The influence of changes in a regulatory framework on shaping ecologically sustainable business transformation: insights from worldwide case studies

Introduction

Climate change and ecosystem depletion represent significant challenges for the planet, seriously affecting ecosystems and human wellbeing, and being driven by various anthropogenic factors, such as greenhouse gas (GHG) emissions from various industrial companies and plastic pollution [10, p. 1-13]. To improve the situation, it has become vital to adopt sustainable business practices among organizations, reducing their negative environmental footprint and ensuring development of an innovative business approach allowing to balance ecological, social and economic needs [7, p. 1-15]. According to recent research, 20% of the leading organizations declared a significant increase of their investments towards an environmentally sustainable future and 49% of companies developed eco-friendly products [39]. Therefore, many companies have already started their sustainable transition with different business transformation levels.

Certain enterprises completely changed their business models for environmentally friendly production, following recent ESG (environmental, social and governance) trends. One of such companies is Interface, an international flooring company, which has created the world’s first carbon-negative carpet tile and managed to achieve carbon neutrality in the whole product life cycle, with promise to become a carbon-negative company by 2040 [41]. Another Danish energy company Ørsted performed incredible 10-year transit from an enterprise generating revenues by selling heat and power predominantly created from coal with high volumes of GHG emissions to the world’s largest producer of offshore-wind energy, achieving its target of transferring 85% energy production to renewable sources 21 year prior to the estimated deadline [28].

Adidas, ASUS and Dell Technologies incorporated circular economy models in their business activities in collaboration with ocean cleaning organizations, utilizing sea waste recycled plastic in production and packaging activities and, therefore, contributing to cleaning oceans, raising awareness about global plastic pollution problem and reducing carbon emissions [1; 3; 6].

Although various leading enterprises introduce different sustainable practices, there are still many companies which prefer obtaining significant profits in current periods to taking long-term actions towards eco-friendly business transformation [43]. Besides, according to a recently issued report, only 2% of corporate sustainability programs achieve the result in comparison with 12% of other business transformation practices [22]. Therefore, nowadays it becomes essential to identify potential directions for stimulating companies’ shift towards eco-friendly business practices ensuring their long-term economic development while achieving positive impact on the environment.

Analysis of the existing studies showed that one of the important factors forcing the company’s management to take eco-friendly business decisions is connected with the legislation framework [10, p. 1-13; 27, p. 162-178; 32, p. 1-13]. At the same time, the analysis of a combination of various types of governmental regulations and their consequential impacts on eco-friendly business transformation remains insufficiently explored within the existing literature. This gap in researches suggests a need for a more comprehensive understanding of how different regulatory frameworks influence the integration of eco-friendly business practices.

Therefore, the purpose of this research was to rigorously examine the effects of specific regulatory mechanisms on the adoption of environmentally sustainable practices. Analyses was based on the classification of regulatory drivers proposed by Tolstaia and Gorbacheva [38]. This analysis was conducted through an exploration of particular international case studies, addressing business response to each type of regulatory drivers in the context of sustainable business transformation, potential shortcomings of these measures and underlying causes. By critically evaluating the role of these drivers, this research was also focused on proposing recommendations on how considered regulatory frameworks can be further refined to better support the transition of businesses to more environmentally sustainable practices.

Discussion and results

The study was focused on examining the effectiveness and shortcomings of legislative drivers indicated on Picture 1 from the view of their influence on sustainable business transformation.

Regulations limiting negative ecological impact from business activities

In order to reduce environmental impact from business operations, regulatory frameworks primarily focus on controlling emissions, waste management, energy efficiency, resource utilization, and other negative aspects of respective industry activities. These regulations govern both business processes, and the environmental quality of the products themselves. The adoption of such green regulations is increasingly important for global environmental sustainability across various sectors, reducing carbon footprints, optimizing resource use, and minimizing waste.

For example, in the UAE, the Estidama Pearl Rating System has accelerated the construction industry's shift towards sustainability by setting strict standards for energy use, water efficiency, and indoor environmental quality [2]. By 2022, the UAE's green construction regulations have yielded positive results, as evidenced by the growing number of developers adhering to these standards and positive consumers’ response [8].

