As New York Lawmakers Unveil the Fashion Act, is Larger Reform on The Way? The Fashion LawAs New York Lawmakers Unveil the Fashion Act, is Larger Reform on The Way? The Fashion Law
Impact Investing Forum 2022
London. Dec 07-08, 2022.
Last week, Stella McCartney, the Act on Fashion Coalition, New York State Senator Alessandra Biaggi and Assembly Member Dr. Anna Kelles publicly unveiled proposed new legislation that focuses on cleaning up the fashion industry. If signed into law, the Fashion Sustainability and Social Accountability Act will call on apparel and footwear retailers with global revenues of at least $100 million that sell products in New York State to publicly make environmental and social disclosures, and set forth plans to improve upon the workings of their supply chains – or risk noncompliance status and the potential for monetary penalties of up to two percent of their annual revenues.
Specifically, the “Fashion Act” (S7428/A8352) would require companies to map out at least 50 percent of their supply chain, identify “significant real or potential adverse environmental and social impacts,” and then disclose targets for prevention and improvement of those impacts. Companies would also have to disclose their material use (by material type); a quantitative baseline and reduction targets on energy and GHG emissions, water, and chemical management; and the wages of workers.
First introduced to the New York State Senate in October, the bill has found three New York Senate co-sponsors, as well as proponents in the fashion industry, with famed fashion designer Stella McCartney, for instance, stating that the legislation is “an example of a step towards a better, more regulated future.” In a report last week, New York Times fashion critic Vanessa Friedman called the proposed legislation a chance to hold “pretty much every large multinational fashion name, ranging from the very highest end – LVMH, Prada, Armani – to such fast-fashion giants as Shein and Boohoo” accountable “for their role in climate change.”
The Fashion Act – which aims to get “fashion retail sellers and manufacturers to disclose environmental and social due diligence policies” – is worthy of the many glowing headlines it has garnered since its public unveiling, as the fashion industry is sorely lacking when it comes to transparency about its occupants’ environmental impact and labor policies (topics that typically fall under the umbrella of Environmental, Social and Governance (“ESG”) reporting), despite being a significant driver of global greenhouse gas emissions.
“Unlike other heavy polluting industries, such as the auto sector, fashion retailers and manufacturers operate in a regulatory-free vacuum,” the New Standards Institute stated in a release on Friday. “This has led to a global race to the bottom, where the companies that have the least regard for the environment and for workers have the greatest competitive edge.”
Against this background, the industry is desperately in need of change. A number of industry initiatives and voluntary collectives have formed with the goal of cleaning-house, but in many cases, they have petered out or missed the mark in terms of what is actually in need of fixing. Getting brands to map out at least 50 percent of their supply chains and set science-based targets to reduce their impacts is an important endeavor, and ideally, the Fashion Act will kickstart a larger overhaul of the fashion/retail system.
However, in order for such an industry-wide ESG reckoning to come into fruition, a number of foundational elements must be put into place first.
From Uniform Data Standards to Reliable Audits
One of the most pressing roadblocks to implementing regulation in the fashion and apparel space (and every other industry when it comes to monitoring environmental and social factors) is the current lack of uniform data standards. Unlike financial reporting, there is neither an internationally agreed-upon standard to measure or calculate environmental and social factors, nor a process for auditing to ensure compliance against such a common standard.
The problem of data standardization and transparency is, of course, not a new one. Back in August 2020, for instance, Commissioner Allison Herren Lee of the U.S. Securities and Exchange Commission noted, “We are long past the point at which it can be credibly asserted that climate risk is not material. We also know today that investors are not getting this material information. The world’s largest asset managers, the largest pension funds, the largest insurers, and every major systemic bank seek disclosure of climate related financial risk.”
As it currently stands, there are hundreds of different ESG ratings systems, such as those from Sustainalytics (a subsidiary of Morningstar), Morgan Stanley Capital International (“MSCI”), Bloomberg, and Institutional Shareholder Services. These firms use unique proprietary models to measure climate risk, human rights and social policy, corporate governance, and supply chain policy, primarily based on voluntary-provided information. A uniform data standard for reporting social and environmental data – paired with suggestions on the relevant data, calculations, and disclosures – is currently lacking to ensure a consistent format in the data collection and reporting process. (The Sustainability Accounting Standards Board’s Apparel, Accessories & Footwear standards are worth noting within the context of fashion/apparel space, as they comprehensively take into account an array of ESG targets.)
Because ESG ratings rely largely on voluntary and survey data provided by companies, themselves, the data is often incomplete, inconsistent, and lacking in rigor compared to companies’ financial data. It was precisely this voluntary data that enabled fast fashion company Boohoo to achieve a AAA ESG rating from MSCI in 2020.
