The Impact of ESG Factors on Digital Transformation: a comprehensive analysis of the EU legislation

Introduction

This essay focuses on the evolution of digital transformation as an urgent, but not a trivial, challenge for companies in all industries.

It requires a vision and strategy to embrace new technologies and a renewed mindset to re-think the business from a digital perspective.

A plan and roadmap to transform the business is needed with deep commitment and support from the top management, as well as a cultural change to motivate and encourage all employees to get actively involved. The key to digital transformation is the business model, i.e. value creation, value delivery and value capture and how to maintain a competitive advantage.

Therefore, the first step is to have a clear understanding of the current and future business composition and models especially in the digital context.

The journey of digital transformation needs to be monitored and managed actively. Measurement and KPI on state and progress are necessary to keep track of the results along the way on the holistic level. Apart from these metrics, the technological barriers should also be monitored, as they can hold back the transformation of an entire company. This is particularly the case for the heavy reliance of many companies, particularly in specific industries, on legacy systems. In keeping with the need for pragmatism, both channels for leveraging technologies are valid and sometimes, companies adopt both strategies.

Key Issues

The main point is: Should companies be governed and managed for the benefit of their shareholders alone or should they be governed to deliver for shareholders as well as the broader stakeholder base? If so, how can investors allocate capital to address sustainability?

In recent years the European Union (EU) has firmly established itself as an international leader in promoting sustainable financial growth, pushing for concrete policy actions and regulatory frameworks to address the negative effects of climate change and to pursue the Sustainable Development Goals of the 2030 Agenda of the United Nations. Starting with the European Commission (EC)’s Action Plan on Financing Sustainable Growth in March 2018 and then, in December 2019, with the Green Deal, the European Union has set itself some ambitious goals on these issues, including a reduction of 55% of greenhouse gas emissions by 2030, and become a fully conditionally neutral continent by 2050. To facilitate the achievement of these objectives, in January 2020 the EC published a Sustainable Finance Plan, with the aim of systematising the economic and environmental policies and encouraging sustainable investment; subsequently, in June 2020, the EU published a Regulation on the Taxonomy of environmentally sustainable economic activities (852/ 2020/EU), as well as a new European Standard for Green Bonds. Finally, the EC recently approved Regulatory Technical Standards for disclosure by financial market participants of sustainability-related information under the Sustainable Finance Reporting Regulation, known as SFDR (2088/ 2019/EU).

The analysis of the effects of these ambitious policy measures is at the core of the present article.

Digital Transformation

Digital transformation is the use of technology to radically enhance or create business processes, culture, and customer experiences to meet changing business and market requirements. In the age of technology, digital transformation has come to be used broadly to indicate the application of fundamental advancements in technologies (e.g., mobile, social media, analytics, and cloud) and new digital business models (e.g., digital on-demand economy, distributed economy, sharing economy, and platform economy) to transform organisations, markets, and business ecosystems. Digital transformation is an ongoing transformation process that radically alters the business model of an organisation. It is a culture change to quickly adapt to diverse digital disruptions, opportunities, threats, and aspirations in highly dynamic, uncertain, and turbulent global digitalised markets.

Digital transformation encompasses business process transformation wherein digital technologies and new digital business models of entirely different kinds are applied to create a new economic model for entirely new business processes, operational processes, and service processes in organisations.

Digital transformation also includes customer experience transformation in an organisation to enhance customer experiences in payments, servicing, purchasing, and consuming. Digital transformation also includes organisational culture transformation using digital technologies and business models to transform and redesign the culture of the organisation. Digital transformation brings radical positive changes in the organisation and new risks and new opportunities. The World Economic Forum estimates that 70% of all businesses will be digitally transformed in one way or another in the coming years, and recent studies have reported that around 64% of organisations globally are in the early stages of adopting digital transformation efforts, with more than 41% of organisations stating they cannot potentially survive digitally without the transformation.

Key Drivers and Challenges according sustainability

While the digital transformation of organisations can be influenced by various factors, these drivers can be categorised into three main groups: technological changes, external changes, and business model changes. On the one hand, the rapid evolution of hardware and software technology and the IT revolutions have inevitably affected the entire world, the digitalisation of business models has naturally followed. This has led to massive investments in IT equipment by enterprises and institutions. The emergence of the Internet of Things (IoT), Big Data, Artificial Intelligence (AI), blockchain, robots, and other technologies has further deepened digital transformation. Although the current technological base is very different from that of the past, it does not fundamentally change the nature of the problems to be solved or the tasks to be performed. On the other hand, technological changes affect organisations mainly through the external environment. The outbreak of the COVID-19 pandemic has rapidly elevated the digital supply chain construction to the strategic level of enterprises, prompting many organisations that previously paid little attention to the digital supply chain to re-evaluate the urgent necessity of digital transformation. Customer dissatisfaction is an external factor that directly affects digital transformation initiatives. In the context of digitalisation, customer demand is shifting from traditional products to integrated and customised solutions. In order to adapt to this unfavourable change in the external environment.