While the development and enforcement of green standards vary depending on the region and industry, the significance of these regulations is undeniable. Some countries, like the UAE, have made considerable progress, while others are still in the initial stages of adopting and integrating comprehensive green standards. Despite these differences, the push towards adopting green industrial standards is critical for addressing global environmental challenges, including climate change, resource depletion, and ecosystem degradation.

At the same time, in practice there are cases when specific environmental industrial standards have been violated. One of the most famous cases was Volkswagen's "Dieselgate" scandal when in 2015 a significant contrast was revealed between the company's reported emissions data and the actual environmental impact of its diesel vehicles. While showing that cars were certified with EU pollution standards, the cars were actually emitting up to 40 times higher amounts of nitrogen dioxide than it was legally permitted [19]. Volkswagen was found to have manipulated emissions tests to mislead regulators about the true environmental performance of its products which led to significant fines and compensation of damages to affected vehicles, but also to serious reputational damage of Volkswagen and reducing its scores in relevant ESG ratings [23].

To resolve this situation, Volkswagen has actively engaged with policymakers and industry leaders to drive decarbonization in the automotive sector [19]. Collaborations with energy firms such as Enel and Iberdrola have also established the foundation for the development of clean energy infrastructure.

Establishment of ESG-related (sustainability) standards

At a global scale, a common framework for corporate sustainability reporting was first established in 1997 with creation of the Global Reporting Initiative (GRI) providing a standardized approach for reporting on environmental, economic and social impacts of the company’s activities and bringing focus on a business transformation towards sustainable development [17]. Numerous ESG-related (sustainability) standards have been further developed by various countries.

Sustainability reporting regulations are continuously amended, and they have recently undergone significant changes. For example, GRI standards were amended in 2021 and supplemented by few industry-specific standards at a later stage [17], and Stock Exchange of different countries issued mandatory ESG-related disclosure recommendations [20, p.6]. In January 2023, the Corporate Sustainability Reporting Directive (CSRD) took effect, expanding the social and environmental reporting requirements and making it mandatory for large companies listed on EU-regulated markets, with potential penalties and other negative implications in case of non-compliance with these new rules [12].

Besides, the International Sustainability Standards Board (ISSB) designed market-driven and investor-focused reporting initiatives such as the Sustainability Accounting Standards Board (SASB Standards) covering industry-specific topics, and International Financial Reporting Standards (IFRS) sustainability disclosure standards, aimed to address investor information needs and ensure long-term competitiveness in the global market [30]. The first two IFRS sustainability standards, IFRS S1 “General Requirements for Disclosure of Sustainability-related Financial Information” and IFRS S2 “Climate-related Disclosures”, become effective for reporting periods beginning January 1, 2024 [30]. Recently, the decision was taken to develop additional IFRS ESG-related standard reflecting nature-related issues beyond climate change which will allow to control corporate reporting on the whole complex of nature-related business risks and impacts [37].

Considering the above, at present times sustainability reporting standards are designed not only to ensure transparency of non-financial reporting reflecting companies’ ESG outcomes for relevant stakeholders, but, more importantly, to support sustainable business transformation across various industries. In practice, companies file either combined financial and non-financial ESG-related reporting, or a separate sustainability reporting in additional to a financial one.

According to recent survey, 96% of the world’s biggest by revenue 250 companies (G250) report on ESG matters [16]. Proper sustainability reporting according to ESG-related standards has led to significant increase in sustainability investments, which are expected to grow by 19 trillion USD by 2025 and 30 trillion USD by 2030 [5, p.4]. About 45% of global leaders in organizations of all industries expect at least a 20% increase of sustainable investments in the next 5 years, and 44% of respondents believe in greater returns from ESG-related investments [4].

Moreover, international companies from different industries report actual positive ecological outcomes associated with implementation of sustainable business practices following ESG-related regulatory requirements. For example, H&M fashion company implemented circular economy models such as usage of recycling technologies, and in 2023 showed positive dynamics in reaching its sustainability targets, including reduction of GHG emissions by 24% in 2023 out of targeted 56% by 2030, 94% usage of renewable energy in its production activities, and achieving 85% of recyclable and sustainable materials in commercial goods coming closer to 100% target set for 2030 [18, p. 83]. Multinational energy company Enel declared graduate transfer to generation of renewable energy and full decarbonization by 2050, and in 2023 achieved reduction of GHG emissions by 26.3% along the entire value chain while generating economic value for all stakeholders [11, p. 124].

