The importance of environmental, social, governance ("ESG"), in particular from the perspective of consumers, stakeholders and regulators, is growing across all industries, and the consumer & retail industry is no exception.
While it may once have been a nice-to-have, consideration of and compliance with ESG matters are becoming fundamental, for not only building and maintaining reputation concerning ESG, but also for regulatory compliance and civil liability. The benefits of 'getting it right' are many, such as increased consumer engagement, improvements to the bottom line and, of course, being a force for good. At the same time, the severity of the potential consequences for non-compliance with ESG rules (and expectations) is also a key factor in driving this change. In some cases, overstating or exaggerating ESG credentials can be more damaging for brands than technical non-compliance, highlighting the sensitivity of the matter. In short, a number of legal issues and risks exist that must be managed.
The consumer & retail industry is being especially impacted by this new order. ESG matters influence nearly every sub-sector of the industry, from food & beverage to fashion, lifestyle & luxury, to consumer electronics, homecare and beauty to retail. Businesses operating in this sector must be cognizant of the new expectations and regulations in this space to ensure they are not caught out and become subject to both legal and consumer scrutiny.
What is driving the growth of ESG importance?
Before looking at the legal issues, it is first worth considering some of the drivers of the increasing importance of ESG matters in the industry. Whether it's the heightening of consumer expectations and awareness because of increased regulation and reporting, or regulators responding to consumer expectations and awareness of ESG issues, ESG is here to stay in the industry.
Changing consumer attitudes
Consumers are changing the way they shop, becoming increasingly conscious about the businesses they engage with and purchase from, by prioritizing brands with a positive impact. Studies indicate that the shift is generational, with younger consumers valuing brands that put ESG importance at the center of their values.
According to the EY Future Consumer Index, 24% of 'GenZ' and 'Millennials' check sustainability claims made by brands (as opposed to only 4% of 'Baby Boomers'), and 21% have stopped buying a product if the brand is not making enough effort to help the environment (compared to 6% of Baby Boomers). While this is certainly not the majority of consumers, the surge in attitudes, specifically their willingness to prioritize ESG matters and boycott product, is evident. It's worth noting that these attitudes are found to be skewed towards consumers with higher incomes, but nonetheless this is a trend that reverberates across sociodemographic backgrounds.
Regulatory scrutiny
There has been an influx of regulatory scrutiny to account for ESG issues as consumers and regulators are demanding greater transparency over ESG issues.
Examples include the EU Emissions Trading System, Uyghur Forced Labour Prevention Act ("UFLPA"), the Corporate Sustainability Due Diligence Directive ("CSDDD"), EU Deforestation Regulation ("EUDR"), the EU Corporate Sustainability Reporting Directive ("CSRD") and the German Supply Chain Due Diligence Act ("LkSG"). Increased regulation is arguably of greater concern than consumer attitudes as there are material, financial impacts may arise from breaching such regulations. The impact of increased regulatory scrutiny is already being seen, e.g., textile shipments with a value of US$29.55 million have been stopped under UFLPA since it came into effect in June 2022.
It is unclear whether regulatory scrutiny has increased in response to changing attitudes and/or a realization that abuses were occurring, or whether the regulatory spotlight shined first with consumer scrutiny following, or whether they have occurred in tandem and continue to reinforce each other. In any event, it is clear that ESG is having, and will continue to have, a serious impact on the way consumers shop and the formation of future regulation. Regulatory scrutiny in particular is likely to be the primary driver of change in the future, as a resistance to change will have serious consequences.
Financial investment industry
The financial investment industry has also been leading the charge with a series of high-profile funds raised specifically to invest in sustainable industries and initiatives and in accordance with ESG principles. This has proved to be immensely popular in attracting investment, but has not been without controversy in some quarters, particularly in the US, with some critics arguing that this ESG-friendly approach unnecessarily politicises business matters and adopts an anti-fossil fuel agenda.
What are the key ESG issues in retail in 2023?
In the consumer & retail industry, important conversations on ESG are taking place in 2023 regarding supply chains, greenwashing, decarbonization, green contracts and the circular economy.
Supply chains
Human rights abuses by corporations in their supply chains have been at the forefront of the ESG discussion in recent years. Forced labor, human trafficking and modern slavery have been found in multiple stages of the supply chain across industry sub-sectors. While once not necessarily seen as part of a business's remit, the responsibility to ensure a clean supply chain is now being imposed on businesses through new regulations.
The US, EU and Germany have recently adopted or proposed new rules requiring enhanced due diligence checks on supply chains to target human rights and environmental issues. UFLPA, CSDDD, LkSG have all either come into force or are being enacted to combat forced labor. Many industry sub-sectors, particularly textiles, electronics, footwear and apparel, have already been seriously impacted. Non-compliance with the new rules can result in heavy fines or civil liability.
'Greenwashing' and 'bluewashing'
Greenwashing refers to a form of advertising or marketing in which businesses make unsubstantiated, misleading, and exaggerated claims about how environmentally sound or "green" its products and/or services are. Bluewashing is a similar criticism, but refers to how socially conscious a business claims to be. This is linked to the transparency and accountability demanded from consumers.
Greenwashing in particular has gained massive traction recently, and committing it now risks legal action, as well as public boycotting. Litigation based on greenwashing allegations at all levels of a company (including the corporate, investment and product levels) has steadily increased over 2023. Given that new laws in the EU allow consumer protection organizations to bring collective redress actions in the field of greenwashing, this can be a major risk to a company's finances and its reputation with consumers.
Decarbonization
Decarbonization refers to the transition to a low carbon economy by using energy sources that produce low levels of greenhouse gas emissions. High emissions from the retail sector may come from many different sources, including transportation, manufacturing and energy use in stores.