‘Sustainability’ goes beyond just climate, and the role that businesses can play in protecting both the environment and supporting broader issues such as human rights has caught the attention of politicians, investors, consumers, and other stakeholders.

In this respect, the European legislator is giving the private sector a leading role in promoting sustainable and inclusive economic growth that avoids the creation of imbalances in the international market, taking into account social, environmental and governance externalities and risks.

The European Commission, via its proposed Corporate Sustainability Due Diligence Directive (CSDD Directive), has put forward a legislative framework to oblige companies — including those in financial services — to demonstrate what action they are taking to protect the environment and human rights.

ESG (environmental, social, governance) and sustainable finance continue to be at the top of UK and EU regulatory agendas. In the UK, a new Green Finance Strategy has provided some clarity over the future direction of travel, and the EU continues to push forward with its Sustainable Finance Action Plan and initiatives under the European Green Deal. All of these impact the financial sector and regulatory expectations of firms.

Greenwashing concerns are paramount and are driving developments around reporting, taxonomies, product labels, ESG data and ratings and corporate due diligence. New reporting standards at global (ISSB) and EU (ESRS) level are nearing completion and additional requirements for transition plans are emerging. Nature and biodiversity are now sharply in focus, with a final disclosure framework expected from the Task force for Nature-related Financial Disclosures in Later 2024.

Benefit Corporation and B-Corp: sustainable business models in comparison

The last part of this essay deals with two forms of entrepreneurial organisations which are committed to creating value for both society and the environment.

Over the past few years, public attention to environmental and social sustainability has grown dramatically. In response to this growing sensitivity, different forms of business organisations have been created that aim to create value for both society and the environment, as well as its shareholders. Among them, the Benefit and B-Corp Companies are two important examples. In this article, we will delve into the differences between the two forms of organisations and analyse the Italian legislation regulating them.

On January 1st 2016, Italy became the first European state and the second country in the world creating a new legal status for companies, called “Società Benefit” (in the US, Benefit Corporation). A Società Benefit is a company which combines the goal of profit with the purpose of creating a positive impact for society and the environment and which operates in a transparent, responsible and sustainable way.

The Società Benefit is a new legal tool to create a solid foundation for long term mission alignment and value creation. It protects mission through capital raises and leadership changes, creates more flexibility when evaluating potential sale and liquidity options, and prepares businesses to lead a mission-driven life post-IPO.

A Società Benefit is neither a social enterprise nor a non-profit organisation, but rather an evolution of the concept of for-profit business to take on the challenges of the 21st century and bring about common benefits both for society and the environment.

The law defines a common benefit as the creation of positive effects (or the reduction of negative ones) vis-à-vis individuals, communities, territories and the environment, cultural and social heritage, entities and associations as well as other stakeholders.

In order to become Società Benefit, a company have to amend its articles of association including in the object clause the aims of common benefit that it intends to pursue. This means that the company will not only pursue the purpose of profit, but also the specific purpose(s) of common benefit that it has inserted in its articles of association.

The amendment of the object clause is closely linked to directors’ duties. Indeed, directors of a Società Benefit have to manage the company with the aim of pursuing the common benefit, taking into consideration both the interests of shareholders, and also the interest of all stakeholders.

Conversely, B-Corp companies have developed in the American legal system as a result of an entrepreneurial movement that involved a large number of companies interested in profit-making in compliance with the highest standards of transparency and performance of socio-environmental quality. B-Corp are profit companies that voluntarily decide to undergo an evaluation path (BIA – Benefit Impact Assessment) to measure the quality of the impact generated on stakeholders: those who manage to obtain a final score greater than or equal to 80 (out of 200) can apply for certification. Please note, however: the certification is valid for three years, after which, if the company considers it, it must possibly be renewed.

The annual fee for B Corp certification varies between Euro 500 and Euro 50,000, based on the company’s annual turnover.

As it should be clear:

•         a company can be benefit without being B-Corp

•         a company can be B-Corp without being a benefit

•         a company can be benefit and also B-Corp.

To sum up, investment managers and financial advisers are increasingly expected to consider sustainability risks in their investment and advice processes, even when they do not offer or specifically advise on green products.

The measurement and management of climate-related risk now form part of business as usual supervision for banks and insurers.

Progress has been made, but there is much more to do.