However, about 35% of global leaders interviewed during recent research mentioned that they are unsure about investing in sustainable practices due to lack of defined standards and tools to assess sustainability performance [4]. Lack of transparency and trust in reported data, time and cost of such projects are among other barriers for making ESG-related investments [24].

Besides, in practice there are companies preparing sustainability reports in order to merely fulfill the requirements of ESG-related standards without making real sustainability efforts or even showing inaccurate information. Nowadays, a deceptive approach where companies or organizations falsely present themselves in their reports or any other sources as environmentally responsible is known as greenwashing, possessing a major challenge to combating climate change by promotion of superficial solutions that divert attention from the real, effective actions needed to be undertaken to mitigate negative effect from the company’s main business operations on the environment [42].

In 2022, several financial institutions were flagged for greenwashing by misleading the public about their green credentials while failing to disclose their financing of polluting industries in their ESG reporting. Notable cases include Goldman Sachs in the U.S., Deutsche Bank AG in Germany, and HSBC in the U.K., which faced regulatory scrutiny and serious fines [31]. In response of this situation new regulations have been considered across various jurisdictions, such as the EU Sustainable Finance Disclosure Regulation (SFDR), expanding the legal framework for green claims, imposing stricter disclosure requirements and criteria for investments labeled as sustainable, with similar rules forthcoming in the U.K. and the U.S., potentially leading to fines within a few years of implementation [31]. The risk of being investigated and prosecuted for greenwashing may also bring additional reputational damages for the company.

Nowadays, it becomes obvious that there is a lack of similar specific standards or stringent requirements for industries with the highest negative environmental impact, such as fossil fuel extraction and significant plastic waste production, to influence their sustainable business transformation. More than 50% of global industrial GHG emissions since 1988 is generated by only 25 companies, including largest oil and gas corporations, and ExxonMobil, Shell, BP and Chevron are considered as the companies with the highest GHG emissions since 1988 [34]. If fossil fuel extraction continues at the same rate as between 1988 and 2017, global temperature, by some scenarios, could rise by 4°C by the end of the century, which could lead to severe species extinctions and global food shortages [34].

Experience of these companies shows a more profit-oriented approach, leaving environmental issues behind their business agenda. For example, BP reduced its climate change adaptation targets while revealing that its annual profits more than doubled to $28 billion in 2022 driven by a sharp rise in gas prices [35]. From 2010 to 2018, ExxonMobil reportedly allocated only 0.2% of its capital expenditure to low-carbon energy sources such as wind and solar, while planning to sustain $20-25 billion annually for capital and fossil fuel exploration through 2025 [9].

Another example of negative influence on the environment may be found in those businesses associated with huge usage of plastics. In 2021, Coca-Cola was considered the world’s top plastic polluter for the fourth consecutive year [25]. In response, Coca-Cola committed to making 25% of its packaging reusable by 2030, and PepsiCo also announced plans to cut virgin plastic use by 50% by 2030 [25]. However, due to remaining concerns regarding Coca-Cola and PepsiCo plastic and water usage, Nordea Asset Management is reconsidering investments in these companies.

Enhancing ESG-related regulations related to the most polluting industries, and enforcing sustainable transformation of only a few companies from such industries may result in significant reduction of GHG emissions and plastic waste from enterprises.

Regulations eliminating greenwashing in marketing

There is also a troubling trend associated with moving greenwashing activities from ESG-related reporting, accessible to a limited number of stakeholders, to social media and marketing platforms with millions of users, where companies increasingly display misleading environmental claims to attract eco-conscious consumers. This deceptive practice misleads ESG-oriented purchasers, giving them a false sense of supporting sustainable businesses.

A notable example is the case of Chevron, which came under scrutiny for its social media images that portrayed the company as committed to sustainability. However, investigations revealed that despite these claims, Chevron remained one of the world's largest GHG emitters. Chevron's 2019 annual report indicates that, while only a very small portion (0.2%) of its capital expenditures from 2010 to 2018 went towards low-carbon energy sources, its net production of crude oil, natural gas, and oil-equivalent actually increased in 2019 compared to the previous two years [15].

