ESG and its impact on contractors

The subject of Environmental, Social and Governance (ESG) issues is a topic that is rapidly climbing the corporate and legislative agenda. Particularly following last month’s COP26, and the slew of countries committing to some form of net-zero targets during the conference, it is clear that companies can no longer afford to ignore the ESG agenda.

As one of the world’s largest polluters, the global construction industry has become a particular focus for change in respect of its ESG impact. This encompasses the entirety of the construction ecosystem, from managing waste and carbon emissions across supply chains, designing buildings with more efficient credentials, and driving technology towards more sustainable products and methodologies.

So much is the importance of ESG compliance that, according to the Governance & Accountability Institute, more than 80% of companies on the Standard & Poor’s 500 report their compliance against ESG standards. In a poll carried out in the construction industry by Global Data, 61% of participants said that they had witnessed clients increasingly demand the use of sustainable construction methods. Project financers are increasingly seeking to comply with the Equator Principles (a risk management framework to support financers in making responsible ESG decisions and managing risks). FIDIC has set out its recommendations for achieving a sustainable and holistic approach to the built environment, and the RICS is in the process of updating its own guidance on how ESG matters can be taken into account in commercial property valuation.

Whilst this focus on ESG issues is welcome, the question remains as to what this means for contractors, particularly those who are small to medium-sized enterprises who may not have the resources or bargaining power to influence an employer’s decision on a given contract. The main points to address include:

• Contractors may be required to address ESG compliance in tenders – Employers are likely to place a greater emphasis on contractors displaying their ESG credentials. Having some form of company policy dealing with ESG is advisable, although like any policy, effort needs to be made to show that this policy has been adopted and is engrained within the company and its staff’s conduct. There are groups that can help in auditing companies for the purpose of understanding and improving their ESG compliance – whilst this might be an unwelcome cost, any value in terms of increasing a contractor’s ability to win tenders will be welcome.  
• Monitoring and reporting requirements will increase – If an employer (or its financers) place an emphasis on ESG compliance, contractors should expect a greater level of monitoring and reporting requirements. This will require a greater level of administration (and therefore cost). Contractors should consider whether they need to have their own ESG officers for this purpose, and what training this individual requires. Given the increased level of scrutiny, it is also important to emphasise the ESG requirements on sub-contractors and suppliers to ensure that they also have sufficient reporting and monitoring standards to feed-into the employer. 
• There is likely to be inconsistencies – ESG compliance is increasingly coming to the fore, but the approach taken by different companies and different countries will inevitably be inconsistent. The requirements may also change from project to project.  Contractors should have their own policies in place, but time will need to be taken to discuss and understand an employer’s requirements, and contractors need to be adaptable. Allowing an employer to lead this process will assist in understanding their needs and help identifying any pricing risks. 
• There will inevitably be a learning curve – The evolving nature of ESG compliance and legislative framework cannot be emphasised enough. There is no one size fits all policy. Contractors should therefore take this opportunity to encourage its stakeholders to propose/adopt new solutions, explore and embrace new technology, and create an environment of change. There is a large number of actors in the construction industry issuing papers or holding training conferences for the purpose of idea sharing, which will be useful to actors at all levels of an organisation.
• There will be a costs impact - One of the main concerns expressed by contractors is the cost of redesigning the construction ecosystem to comply with increasing ESG requirements. In the context of the ongoing Covid-19 pandemic, where margins are tight and supply chains remain disrupted, any increase in costs or administration will be unwelcome. Therefore it is important to have upfront conversations with employers about their requirements, and ensure that pricing adequately reflects the cost of complying with increased ESG requirements. Particular care should also be taken in ensuring that the contract protects the contractor against the cost of any new legislative provisions that are introduced during the construction.
• Contractors can also look within their jurisdiction to see whether there is any government support or grants available to assist companies in adapting to new ESG requirements, if these costs cannot be covered within project budgets.