterprises, publicly traded companies, but what about middle market or privately held companies? How should our audience here be ready as the requirements are cascading down to their supply chains? What are some of the practical things that we could get ready for?
LM:So I think the first thing is to think about that you are not alone in the market. So you are middle market company, you have suppliers and you supply to somebody and you produce your end product or services or end consumer or to somebody else that is going to use your product as a raw material for something else. So you are part of a value chain regardless of your business, regardless of your size. So it's hardly ever we going to think about a company that is not part of this. Again, now thinking about how the world is changing in terms of supply chain, we started 10 years ago or more probably in the beginning of the year 2000, 20 years ago already. So with the globalization, all the globalization was a big theme for everybody. We are going to go to markets that are far in China, we're going to start getting raw materials from elsewhere in the world, and this supply chain was getting farther and further.

So now we are going to start thinking about going to long distances and to get our raw materials to depend on these global markets and all the intricacies on the dependencies of the global market. This is changing more and more large companies are opting for a near shoring because they see that all these trade agreements and far shoring dependencies are not working anymore. But more and more large companies are opting through near shoring. What does that mean for middle market companies in the US for instance? They are going to get more demand from these larger international corporations. They're going to start looking at the national market. Where are my suppliers in the national market? Are those middle market companies that are there ready to supply for these larger companies? The question is, are they really ready to supply for these larger companies? And to your point, and when you started that conversation, these larger companies are most likely public companies.

We have obligations to their shareholders. We have targets and agreements with their stakeholders in general for ESG and sustainability. And because these large companies, they have all these agreements with all the stakeholders, these agreements will include their suppliers. So if you're a middle market company in this new scenario of near shoring, you must be ready to be competitive to be able to provide services and products for these larger companies that are looking to domestic markets for their raw materials, for their suppliers. Now the step is for you as a middle market producer, a manufacturer for instance, you can no longer think like ESG is a cost center, or ESG is something that is nice to have now becomes a must-have if you want to become competitive in this new supply chain 2.0 or new version of supply chain that's happening today. All these near shoring, large companies looking at the domestic markets for their suppliers, if you want to be part of this, you have to get your act together in terms of ESG performance, sustainability, and be ready to become part of their supply chain of these larger companies.
FL:That's a very great point, Lourenco, Maram, let me ask you this, from cascading requirements, we've seen it from top to down, from larger companies to smaller companies, what about different regions from EU to US companies? Are you seeing that too?
MS:Yeah, absolutely, and that's a great comparison to make because in more regulated spaces or jurisdictions, that's where you start seeing these trends coming from and then to what Lourenco was speaking to, they start working their way towards new jurisdictions or new entities that may not be immediately covered in the scope of the regulations. And we're definitely seeing that from the EU to the US, especially for companies that are a part of what are more conventionally or traditionally North American and EU centric supply chains. So for example, the automotive and manufacturing sector in particular, there's a lot of business between the EU and North America in that space. And so middle market companies in the US are already in a lot of ways being subjected to some of these requirements indirectly through these flow down provisions or cascading requirements because they're customers who are purchasing their products or purchasing parts from them.

At some point are importing those parts or finished products into the EU, and they're subject to requirements that are already in place and that are only going to increase in the level of how stringent they are in the coming years in the EU. EU has one of the most aggressive green strategies in the world right now pursuing de-carbonization at a much more rapid rate than a lot of other jurisdictions are. And the way that that's being implemented is through a lot of these regulations and directives. For example, CSRD, which is coming into effect in the coming years, is going to start implicating companies that may not even be doing direct business in the EU, but depending on their footprint and their size will get pulled into some of the reporting obligations. So as far as to answer your earlier question, what does that mean, right? It sounds very big and stressful for a company that may not have the resources to stay up to date with everything that's happening, a continent away, really control what you can.

That's I think, the short of it for a company in the ESG space. Whether a company has started doing an ESG initiative or is thinking about starting doing one, I think there's a temptation to bite off more than you can chew because you look at what other companies are doing or what other organizations have done and think you're going to replicate that. But it's far from one size fits all. It's not even small, medium and large. It's really very customized to your operations and your realities, and that's how you succeed in the ESG space. Because the last thing you want to do is start an initiative that you can't maintain. It needs to be something that's sustainable, that fits into your business reality. But that also at the same time, you don't want to make statements or promises that you can't fulfill because that's the main premise behind the ESG movement, is to make sure that companies have the data and metrics to back up the statements that they're making.