This trend not only undermines genuine sustainability efforts but also facilitates the misleading promotion of unsustainable businesses and products, thereby diverting attention of ESG-concerned customers from truly responsible practices. In response to this situation, regulatory authorities in certain industries (for example, fashion industry) consider development of anti-greenwashing regulations for social media, invoking companies to take collaborative actions in this process and ensure that they do not present misleading information in their marketing campaigns [40].

Governmental financial measures

Governmental financial measures remain another important stream enforcing eco-friendly business transformation. These measures may be divided into restrictive via imposing taxes or levies on “brown” industries, and stimulative granting environmentally sustainable initiatives with state support measures.

There are numerous examples when policy-makers introduced special environmental taxes aimed to reduce GHG emissions or taxes on super-profitable “brown” businesses which may have secondary positive ecological effects, resulting in different environmental and economic outputs. For example, in 2012 Australian Government introduced Carbon Tax aimed to cut greenhouse gas emissions by charging coal and gas-powered energy producers $25.40 per ton of CO₂, incentivizing them to reduce their carbon footprints and invest in cleaner energy [36]. While this tax contributed in reduction of emissions and generated revenue for renewables, this initiative faced strong political and public opposition due to its impact on household bills and business costs, leading to its repeal in 2014. Although this tax was cancelled two years after its introduction due to significant criticism, there could be alternative ways of adjusting this initiative allowing to eliminate its negative effects instead of abolishing the tax. Being subject to additional analysis, policy-makers could perform additional feasibility studies and introduce this tax gradually, reinvesting tax revenue into support of households and green projects, and designing complementary policies supporting effective reduction of GHG emissions without significant economic disruption.

To effectively reduce GHG emissions from high-polluting industries without causing undue economic strain, governments may need to implement sector-specific taxes that target major emitters like coal or oil, while allowing businesses time to adapt through gradual implementation. Combining these taxes with tax revenue recycling, such as investing in renewable energy, supporting local people affected by the law and providing transition support for business, can help to mitigate negative economic and social impacts and encourage the adoption of cleaner technologies by the targeted companies.

On the other hand, policy-makers may stimulate adoption of environmentally friendly practices, providing businesses with governmental support measures such as subsidies or tax incentives and, therefore, making it easier for companies to invest in sustainable technologies and processes [26]. ESG-related state support measures of different nature, including various tax incentives, vary by countries and industries, and remain a viable instrument encouraging businesses to align with environmental goals by lowering the initial investments needed for realization of eco-friendly projects [29]. Regulations for green project financing also vary by country, and, for instance, include the EU Taxonomy setting specific criteria for governmental support of sustainable projects [13].

There are numerous positive examples when governmental support measures enhanced realization of eco-friendly projects and sustainable business transformation. This factor has become one of drivers for realization by Ørsted its 2.9 GW Hornsea 3 offshore wind project in the U.K. allowing to reduce the level of global GHG emissions, while the project is supported by the government, providing effective pricing strategy, subsidies and tax incentives [44]. Another example is associated with provision of tax incentives to purchasers of electric vehicles such as Tesla and solar panels, typically in the form of rebates claimed at the time of purchase or tax credits reducing individual income tax in the period when tax declaration is filed [33].

However, in practice there were projects which failed to achieve the desired result irrespective of obtaining state support measures. One of remarkable examples is a bankruptcy case of Solyndra, a company that developed tubular solar panels. Solyndra raised over a billion dollars from investors and secured a large loan guarantee from the Department of Energy (DOE) received under the Energy Policy Act of 2005 [14]. However, the company went bankrupt due to high costs, inability to sell panels at a premium price, and competition with cheaper Chinese solar panels. An Inspector General's report revealed that Solyndra had misrepresented its sales contracts, exaggerating commitments by hundreds of millions of dollars and providing inaccurate information to both the DOE and credit rating agencies [14].

Solyndra project revealed the necessity to perform detailed and fair feasibility study to ensure that the project would be profitable, especially in the case of obtaining state support, disclose accurate information, and perform analysis of lessons learnt from previous similar projects. Verifying that the project meets sustainability criteria and has predominantly positive impact on the environment should become an additional routine before the beginning of similar projects. Further during the period of project realization, it is essential to prepare annual reporting on meeting criteria for obtaining state support measures and declaring the amount of clamed state funds.