Retailers have to confront their own direct and indirect emission. Over the next five to ten years, retailers could see increases of 10-15% of their annual capital budgets to pay the costs of increased emissions. The challenge will therefore be who will have to bear the brunt of the rise in costs. It is likely that it will have to be borne by stakeholders such as vendors, suppliers, governments, regulators and investors.
Green contracts
Green contracts are commercial contracts that include clauses requiring that the parties fulfill certain 'green' obligations for the term of the contract. Such clauses can include reducing greenhouse gas emissions; targeting 'net zero' objectives; and providing incentives to counterparties to achieve sustainability goals.
Of note in this field is 'The Chancery Lane Project,' which is a global network of lawyers and business leaders that are using green contracting to fight climate change and deliver "fast and fair" decarbonization. It has developed a number of template clauses aimed at decarbonising contracts, which are available to anyone to include in a variety of contracts.
Packaging and the circular economy
The circular economy refers to a model of production and consumption in the industry that incentivizes market participants to reuse products rather than discarding them, which would result in the extraction of new resources. There is considerable focus in the industry on reducing waste, encouraging reuse/resale and improving this circular economy.
Fast fashion in particular is being encouraged to focus on this matter as textile waste is seen as far too high. As such, innovative materials and waste management technologies are being developed and encouraged in the fast fashion sub-sector to reduce their impact on the environment. To facilitate these changes, emphasis should be put on product design to promote durable and long-lasting materials, support should be given to repair, and reuse materials (e.g., tax breaks).
Shareholder Activism
ESG-related shareholder activism campaigns have significantly increased over the last few years and are set to grow further, as many activists seek to promote an ESG-friendly agenda and to call out companies for what they see as bad practices or bad behavior. This usually includes campaigning via media channels and social media, attending and speaking up at general meetings and encouraging institutional investors to vote against resolutions for the re-appointment of directors and the like. In some cases, it may also include the threat of legal action, including derivative claims on behalf of the company.
What challenges does the industry face in adjusting?
The consumer's willingness to pay more
As explained above, data shows that there has been a shift in consumers' attitudes, favoring products from businesses that have ESG-orientated values. However, it should be noted that there is a rebuttal to this trend as, at times, there appears to be a difference between what consumers say they expect and how they tend to act. While consumers may demand sustainable products, they are not always willing to pay a higher price for them. Many 'consumer packaged goods' executives said that the main challenge to their ESG initiatives is generating sufficient consumer demand for higher priced products, despite statistics saying consumer mind-set has shifted. The gap between demand and execution makes it additionally difficult for retails to decide on the approach they should take.
Scalability
There are two kinds of scalability considerations:
- First, when businesses try to collaborate on sustainability efforts, these efforts can be ring-fenced as different partners have different interests for the business. These needs must be prioritized, which can lead to unproductive tensions and conflicts, which then makes it harder to scale and execute a strategy.
- Second, from an investor's perspective, they may consider focusing investments into businesses that use, for example, only recycled materials in its product development. However, this is likely to be seen as more of a risk for investors, and therefore the question of how scalable these product's/businesses are, if investors are going to be hesitant to invest in them, must be considered.
Measuring compliance
The main difficulty, for analysts and consumers alike, is gathering information in order to understand how ESG-friendly businesses are. This is the case for gathering information on supply chains, material production and usage, and monitoring the steps businesses are taking to comply with ESG commitments. The lack of, or questionability, of concrete data leads to critics of ESG commitments, which, in turn, has a snowball effect on the confidence stakeholders have in supporting ESG matters. If consumers cannot measure compliance, they cannot vote with their feet, and with the risk of consumer behavior changing, businesses may be slow to implement the changes required.
Consequences of getting it ‘wrong'
Legal consequences
With an increasing amount of regulation, so too do the legal ramifications for non-compliance increase. As mentioned above, the introduction of UFLPA has already led to apparel, footwear and textile shipments with a combined value of US$29.55 million being stopped, and greenwashing litigation is currently skyrocketing, with some of the biggest names in the retail & consumer industry being hit.
There may be a host of consequences and penalties for breaching the ever-growing list of ESG regulations, examples include (depending on the jurisdiction, business and breach involved):
- up to two years in prison for company directors and/or fines amounting up to 4% of a business's global turnover, up to a maximum of £20 million (UK Modern Slavery Act);
- fines (maximum 4% of EU turnover), confiscation of products and temporary exclusion for public procurement process and public funding (EUDR);
- civil liability (corporate liability and personal liability of directors); and
- goods seized at the US border, sanctions, export restrictions and import controls (UFLPA).
Reputational consequences
All of the above feeds into the reputation of a business, whether it is through calls for boycotting through social media or being found liable for greenwashing claims. In particular, the evidence that younger generations are willing to switch brands if they detect unethical practices poses a serious threat to the retail & consumer sector. In the age of social media especially, legal and public scrutiny can certainly reinforce each other.
What does the future hold?
It is clear that ESG considerations in the retail & consumer industry are important and growing. There is a debate as to the longevity of ESG as a key-driver in decision-making, with changing stakeholder attitudes in the US being an apt example. For example, if the anti-ESG sentiment continues to grow in the US, there is a chance we will see a reversal of the change that has come to fruition over the last few years. By contrast, the EU continues to push for further ESG-related regulations and so it is possible we will see a material divergence in approach between the two regimes over time.
However, if this is indeed a generational change, it is probable that ESG matters will only continue to rise in importance. Further, even if stakeholder attitudes begin to shift against the ESG agenda, the increasing amount of ESG regulation that already exists and is already scheduled to be enacted will continue to hold companies to account for the near future.
Kinzah Khan (Trainee Solicitor, White & Case, London) contributed to the development of this publication.
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