Compliance Trends and Developments in Mexico

Emphasising ESG concerns in the corporate sector has proven to be beneficial in maintaining healthier and more resilient companies. With changing environments due to health, political and economic instability, climate change, shifts in social dynamics, consumer habits, etc, it has become increasingly evident that companies cannot be driven solely by an economic purpose. Hence, there is a growing demand from investors to ensure that businesses place ESG factors at the core of their strategies.

ESG has proven to add value to business models by:

• attracting investors with a sustainable focus;
• maximising a company’s performance by correlating impact metrics with business metrics;
• increasing brand value by implementing sustainable practices that generate greater credibility and loyalty;
• enhancing organisational resilience by adopting sustainability standards that address environmental changes;
• improving performance by institutionalising processes and initiatives towards a global purpose;
• providing real-time, operationally supported information to customers, employees and social investors; and
• driving and promoting new social, economic and environmental policies that demonstrate the advancement of a more deeply rooted culture of corporate social responsibility.

The role of the board of directors in ESG

The COVID-19 pandemic severely challenged the crisis management plans of many companies in the world, and Mexico was no exception. It was the first time that risks that had previously been considered independent came together, including health, safety, supply chain disruption, stock price decline, decrease in sales, decrease in savings and decisions by authorities on how to handle the pandemic (lockdown).

The pandemic magnified the strengths and weaknesses of boards of directors and their operating methods. Those who entered the crisis with robust corporate governance were better equipped, as the pandemic proved to be an acid test for:

• cohesion and solidarity;
• boards' trust in the ability of their executives to address the crisis;
• the self-control and maturity of boards and their executives;
• the effectiveness of crisis management tools and processes;
• the ability to seize opportunities (ie, taking advantage of competitors facing difficulties);
• the strength of succession plans (if any); and
• the commitment and motivation of employees, among many others.

In a post-pandemic world, it is crucial to fully understand and incorporate into the DNA of boards the importance of having a robust corporate governance that:

• recognises and protects the rights of shareholders and stakeholders;
• ensures the accurate and timely disclosure of significant organisational matters;
• promotes equal treatment and safeguards the interests of all shareholders; and
• generates economic and social value for the organisation.

The board of directors should be seen as the agent to direct and control the shareholders, being the primary force that pressures the company's operational executives to seize opportunities and fulfil their obligations to shareholders, employees, customers and the communities in which they operate, safeguarding the future of the organisation. To fulfil this role, the board must be independent of the company's management. The ideal board should not have the CEO/director of the company as a member, as this would compromise independence and hinder its ability to provide critical input.

On the other hand, the board of directors, consistent with its fiduciary duties, must take ESG factors into account, implementing and monitoring systems to identify and address material risks, to preserve and protect the value of the company in the long term. It is imperative that companies monitor and address these ESG risks, as they can damage and alter strategies, business positioning, operations and relationships that are essential to guarantee its long-term sustainability.

A wide range of private and public companies in Mexico are already signatories to the United Nations Global Compact and have adhered to its ten principles to protect human rights, maintain ethical labour practices, preserve the environment and combat corruption. For such purposes, there is a tendency in public companies to create specific committees (sustainability, inclusion or diversity committees) to continue strengthening the company’s strategies regarding ESG matters, among other objectives, to contribute to increasing customer satisfaction, operational continuity and reductions in costs.

In conclusion, in Mexico there is a lack of metrics to establish what constitutes successful corporate governance, considering that one of the main challenges is the separation of ownership and control, whereby someone other than the owner makes the decisions.

The Taxonomy

Presented on 16 March 2023 by the Ministry of Finance and Public Credit, Mexico’s Sustainable Taxonomy (the Taxonomy) is a globally unique tool facilitating a comprehensive approach to sustainability. It provides a classification tool to determine which economic sectors and activities can be considered sustainable. The Taxonomy establishes three objectives:

• mitigation of climate change;
• gender equality; and
• access to adequate basic services related to sustainable cities.

The Taxonomy is directed at six economic sectors:

• agriculture, livestock breeding, forestry and logging;
• the generation, transmission, distribution and commercialisation of electric power and the supply of water to the final consumer;
• construction;
• manufacturing industries;
• transportation; and
• waste management and remediation services.

To align the 124 activities assessed in such economic sectors, the following criteria must be met:

• eligible activities must be included in the Taxonomy;
• such activities must be classified under various metrics and thresholds;
• Non-Significant Harm (NSH) criteria must be met; and
• activities must maintain minimum safeguards.

The use of the Taxonomy will require ethical behaviour among companies that intend to communicate to their stakeholders that their economic activity is sustainable, according to criteria of legitimacy and based on science; therefore, it seeks to reduce the risks of greenwashing and “social washing”. Although the Taxonomy has no direct regulatory objectives, which means it does not require compliance with environmental regulation and legislation protecting human rights, it will provide certainty and transparency to financial markets and investments in sustainable activities. The Taxonomy also establishes cross-guidelines to identify activities to ensure compliance with gender equality.