While many consumers and investors want to view such ESG ratings with the same credibility as the company credit ratings that Moody’s or S&P assigns, there are critical differences that exist between these ratings. For example, credit ratings are based on precise, publicly available market information and companies’ audited financial statements, and are calculated using similar methodologies across the various rating agencies. Companies’ financial statements are compiled according to the strict and legally enforceable GAAP or IFRS guidelines and then audited by an independent auditor registered with the Public Company Accounting Board in the U.S. for compliance with those standards. Auditors then prepare a report that is filed with the Securities and Exchange Commission (in the U.S.), where omissions and errors are met with sanctions, fines, and potential jail time.
In lieu of a standard framework or industry-specific guidelines, and reliable audited data, each individual company is left to decide how it calculates its impact and risks, and how it tracks its progress in furtherance of ESG targets. In a best-case scenario, even if companies are honest with their data, the lack of a uniform reporting standard still leads to inconsistent comparisons across companies – a well-documented complaint from parties ranging from asset managers to regulators. In a worst-case type of scenario, this lack of standardization invites companies that do not like the results of their current methodologies or their progress towards certain targets to simply change how they calculate their impact or to exclude problematic suppliers and products altogether.
Hardly a hypothetical issue, Brookings found that while more than 80 percent of major global companies report on some aspects of their social and environmental impacts, the data required to assess whether such ESG efforts have achieved a positive social and environmental impact is “often missing, incomplete, unreliable, or unstandardized.”
More than that, industry-wide standardization is critical because corporations notoriously have a mixed track record when it comes to voluntary disclosures – and this happens across industries. Research from individuals at the Center of Economic Research at ETH Zurich, University of Zurich, and University of Erlangen-Nuremberg-Friedrich confirms that while voluntary disclosures have been hailed as an effective measure for better climate risk management, corporations tend to cherry pick their data when it comes to climate-related data and report non-material information.
Still yet, in an article for the Harvard Law School Forum on Corporate Governance, Timothy M. Doyle essentially asserts that ESG ratings do not really rate anything given that companies are making “select and unaudited disclosures,” and that even third parties’ ESG ratings can “vary dramatically … due to differences in methodology, subjective interpretation, or an individual agency’s agenda.”
Without a standard framework or government mandated guidelines to calculate key environmental risks (in something of the same way as how banks or other highly regulated industries are given standards by the government, which sets the parameters and standards of key metrics like leverage or capitalization ratios), and given the overarching pattern of companies putting forth carefully curated information on the ESG front (and downplaying the negative aspects) of their operations in order to showcase themselves in their best light to consumers, investors, and regulators, greenwashing and gamesmanship scenarios are not difficult to imagine.
Not an Isolated Issue
Of course, the issue with data standardization, integrity, and transparency is not isolated to the fashion industry; it is a complex global market problem that regulators around the world are actively addressing with input from industry and the world’s leading experts in corporate finance and financial markets. Determining the right standard for each industry is what the SEC, the European Commission, and various other regulators around the world have spent years grappling with how to implement. The Global Reporting Initiative, Task Force for Climate Related Financial Disclosures, and Sustainability Accounting Standards Board have put forth the most widely accepted standards and are expected to be the benchmarks regulators will converge around to varying degrees.
One such effort comes by way of the Corporate Sustainability Reporting Directive (“CSRD”), which the European Commission introduced in April 2021 in order to upgrade the 2014 non-financial reporting directive, and improve the coverage and reliability of sustainability reporting. When it comes into effect in 2023, the CSRD is expected to increase the number of companies that disclose sustainability information and require them to report their sustainability performance using EU-wide disclosure standards developed by the European Financial Reporting Advisory, a private association with strong links with the European Commission. (The CSRD will, nonetheless, give companies significant discretion on what and how to disclose, and imposes different requirements for companies that differ by sector and size.)
At the same time, the U.S. Securities and Exchange Commission is exploring a rule to adopt mandatory ESG disclosure rules that will apply to publicly listed companies.
The general consensus among regulators appears to be that without standardized and accurate data, effective regulation is impossible, which is one reason why we have not seen more regulation in this realm. However, with rising ESG awareness and enduring calls from consumers and investors, alike, paired with dogged efforts from researchers, lawmakers and regulators, it appears as though the status quo is changing.
Ultimately, fashion is undoubtedly in need of greater regulation, and a state law that mandates greater transparency for the biggest players in the industry is a welcome start.
Kristen Fanarakis is the founder of Los Angeles-made brand Senza Tempo. She spent over a decade working on Wall Street in foreign exchange investment, sales & trading, and works with the Center for Financial Policy in Washington, D.C.