In an era where a company’s reputation can soar or
plummet in one news cycle, a single misstep in selecting the wrong business
partner, supplier, or investment could lead to severe financial,
reputational, and/or legal repercussions.
Searches show that more than 90% of the companies
have confirmed facing a disruptive incident related to a third party in the
last three years. 91% of companies are also considering the enhancement of
their compliance procedures in the next five years.
Increasing global regulatory scrutiny and evolving
corruption and fraud schemes have significantly compelled companies to further
examine their business relationships and reassess their risk strategies hence
stressing the importance of compliance and due diligence processes, including
reputational due diligence.
This article unravels:
- Reputational due diligence and its importance
- Challenges in compliance and due diligence
implementation
- Consequences of absent due diligence processes
- Solutions to poor due diligence and rewards of good
practice
Reputational Due Diligence and Its Importance
Reputational due diligence involves assessing the
character, history, and credibility of an individual, company, or entity before
entering a business relationship. It aims to identify any potential risks
related to reputation, integrity, or ethical conduct. Reputational due
diligence goes beyond financial analysis.
It delves into non-financial aspects such as legal issues, past behaviour,
affiliations, and media presence.
It’s important because it:
- Mitigates risks: By identifying red flags early on, businesses can avoid partnering with entities that may harm their reputation.
- Builds trust: Transparent due diligence fosters trust among stakeholders, investors, and customers.
- Fosters legal compliance: It helps comply with anti-corruption laws, anti-money laundering directives, and other legal requirements and regulations.
Challenges
in Compliance and Due Diligence Implementation
Due diligence, though essential, is increasingly
challenging due to evolving regulatory landscapes and the complexities of
global business operations. Companies grapple with identifying relevant
questions, using outdated technology in some cases. They also struggle with
time constraints and unexpected costs.
Moreover, insufficient expertise can lead to misjudgements, while subjectivity
in data interpretation, limited access to information, legal complexities, and
accurate valuation can further complicate the process.
Evolving Regulatory and ESG Challenges
Long gone are the days where ESG (environmental,
social, and governance) practices were an aspiration. Today, financial service
companies and other firms are expected to conduct mandatory human rights and
environmental due diligence as a regulatory standard.
For example, the Corporate Sustainability and
Social Responsibility Directive (CSDDD), also known as CS3D, strives to
implement stringent accountability measures for businesses to tackle
environmental and human rights issues efficiently
But What is ESG exactly? Why is it important?
And what challenges or risks does it bring forth?
ESG stands for Environmental, Social, and
Governance, the three key areas companies must consider when evaluating
performance and making decisions. These areas significantly impact a company's
financial performance, reputation, and long-term sustainability.
The E stands for Environmental (E), which includes
sustainability practices and environmental impacts such as high carbon
emissions and sustainable sourcing. The Social (S) refers to how a company
treats people and societies, including issues like human rights violations and
child labour; and the (G) refers to governance. Governance involves company
policies and practices, including ethical policies and fair practices.
Its importance
ESG (Environmental, Social, and Governance) is
essential for businesses today as it supports long-term sustainability, risk
mitigation, and value creation. It helps mitigate risks by identifying and
addressing potential financial, operational, and reputational liabilities early
on. ESG due diligence enhances corporate reputation and drives innovation,
attracting investors who value sustainability. It ensures companies' policies
and practices align with sustainable and ethical standards, meeting investor
expectations. Furthermore, ESG attracts and retains talent by prioritising
social and environmental responsibility. It helps companies access sustainable
funding sources and tap into new markets and investment opportunities. In
summary, ESG is crucial for businesses to mitigate risks, enhance reputation,
ensure sustainability, meet investor expectations, attract talent, and access
sustainable funding.
The risks it brings forth
ESG (Environmental, Social, and Governance) practices
can bring forth several reputational risks for companies if not managed
effectively. Poor environmental practices, such as high carbon emissions,
pollution, or deforestation, can lead to negative publicity and reputational
damage as consumers and investors become more conscious of environmental
issues. Failure to demonstrate a commitment to social responsibility, including
fair labour practices, human rights, and community engagement, may result in backlash
from consumers, employees, and advocacy groups. Weak corporate governance,
including a lack of transparency, board diversity, or ethical leadership, can
undermine stakeholder trust and damage a company's reputation. Poor employee
relations, such as labour disputes, mistreatment, or discrimination, can lead
to negative perceptions and reputational risks for companies, affecting
recruitment, retention, and overall company morale. Companies may face
reputational risks if they are associated with suppliers or partners involved
in unethical practices, even if they are not directly responsible. Mishandling
of customer data or cybersecurity breaches can severely damage a company's
reputation, eroding trust among consumers and stakeholders.
Companies that do not align with stakeholders'
expectations on ESG issues risk losing investor support and consumer loyalty.
Failure to comply with ESG-related regulations may lead to negative publicity,
consumer boycotts, and potential legal risks. In the digital age, negative
information or controversies can spread rapidly through social media and online
platforms, significantly impacting a company's reputation in a short period of
time. Reputational risks can affect investor relations, leading to decreased
stock prices and a loss of investor confidence in the company's long-term
prospects.
By conducting thorough investigations and discreet
enquiries, companies can proactively identify and mitigate potential risks,
thus avoiding legal issues, operational disruptions, and reputational damage.
This proactive approach enhances corporate reputation by showcasing a
commitment to ESG principles and appealing to socially conscious stakeholders.
Additionally, reputational due diligence ensures long-term sustainability by
assessing a company's practices and alignment with global goals. By promoting
transparency and addressing supply chain risks, it fosters stakeholder trust
and empowers companies to navigate the ever-evolving ESG terrain.
