Why Private companies are facing new scrutiny of their ESG performance

By Kirsten Vosen, Audit & Assurance Partner, Deloitte & Touche LLP

Talking points

• Although many private companies operate outside the public spotlight, their environmental, social, and governance (ESG) performance is coming under new scrutiny.
• Learn how regulators at the state, federal, and global levels are proposing or enacting rules that are likely to affect many public companies.
• Explore why now is the time for private companies to embrace ESG readiness as it could turn a growing burden into a source of competitive differentiation.

There was a time when companies treated corporate social responsibility as an important but unregulated responsibility. Those days are coming to an end, and not only for public companies.

Regulators worldwide have proposed or enacted rules by which companies must report on their progress toward ESG objectives. Meanwhile, a range of stakeholders—including investors, customers, suppliers, and communities—are scrutinizing companies’ track records on this score. All this will likely bring new attention to the ESG performance of private companies.

Casting a wider net

Some regulators are casting a wider net to encompass a broader range of businesses.

In the US, for example, federal government contractors may soon have to comply with new rules proposed by the Biden-Harris administration that would require federal contractors to report their greenhouse gas (GHG) emissions, with the exact extent of the reporting decided by the company’s annual revenues.

Private companies could also be impacted by a new rule proposed by the US Securities and Exchange Commission (SEC). Under this rule, companies that are investees or portfolio companies of an in-scope registered fund may soon have to prepare and provide ESG information to such funds.

State governments are also weighing in. California now requires US entities with more than $1 billion in annual revenues that do business in the state to publicly disclose their direct (Scope 1) and indirect (Scope 2 and 3) emissions. The state of New York may soon follow suit, as similar bills were introduced into the legislature.

Then there’s the activity taking place outside the US. Jurisdictions around the world are finalizing or advancing regulations that may mandate ESG-related reporting and disclosure. One finalized rule is the Corporate Sustainability Reporting Directive (CSRD). If your company has operations in the European Union (EU) or even one subsidiary or branch located there, the CSRD may require you to provide a significant number of new disclosures with assurance required immediately, often as early as 2025 data.

The evolving role of ESG diligence

Even private companies that aren’t subject to regulatory reporting requirements in the near term may want to pursue general sustainability initiatives within their operations and governance programs. ESG performance can create business value such as positive market reputation, strategic relationships with value chain participants, and capital market attractiveness.

In the past, companies tended to focus on what was legally required, prove they were compliant, and illustrate some areas of improvement. Their assessments didn’t always account for significant variances in region, sector, and company-specific ESG-related risks.

Moving forward, private companies will likely have to deliver much more information and insight about their progress toward ESG objectives if they want to not only stay compliant but attract new sources of capital and strategic partners as well. Areas for heightened ESG diligence include:

• Growth strategy. More private company leaders will likely need to explain how their existing core services and products are evolving to meet the market’s expectations for sustainability and other ESG expectations.
• M&A. Potential suitors considering a private company in an acquisition will likely want to evaluate the target’s operations and financial projections for quantifiable impacts from ESG issues that could impact their profitability and, thus, valuation. In addition, companies will want to know if an acquisition will bring it into scope for new regulatory reporting requirements.
• Scenario planning. Climate-risk modeling is poised to become a differentiating tool for assessing a company’s business resiliency over a series of scenarios and delivering market outlook insights.

The case for enhanced governance of ESG

For many private companies and family enterprises, these new reporting requirements will likely exceed their current internal capabilities. Many may need to consider hiring or realigning their internal finance organizations to add the capabilities necessary to take this on. Alternately, they may want to consider teaming with an organization that can support their growing ESG obligations. An outside provider can advise them as they determine how their strategies relate to regulatory mandates or voluntary commitments. A provider can also use modeling and forecasting to see how data gathered for ESG initiatives can be integrated into existing tools.

Deloitte can provide insights and advice as you navigate this rapidly changing environment. Feel free to contact me, Kirsten Vosen, with any questions.