Government Regulation Is Driving Business Interest in Sustainability for Manufacturing Companies in All Industries

Multiple factors are driving increased interest in corporate sustainability, including public perception, customer expectations, enhanced efficiencies, employee initiatives, and Environment, Social, and Governance (ESG) investment. However, perhaps the key driver for business interest in sustainability is increased government regulation. The United Kingdom, Japan, the United States, the European Union (EU), New Zealand, Australia, Brazil, Hong Kong, Singapore, Canada, and Switzerland all have mandatory climate disclosure regulations proposed, approved, or in process. Additional countries and regions, such as Germany, Switzerland, and the EU, are requiring more stringent corporate due diligence practices within supply chains, addressing human rights and environmental standards.

Moreover, the EU has a Circular Economy Action Plan (CEAP), which aims to make sustainable products mainstream in the EU. The CEAP has announced initiatives that address the lifetime carbon emissions of products, addressing how products are designed, while encouraging sustainable consumption and writing legislation that optimizes resources, prevents waste, and supports product repair and reuse. The first industry sectors targeted with CEAP are those that consume meaningful resources and have a high probability of achieving success with circular applications, such as electronics and Information and Communication Technology (ICT), vehicles, batteries, plastics, packaging, textiles and apparel, construction and buildings, and food & beverages.

Climate disclosure, ESG reporting, and corporate responsibility obligations are changing rapidly in a legislative and regulatory environment that requires close attention from companies with a global presence.

Mandatory Climate Disclosure

• United Kingdom: Mandatory climate disclosure reporting went into effect April 6, 2022, for the largest U.K.-registered companies, with requirements focused on the Task Force on Climate-related Financial Disclosures (TCFD).
• Japan: Tokyo Stock Exchange “Prime” market companies began reporting climate disclosures aligned with the TCFD beginning April 2022.
• United States: A 2022 Securities and Exchange Commission (SEC) proposal called for companies to adopt climate disclosure requirements as early as 2023, while also addressing climate risks and company climate targets to investors. The SEC currently indicates that “final action” will occur in April 2023 for large public filers. Smaller companies have until 2025 to comply.
  • California: On January 30, 2023, two bills were presented in the California State Senate mandating emissions disclosure of corporations and climate risk of financial institutions (Corporate Climate Data Accountability Act and Climate-Related Risk Disclosure Act).
• EU Corporate Sustainability Reporting Directive (CSRD): The EU is set to require all large companies listed on the European stock exchange to report their carbon emissions beginning in financial year 2024.
  • According to EU climate law, countries in the EU must cut their Greenhouse Gas (GHG) emissions by 55% by 2030, with a goal of being climate neutral by 2050.
• New Zealand, Australia, Brazil, Hong Kong, Singapore, Canada, and Switzerland: These countries all have mandatory climate risk reporting proposed or in process, mostly aligned with the TCFD framework (reporting climate risks and opportunities).

Corporate Due Diligence and Supply Chain

• German Supply Chain Due Diligence Act: From 2023, companies with at least 3,000 employees will be required to comply with certain human rights and environmental standards. From 2024, companies with 1,000 or more employees will be covered, with the required specifications supporting more sustainable supply chains.
• EU Corporate Sustainability Due Diligence: In February 2022, the EU proposed legislation requiring both EU companies and non-EU companies that meet certain employee and revenue sizes to address due diligence requirements with respect to human rights and environmental standards.

With mandatory climate disclosure increasing worldwide, companies need to have a year-by-year comprehensive framework to reach net zero. In recent reports, ABI Research has identified 30 action items for reducing carbon emissions, water use, and waste for industrial and manufacturing companies, with lists of recommended technology vendors and suppliers for enabling the actions. ABI Research also views the European regulations as the most stringent, as it aims to be the world’s first climate-neutral continent (net zero emissions by 2050).

However, the most immediate regulatory impact for most companies, especially Small and Medium Enterprises (SMEs), is understanding how to approach the measurement of Scope 1, 2, and 3 emissions. Scope 1 and 2 emissions (carbon emissions within a company’s own operations) are simpler to assess, as data are more readily available, such as invoices for vehicle fuel or utility bills for electricity. Scope 3 emissions are more complex, as these include all activities upstream and downstream from the company, and they are generated by hundreds or thousands of suppliers or third parties over which the company may have little control. Therefore, with certain companies assessing Scope 3 emissions for the first time, ABI Research recommends hiring an external ESG consultant with expertise in carbon accounting. The next step will be to select an approach for calculating the company’s Scope 3 emissions. There are three primary methods, including the spend-based method, the supplier-specific (or supplier-survey) method, and the Life-Cycle Assessment (LCA) method. Historically, the most common approach has been the spend-based method, which estimates carbon emissions by using an online calculator, or having a consultant estimate emissions, based on procurement spending. The second, more accurate method involves sending surveys and requesting emissions data directly from suppliers. This approach is simple to automate, but it can be tedious to sort through responses and the data may not be fully accurate. The most scientific and accurate method, though it can be expensive, uses LCA data, considering cradle-to-gate emissions from the extraction of raw materials to manufacturing to distribution. LCA data can also estimate emissions from the “use of sold products,” which can be the major source of emissions for many industries, such as automotive, industrial equipment, and electronics.

In further response to emissions disclosure, Carbon Disclosure Project (CDP) reporting shows that some industries are better prepared than others for the upcoming regulatory changes. While some sectors, such as power generation, technology, healthcare, and services, are all above average for public Scope 3 emissions reporting, the manufacturing sector is well behind the average for Scope 3 reporting by industry. Large manufacturers have an inherently more challenging role in the climate fight, as the emissions of a company manufacturing heavy machinery and equipment cannot be compared similarly to a software developer or services provider. This is why the manufacturing sector will need both public and private support to reach net zero, and certain technologies, such as Artificial Intelligence (AI)-enabled analytics platforms, carbon management software, and energy management solutions for buildings and factories, are already receiving a boost from climate-related regulations. In the future, it is anticipated that previously siloed solutions, such as software for Enterprise Resource Planning (ERP), Product Lifecycle Management (PLM), Supply Chain Management (SCM), carbon accounting, and more, will integrate for automated carbon emissions measurement and standardized ESG reporting.

Finally, disclosing carbon emissions is just the first step. To fully achieve global climate goals, regulatory “push” mechanisms and capital markets’ “pull” incentives will have to work together to encourage long-term value creation for companies that invest in sustainable products and operations. Supported by large-scale tax credits and public investment, such as the European Green Deal and the Inflation Reduction Act in the United States, manufacturing companies can view corporate responsibility not as “added costs and compliance,” but rather as an investment in the future value of the company. Incentivizing sustainable businesses can be invaluable for global communities and governments—supporting cleaner air, cleaner water, lower carbon emissions, and a livable environment.