UBO Challenges
Furthermore, tracing Ultimate Beneficial Owners
(UBOs) can be quite challenging. This challenge is due to ownership structures
that involve multiple entities, layers, and nominee shareholders which adds to
the complexity of tracing the ultimate beneficial owners. Data inconsistencies,
as well as the limited accessibility and varying reliability of UBO registers
across jurisdictions, further complicate this process. The difficulties are
exacerbated by increasing regulatory scrutiny and the prevalence of manual
outdated processes which may introduce false positives. This leads to wasted
resources diversion of analysts’ focus, and time away from investigating
higher-risk cases.
Supply Chain Challenges
Consequently, global development infrastructure
projects like the Belt and Road Initiative (BRI) increase opportunities by
enhancing connectivity, accelerating trade, and scaling supply chains;
nevertheless, they also bring forth significant complexities.
While the BRI opens doors for economic growth and
development through enhanced connectivity and trade facilitation, it also
introduces a complex web of challenges that require careful consideration and
proactive management.
The development of extensive infrastructure, including
roads, railways, ports, and digital networks, reduces transportation costs and
times, streamlining trade and making it more efficient, particularly for
time-sensitive goods. Additionally, the establishment of new trade routes, such
as the China-Pakistan Economic Corridor (CPEC), and improvements in trade
facilitation drive significant increases in trade volumes, contributing to
economic growth for participating countries.
However, this ambitious initiative also presents a
range of risks and challenges. Large-scale infrastructure projects and
increased trade flows can create opportunities for corruption, especially in
countries with weaker governance structures. The environmental and social
impacts of these projects are also a concern, particularly in regions with
sensitive ecosystems or vulnerable communities.
Companies involved in the BRI must therefore implement
robust anti-corruption measures and conduct thorough environmental and social
impact assessments to mitigate these risks.
Furthermore, the increased complexity of supply chains due to heightened trade
volumes and the involvement of diverse partners and suppliers necessitates
sophisticated logistics and risk management strategies to ensure smooth
operations and protect against reputational damage. Additionally, the
intensified competition resulting from increased market access could pose
challenges for businesses, which need to swiftly assess the integrity and
creditworthiness of their partners.
All in all, the BRI offers significant potential for
economic growth and development through enhanced connectivity and trade.
However, realising this potential requires a comprehensive approach to risk
management, addressing the multifaceted challenges related to corruption,
environmental and social impacts, supply chain complexity, and heightened
competition. Companies must be vigilant in their due diligence and proactive in
implementing measures to mitigate these risks to fully capitalise on the
opportunities presented by the BRI.
Consequences of Absent Due Diligence
Processes
The absence of integrity due diligence processes may
result in serious legal consequences, fines or sanctions. For instance, in 2015
a prominent worldwide bank was forced to pay USD 714 million to the US Justice
Department because it failed to apply due diligence to its anti-money
laundering efforts.
Similarly, S&P Global, Inc. faced a USD 78,750
settlement for insufficient due diligence on a newly acquired subsidiary,
leading to dealings with a sanctioned Russian oil company. These cases
highlight the potential legal and financial repercussions of inadequate due
diligence, which can also manifest as costly civil suits or substantial losses
due to overestimating asset values or unforeseen compliance issues.
Beyond financial and legal risks, companies neglecting
due diligence can face unethical practices such as bribery, corruption, and
labour violations, which can severely tarnish their reputation and erode
stakeholder trust. This is particularly impactful in merger and acquisition
deals, where over 50%
reportedly fail due
to poor due diligence. Relying on vendors and third parties without properly
vetting them may result in delays, quality concerns, and disruptions to the
supply chain, impacting relationships with clients, suppliers, and
collaborators, potentially leading to business failure.
Operational risks are also significant, especially
when relying on unvetted vendors and third parties. Such reliance can lead to
delays, quality concerns, and disruptions to the supply chain, contributing to
the estimated 5% of revenue that organisations lose annually due to fraud,
averaging USD 1.5 million per case, according to the Association of Certified
Fraud Examiners. Therefore, comprehensive due diligence is not just a safeguard
against these risks, but a strategic imperative for building and maintaining
trust, ensuring operational efficiency, and securing long-term business
success.
Solutions to Poor Due Diligence and the
Rewards of Good Practice
To address poor reputational due diligence, companies
must re-evaluate their risk-based approaches and their due diligence strategies
to externally identify and categorise the traced risks stemming from their
business relationships and to internally foster a culture of compliance and
accountability. An effective reputational due diligence approach addresses the
immediate risks associated with the subject under investigation as well as the
risks associated with the wider circle of this subject. This approach ensures
that no stone is left unturned. Thus, if properly implemented the rewards of
thorough due diligence extend beyond risk mitigation. They elevate
decision-making, improve stakeholder trust and give rise to a stronger brand
image.
How Cedar Rose Can Help
Cedar Rose offers comprehensive due
diligence solutions that help your business make informed decisions and steer clear of
reputational risks.
With over 27 years of experience and global
reach across 250+ jurisdictions, our team of experts ensures data
quality and compliance with international regulations like the Anti-Bribery Act
and FCPA. From forging strategic alliances to navigating mergers and
acquisitions, we equip you with the necessary insights and tools to succeed.
Talk to us for a personalised solution.
Sources
- https://www.integrityriskintl.com/eu-regulatory-compliance-trends-2022/
- https://drata.com/blog/compliance-statistics
- https://www.gtintel.io/blog/global-ubo-investigations-challenges
- https://ethixbase360.com/supply-chain-screening-challenges-organizations-and-risk-management/
- https://www.ssacpa.com/fraud-study-results-2024/
- https://fastercapital.com/topics/the-consequences-of-neglecting-due-diligence.html