AI and ESG: Are they in conflict?
Introduction
As the importance of Environmental, Social, and Governance (ESG) considerations continues to rise, companies in the UK are integrating these principles into their operations. With the advent of advanced technologies like artificial intelligence (AI), businesses can not only enhance their ESG compliance but also drive innovation and efficiency. This short article will explore some elements of UK’s landscape, the implications of ESG for companies and in-house lawyers, and practical tips for leveraging AI to meet these targets.
What is ESG?
ESG stands for Environmental, Social, and Governance, which are the three central factors used to measure the sustainability and societal impact of an investment in a company. Here’s a quick breakdown:
Environmental: Focuses on how a company acts as a steward of nature, including energy use, waste management, and resource conservation.
Social: Examines how a company manages relationships with employees, suppliers, customers, and the communities where it operates.
Governance: Concerns a company’s leadership, executive pay, audits, internal controls, and shareholder rights, as well as compliance with relevant regulations and policies.
AI is increasingly being used to automate the tracking and analysis of ESG data, assisting regulators in enforcing ESG regulations and encouraging companies to improve their governance practices.
AI Applications in ESG Compliance
AI technologies can significantly enhance how companies approach ESG compliance. Here are a few specific applications:
Data Analytics: AI-driven analytics can help companies gather and analyse vast amounts of data related to their environmental impact, such as tracking carbon emissions and energy consumption, leading to more informed decision-making.
Machine Learning for Risk Assessment: Machine learning algorithms can identify potential risks related to social governance, such as labour practices in the supply chain. By analysing historical data, these systems can predict and mitigate risks before they escalate.
AI in Supply Chain Management: AI can optimise supply chains by ensuring ethical sourcing and reducing environmental footprints. For example, AI tools can assess supplier practices to ensure compliance with ESG standards, enhancing transparency and accountability.
It's important to recognise that even in a digital supply chain, physical logistics cannot be ignored. Companies like Amazon illustrate this, as their digital platforms rely heavily on physical infrastructure, including data centres and transportation networks. This highlights the need to consider ESG factors in both the physical and digital aspects of supply chains.
Challenges and Considerations
While AI offers significant advantages in meeting ESG targets, there are challenges to consider:
Data Privacy Concerns: As companies collect and analyse more data, compliance with data protection regulations (like GDPR) is crucial.
Algorithmic Bias: AI systems can perpetuate biases present in their training data. Regular audits of AI algorithms are essential for fairness and transparency.
Energy Consumption: The computational power required for AI can consume significant energy and water. This raises concerns about sustainability, necessitating a balance between AI use and ESG goals.
© The Times - 4 October 2024
UK Government Regulation of ESG Ratings Providers
In November 2024, the UK government took the next steps to regulate ESG ratings providers:
Draft Legislation: Draft Statutory Instrument: The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.2) Order 2024 for ESG ratings providers was released in November 2024, with plans to introduce it to Parliament in early 2025.
Technical Feedback: The draft legislation is open for technical feedback until 14 January 2025.
Supervision: The Financial Conduct Authority (FCA) will supervise ESG ratings providers under the new legislation.
Note: Code of Conduct: The International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) have developed voluntary code of conduct focusing on ESG ratings, transparency, good governance, and managing conflicts of interest.
In October 2024, the House of Lords Select Committee on the Modern Slavery Act 2015 published a report setting out recommendations for reforming the existing legislation and bring it in line with international best practice (eg, EU Corporate Sustainability Due Diligence Directive).
EU Note: As ESG is a vast topic in itself, there are also EU legislative and regulatory pieces to factor for those companies doing business cross-border with the EU. For example, the Platform Work Directive, which aims to regulate the digital platform work sector was published on 11 November 2024. EU Member States have by 2 December 2026 to implement the directive. One aspect of the directive of interest to AI champions is the rules on algorithmic management in the workplace. This is the use of algorithms for monitoring, rewarding, or disciplining work on digital platforms.
ESG Reporting Requirements
While larger corporations often face stringent ESG reporting obligations, smaller companies are encouraged to adopt best practices, such as:
Mandatory vs. Voluntary Disclosures: Not all companies are legally required to report on ESG matters, but voluntary reporting can enhance credibility and attract investors. Aligning with frameworks like the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB) can provide a structured approach.
Setting Measurable Targets: Establishing clear, measurable ESG targets is crucial, such as goals for reducing carbon emissions or improving workforce diversity.
Practical Tips for In-House Counsel
Here are some practical tips for in-house legal counsel looking to integrate AI into their ESG strategies:
Conduct a Technology Audit: Assess current technology capabilities and identify gaps where AI can enhance ESG compliance.
Collaborate with IT and Data Science Teams: Work closely with IT and data scientists to leverage AI tools effectively.
Develop an ESG Strategy: Create a comprehensive ESG strategy that incorporates AI, including measurable targets and key performance indicators (KPIs).
Regular Training and Awareness Programs: Ensure all employees understand the importance of ESG and how AI can help achieve these objectives.
Monitor and Report Progress: Use AI tools to track progress against ESG targets, ensuring compliance and demonstrating commitment to stakeholders.
Contract Checks: Considering updating your ESG interested contract clauses, such as:
Employment and personnel
Supply chain management in line with ESG-related codes of conduct
Human rights, diversity, equity and inclusion, health & safety
Bribery, corruption, and anti-money laundering
Economic sanctions
Document execution
Tax
Conclusion
Commentators report embracing ESG principles is not just a regulatory requirement but a strategic advantage. By leveraging AI and technology, companies could enhance compliance efforts, drive innovation, and contribute positively to society and the environment. We hope that AI technology will become more energy efficient and closely aligned with ESG principles. If it doesn’t, it could pose challenges for global ESG efforts. Regardless, it’s likely that companies will lean towards the benefits of technological clarity, especially when it comes to ESG ratings, scores, disclosures, and fund strategies.
At RMOK Legal, we champion the in-house legal counsel in raising their unique voice to the C-Suite on all EGS matters. With all the complexities here, it is important for everyone, including Legal, to be heard and thoughtful action taken.
The single biggest problem in communication is the illusion that it has taken place.’
– George Bernard Shaw