ESG compliance in Mexico shall be implemented to ensure that companies, organisations and entities use the Taxonomy ethically and in accordance with the applicable laws, regulations, standards and practices. This is a relevant issue for Compliance Officers, who must identify the inherent risk scenarios that greenwashing and social washing will generate for the company, as well as adjust the control environment to ensure the application of the NSH principle and promote the transparency that allows the financial sector and different stakeholder groups of organisations to have confidence in the classification and sustainability rating of business activities.

Amendment to the Securities Market Law

A working team comprised of authorities and participants in the Mexican stock market is working on amending the Securities Market Law. Within this project, a new section is being considered that would grant the Ministry of Finance the authority to establish general provisions regarding sustainable and equitable development, with the prior opinion of the Securities and Banking Commission and the Mexican Central Bank. These provisions are expected to apply to securities issuers, brokerage firms, stock exchanges, rating agencies and other participants in the Mexican market.

Mexican pension funds

In terms of ESG regulations, the National Commission of the Retirement Savings System (CONSAR) currently has a regulation on ESG investments. The ten Retirement Fund Administrators (AFORES) have been incorporating these aspects into their strategies since April 2022, and must include an analysis of issuers' adherence to ESG standards in their assessment of characteristics and risks inherent to the investments they make.

On 27 September 2022, CONSAR published a regulation establishing that the AFORES are already obliged to have a continuous ESG training programme in place for personnel.

In addition, the Mexican AFORES worked with the AMAFORE(the Mexican Association of AFORES) in 2022 to standardise an ESG questionnaire for public companies, which is expected to be disclosed and implemented by mid-2023.

Sustainability Reporting Standards

During the first quarter of 2023, the Mexican Council for Financial Reporting Standards (CINIF) publicly announced its annual work plan. In addition to its objectives of continuous improvement of existing financial regulations, it presented its plans regarding publications and collaborations with other counterpart organisations worldwide, including its plan for the development of Sustainability Reporting Standards (SRS).

The SRS are important as they are the benchmark for sustainability reporting for private companies in Mexico, and likely for other Latin American countries as well. Furthermore, they will serve as a pathway for transitioning from voluntary reporting (the current state) to mandatory reporting, and will greatly contribute to the overall development and adoption of an “ESG culture” in Mexico.

Publicly traded companies (with listed securities on the Mexican Stock Exchange or the Institutional Stock Exchange) will adopt the “IFRS S,” which are the sustainability standards developed by the London-based International Sustainability Standards Board (ISSB). These standards are expected to become the most widely used regulatory framework worldwide for reporting ESG. Private companies (not listed on stock exchanges) will adopt network and information systems (NIS), which will be developed and implemented in two phases according to the plan.

In the first phase, starting in 2023, two documents will be developed:

• General Standards for Sustainability Information Disclosure (NIS 1); and
• Disclosure of Basic Sustainability Indicators (NIS 2), which will require companies to report minimum (quantitative) indicators for all dimensions of sustainability.

Both standards are expected to come into effect in 2025.

In the second phase, starting in 2024, new NIS will be developed to gradually complement the existing set, potentially aligning with thematic standards issued by the ISSB.

Financial information and sustainability are complementary spheres, with an interesting intersection that deserves ongoing study and analysis. Financial statements alone are not sufficient to assess the comprehensive value of a company and its ability to be sustainable over time.

Chief sustainability officer (CSO)

ESG has brought new roles within companies and their organisational structures. The emerging role of the CSO is a clear example of the recent trend in corporate organisational design that responds to the need to assign duties of co-ordinating the organisation’s sustainability efforts to a dedicated professional. Tracking sustainability performance and reporting and ensuring compliance with ESG frameworks and standards are day-to-day tasks that should be carried out within the control and supervision ethics environment of the organisation.

The interaction of the ethics compliance officer and the CSO on a day-to-day basis is seen as a rapidly emerging compliance best practice in Latin America, and Mexico is no exception. The new relationship of the ESG function implies its role as the first line of defence against greenwashing and social washing. Ethical compliance work will remain the second line of defence to prevent ESG conflicts and litigation that can arise from social concerns, operational incidents and the perception of unethical, misleading or deceptive ESG information dissemination by the organisation. The above has led to a deeper understanding of the role of compliance as a basic tool for ESG oversight, being the cornerstone for any company to supervise compliance with the applicable regulatory framework and the ESG commitments assumed with the company’s stakeholders (lenders, investors, clients and authorities).

Therefore, to make ESG information more useful to the different stakeholders of a company, a solid financial complement is required. For example, for each ESG risk that a company identifies, it is necessary to identify potential impacts on the financial position, operating results, supply chain and cash flows. Eventually, these disclosures will enable companies to access capital more easily and remain relevant in the market.