Assignment of high scores in ESG ratings

One more incentivizing measure is associated with the assigning companies with high scores in ESG ratings aimed to assess a company’s performance across sustainability dimensions, including environmental impact, social responsibility, and corporate governance. These ratings are based on a thorough analysis of factors like carbon footprint, energy efficiency, labor practices, and governance structures, using data from public disclosures, company ESG-related reports, and third-party sources. ESG ratings offer asset owners, institutional investors, regulators, corporate managers and other stakeholders an insight into a company’s commitment to sustainable practices, enhancing company’s reputation, attracting responsible investors, and potentially improving financial performance [21, p.1-16].

ESG ratings tend to motivate companies to adopt sustainable practices, meet regulatory expectations, and remain competitive in a market that values sustainability, making companies more attractive for investors. Although ESG ratings in most cases may be prepared based on accurate information, there is a room for potential manipulation from the side of particular companies in case of inaccurate reporting of their sustainability indicators or even providing misleading ESG-related information. Besides, there is a variety of ESG ratings prepared based on different sustainability indicators which makes it practically difficult for stakeholders to fairly compare companies’ ESG performance. To enhance the transparency of information provided in ESG ratings, a standardized set of indicators and metrics for critical environmental issues should be developed at a global level.

Conclusions

The global effort to combat GHG emissions is progressing slowly, with major emitters, particularly in the oil and gas industry, continuing fossil fuel exploration and resisting the adoption of sustainable practices. Despite significant advancements in ESG-related legislative frameworks, additional reforms are needed to enhance sustainability regulations effectively. These changes must aim to curb global temperature rise and address other crucial environmental issues, such as deforestation, plastic and water pollution, and ecosystems degradation.

To achieve meaningful progress, regulatory measures should primarily target “brown” industries and companies with the most substantial negative environmental impact and minimal efforts in introduction of eco-friendly practices, including imposing restrictive measures in respect of ecologically unfriendly operations and incentivizing shift to eco-friendly types of business. Where the complete elimination of unsustainable practices, such as fossil fuel exploration or plastic use in production, is not feasible, policy-makers may need to focus on promoting their gradual shift to sustainable operations while obtaining compensation for their environmental impact in the form of taxes or through participation in approved ecological initiatives. Promotion of “big brother” experience of a company from similar business may be also considered.

Additional amendments of ESG-related regulations may include:

● Standardized set of indicators and metrics for critical environmental matters should be developed at a global level to be used in local ESG-related regulations, ESG reporting standards and ESG ratings;

● Standards and tools have to be designed at a global level allowing to assess companies’ sustainability performance, and to present correlation between financial and non-financial ESG indicators in order to ensure attraction of additional ESG investments;

● Anti-greenwashing regulations need to be introduced for all industries and covering different sources, including ESG reporting and social media;

● ESG reporting should become 100% obligatory for all medium to large companies across all industries and countries;

● Tangible and fair penalties should apply for non-compliance with ESG-related regulations (including non-provision of ESG-related reporting or disclosure of misleading information);

● Additional taxation for environmentally unfriendly businesses may need to be considered, accompanied by comprehensive preliminary feasibility studies with further progress assessment to verify whether they remain effective in achieving set goals or require relevant adjustments;

● State support measures may need to be provided for eco-friendly projects. In this case it is essential to ensure performing detailed and fair feasibility study, collection and presenting accurate information, investigation of lessons learnt from similar projects and assessing potential positive environmental impact prior to the project commencement, and maintaining proper annual reporting in the course of project realization.

● Priority may be given to economic (including tax) incentives promoting long-term commitments to sustainable goals rather than short-term gains, including performance-based state support linked to ecological and financial milestones ensuring companies prioritize environmental objectives while applying effective risk management practices;

● New regulatory initiatives should include preliminary comprehensive examination from various perspectives, including economic, ecological, and social aspects, to ensure that they are going to be effective;

● The development of regulations enforcing environmentally sustainable business transformation should be accompanied by a collaborative investigation, combining potential investors, leaders from core companies of particular industries, academics, policy-makers, representatives from local communities, which will enable the alignment of business needs, social considerations, and the timely implementation of environmental actions sufficient for meeting globally set ecological targets.

Development of a standardized industry-focused policy framework, supplemented by performance of comprehensive preliminary feasibility study and reasonable dialog with respective stakeholders, is essential for promoting environmentally sustainable business transition across industries and reducing negative ecological footprint.