And last year we saw some green washing enforcement actions and lawsuits beginning, and that's continuing into 2023 and expanding in some ways because now we're not just focused on the green part, right? The E part of ESG, but we're also looking at the social and the governance. So some folks have started using the term ESG washing. So any of those three components, if you're making unsubstantiated claims or claims that you can't back up, you could find yourself being challenged either by an agency, an enforcement agency, your own shareholders, the public, any of your consumers or customers. So it's definitely something that you should be cautious and be prudent, but also at the same time, be proactive because I think as Lourenco was talking, these things are coming and will be happening in some way, shape, or form.
FL:I love your point Maram, that be proactive, and there's no one size fits all solution for ESG. Everything's customized. Everything's very, very customized to that specific organization based on your supply chain, based on how you're strategizing on the sustainability, everything's really customizable. That was a great point. So switching gears for a little bit, I know Lourenco, you mentioned briefly about ESG not being a cost center, right? Given the economic downturns, the recession concerns and everything, I've heard from so many different organizations saying ESG may be on a chopping box as their budgets are tightening. Maram, what's your thoughts on this?
MS:Yeah, I'm excited to see what Lourenco was going to say from his perspective. But yeah, from a legal perspective, I mean, here's the thing. I think we all need to take a step back and not panic in some ways. And I know we hear that a lot just in general conversations about the recession, but from my perspective as an environmental attorney and everything that's happened in the past 50 or so years in terms of environmental regulations and policies, there's always pushback. There's always some issues when we think about the costs related to these things. So as environmental regulations were developing, there was definitely a lot of pushback, a lot of confusion about why certain things were required or necessary, and even until today we go through in the United States proposed rulemaking, right? Government agencies have to show why certain costs would be appropriate or reasonable to the market and why the regulation has a need that exceeds those costs and is ultimately for the best, both in terms of the market and health and safety and the public safety.

And so I think that's similar reality here. So ESG and its related subject area of sustainability because this is where it all plugs in, business sustainability at its core is about making sure that your company can continue to operate long term. So we have the soft version or definition of sustainability, which is about air quality and greenery and the planet and all wonderful important things as far as the environmental protection considerations are. But sustainability in the business context isn't just about that. It's about the environment, it's about human health, it's about human rights, things like that. But it's also about the sustainability of your business. And so when we talk about ESG and sustainability and whether they're on the chopping block, absolutely just like any other operational considerations, if there are budget constraints, that's the reality, and the company will have to decide what can stay and what can go.

But ESG is not just a risk, it's an opportunity area for companies and as is sustainability. And so if a company has been pretty well invested in the sustainability space in particular, from what I have seen and what the goal is behind ESG metrics is that it's a chance for you to leverage what you're already doing so that you can get bit better insurance rates, you can get better investors, you can tap into new opportunities that maybe weren't available to you before. And I think that's only going to continue going forward as investors and other stakeholders demand more of this information. And so companies really need to think about short term versus long term. It might cut some costs immediately for you if you don't do what you've already started as far as ESG, but it could also cost you in the long run.
FL:I love your point on that Maram, that it's an opportunity, not only risk, there are risk component to it, but view it as an opportunity and it could actually be a competitive advantage for the organization. I love that, Lourenco, what's your thoughts on it? As the budgets are tightening, the audience, be aware, what's your thoughts on this?
LM:Well, I have to be honest, after this amazing speech, it's very challenging to compliment that. So from the ESG point of view and putting ourselves in the shoes of a CEO and the CFO of a company. So what are the objectives of these folks? They have an objective of to Maram's point, to have to their shareholders of the company, produce sustainable, repeatable, and steady cash flows and revenues and new business growth. So that's the objective of a CFO and CEO. When they think about the sustainability of the company and the business, how do they do that? CFO has to go in to the market and look for better ways to finance the company, how to fund the company, how to do cost control, how to manage the costs and expenses, how to make sure that the data is well reported, I think is correctly reported to the shareholders. And they are answering shareholders' demands. ESG will help the CFO to manage all these stakeholders.

ESG is to Maram's point, is a competitive advantage, is a mechanism that will help the CFO to get better funding in the market, to be able to negotiate better contracts with their suppliers. So that's cost control and cost efficiency, will be able to have better information for their shareholders, information that the shareholders are thirsty for. So we are thirsty for sustainability and ESG information because these investors, they have to report themselves and the consumers are also thirsty for these information. So the CFO will be able to report that as well. Regulators the same way. So ESG will help the CFO to manage all these stakeholders in the most effective way and with guaranteeing efficiency and guaranteeing the sustainability of the business. So putting all this in perspective, ESG and sustainability becomes essential to the survival of the company and talking about everything that we already discussed, supply chain changes, regulations, the legal environment, everything is telling, it's all the signals are being given to the CEOs and CFOs of the companies to take a step back and say, okay, do I want to survive in this new environment?

Do I want to keep on producing reliable and repeatable and steady cash flows, my business maybe to go to the market and fund myself with decent cost of capital. So my cost of capital also is something that CFOs need to think about. The ESG comes with this ability into this methodology to enable the CFO and the CEO to manage their business in the more sustainable way. That's why I think it's Maram's pointing to your point. It's a matter of survival, it's a matter of competitiveness, it's a matter of keeping this competitiveness in the long term. This to Maram's point, it's not a short-sighted game, it's a long-term game. So you have to think about the long term survival is in the long term. It used to be shareholder value approach, all these short term ness, very shortsightedness approach, is no longer valid. It cannot longer apply this to the current state and current scenario and the future scenario happening.
FL:Yes, thank you so much. It's an ever-changing landscape too. So we need to be vigilant around that environment. I love that survival and also thriving too with this ESG strategy.
MS:Yeah, Favor. And Lourenco, I think I love your comments on that and it's so valuable to think about it from the CFO's perspective and the C-Suites perspective has well perspectives. So that's I think one of the big lessons for a lot of companies. Oftentimes we think of boards or the C-suite as a monolith. And the reality that I think we're starting to see with ESG is that that's not necessarily true. There are very varying perspectives related to ESG and different priorities. And in a lot of cases that may lead to some debate which is healthy. I think for organizations and thinking about their long-term planning, it's very valuable to have those conversations and think about things in a truly pragmatic way. And so one of the things in the United States that we've been seeing a lot in the past couple of years is a more philosophical debate about ESG as far as good versus evil.

Is it positive, is it negative? And that's all well and good. Those are certainly debates that can be happening and should be happening in different spaces. When it comes to, from a legal perspective, for example, in client counseling, for us, that's not really the priority for us. Same probably for you from an accounting perspective. I mean, we all have our different opinions or views of the tax code, for example. But at the end of the day, implications for a business have to be addressed. And part of that, and I think why this is a tough topic still in the US for a lot of companies is because it isn't hard law in a lot of ways, although it's getting there and thinking through different requirements that are coming from a different part of the world, specifically the EU, more often than not, the EU has applied a different standard than the United States has up until today.

So in the US we focus on strict materiality that is the bottom line. In the EU, they have applied a double materiality standard. And so the consideration of just what's sustainable for your business is no longer the only priority, equally important is global sustainability, environmental sustainability. And so having some of these conversations I think is very important because level setting with your board, with your stakeholders, with your customers is probably the most important thing you can be doing to avoid confusion, to avoid misleading statements, making unsubstantiated claims, and that's where someone like you, Lourenco, in your perspective, is so crucial for a company helping them understand what these things even mean for three letters, it's a very, very broad and a very, very complex topic.
FL:It's a big three letter or very big, very wide, it's very broad as far as the topics that it touches, right? Environmental, social governance, it's just very broad to even just look at one of each. So that's a very good point. I feel like I could do this webinar for two more hours here, but we have some time limit. So let me get through this last question. So if the audience could walk away with just one thing from this panel discussion, what do you want it to be, Lourenco, I'll start off with you on this.
LM:The one thing is that ESG is essential. It is a competitive advantage. It's no longer a nice to have, it is a must-have and it's not going to be a must-have now, but it's going to be something that enable your business to perpetuate in the future. It's essential, it's not a cost center, it's an investment, is an investment for the future or stable and sustainable future of your company.
FL:That's amazing comments. Thank you, Lourenco. Maram?
MS:That's a tough one. No, I mean there are so many points to what you were saying Favor, we could keep going up about this for a while, but I think my big takeaway to companies as they think about ESG for 2023, have a plan. I know that's so simple, but take a moment, pause, if you're in the US, it's great that there are still some developing regulations. It's not all immediate or eminent. It may be now or in the near future when a company that you do business with requires certain information or certain testing, reporting, et cetera. And so don't be caught off guard. Get ready now, even if you aren't willing or interested to go all in on ESG, not everyone will be, and not every business will necessarily want to do that, and that's where this whole one size does not fit all idea comes in.

Think through your strategies, your operations, your products, your customers, your shareholders, your investors, all your different parties, what's material to you? What matters to you. If you do one thing this year, consider doing a materiality assessment and think through what your priorities are. Because I guarantee you, once you start doing that, you'll also start identifying the things you're already doing and that you're doing well. And so take advantage of those opportunities. Make sure that you're highlighting your successes, that you're focusing your resources in your top risks, right? Don't waste money and time on things that aren't actually as material as you may have thought they were 10 years ago, the last time you took a look at it, for example. So have a plan, get the resources you need to help you with that plan and then execute it when and as you're able.
FL:Perfect. We should have a tagline, ESG now.
FL:Well thank you so much Lourenco and Maram. This was wonderful conversation. I really enjoyed it. Hope our audience was able to take away few things that they could implement in their companies, and thank you so much for joining us.
LM:Thank you.
MS:Thank you.

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