Bridging the gap: how ESG practices are promoting social equity in the cannabis industry

5 min read

President Joe Biden recently issued his first veto, to block a measure which would have prevented managers of retirement funds from using Environmental, Social and Governance (ESG) considerations in investment decisions.

Several US state legislatures have enacted restrictions on how state pension funds can use ESG criteria, and the future of ESG in the US remains clouded by its recent emergence as a hot-button issue embroiled in the ongoing politico-cultural wars.

Current legislations

Despite this, most medium and large businesses, public and private, continue to report some form of ESG information, and many other stakeholders continue to evaluate and use the data in investment decisions.  

In the European Union, the regulatory environment is much clearer – the recently-adopted EU Corporate Sustainability Reporting Directive (CSRD), which requires detailed sustainability reporting requirements, will be phased in starting in January 2024 for large companies, and will apply broadly by 2028.

So, despite these recent controversies, ESG reporting requirements will become increasingly important as investors and stakeholders continue to prioritize a company’s impact on society and the environment. 

The current status in the US – voluntary reporting using a range of ill-defined ESG criteria – seems likely to yield to a more structured regime with formal standards for reporting, new regulatory initiatives and perhaps more industry-specific requirements. 

In the emerging US cannabis markets ESG is not optional – compliance and reporting with a range of ESG requirements is mandated by the state regulations which control licensing of cannabis businesses.

The new cannabis legalization efforts in many US states provide illustrative examples of how ESG reporting can work (or not). Reporting regulations are often burdensome and violations can result in business shutdowns and suspension or denial of licenses. The regulations typically have several key objectives:

  • Track in-state commerce (often from “seed to sale”) in cannabis to facilitate collection of tax revenues
  • Prevent diversion to grey and black markets
  • Allow for product recalls if cannabis products fail mandatory testing.

Medical marijuana programs have been in place for some time, recreational use is now legal in about 30 states, and some form of federal decriminalization is expected within a few years.

Most states that have recently legalized cannabis have incorporated some type of “social equity” provisions, designed to ensure that individuals and communities that have been disproportionately affected by the war on drugs have an opportunity to participate in the legal cannabis industry.

This can include provisions such as targeted licensing and funding for individuals and communities that have been disproportionately impacted, as well as requirements for companies to hire a certain percentage of employees from these communities.

Environmental impact

In addition to social equity provisions, ESG reporting requirements can also relate to the environmental impact of cannabis cultivation and production. For example, companies may be required to report on their efforts to reduce energy consumption, water usage, and greenhouse gas emissions.

Additionally, companies may be required to disclose information about the chemicals and pesticides used in their cultivation and production processes.  Governance provisions may include restrictions on Management Services and Financial Services Agreements (MSAs and FSAs) in an attempt to prevent predatory partnerships with larger cannabis companies.

These provisions (and detailed legislative requirements in general) vary widely from state to state, but are generally designed to spur the creation of new “micro-businesses” in the cannabis industry, which is currently dominated by the large “multi-state operators” (MSOs), mostly public companies (Toronto TSX/TSXV) with revenues over $100MM. The social equity provisions have been controversial and subject to many legal challenges, some successful (e.g., residency requirements have recently been struck down under the Interstate Commerce Act).  Compliance is expensive for a new small business, and so far the results have only minimally improved micro-business participation in the industry. 

The Minority Cannabis Business Association (MCBA) summarized the state of current social equity provisions in their 2022 summary – “The number and efficacy of state social equity programs does not reflect the expressed commitment to achieving equity through cannabis.”

So what lessons can we learn for ESG reporting from the cannabis social equity experience?  Here are some suggestions:

Stable and robust regulatory and reporting requirements

Cannabis legislation and social equity requirements vary widely, from states with minimal social equity rules to those with elaborate provisions.  In some states the rules have changed regularly as a result of legal challenges or new legislative objectives. In the wider ESG context, organizations such as the Sustainability Accounting Standards Board (SASB) and others are currently drafting proposed standards for ESG.  Industry standards will accelerate ESG adoption and help prevent companies from gaming the system by cherry-picking favorable evidence in their reports.

Industry-specific requirements

Implementing and reporting on social equity requirements for cannabis is expensive, particularly for small businesses, so much so that legal markets generally can’t compete on price with the still-thriving black market. In the broader context, industry-specific requirements could reduce reporting costs for participating companies and help investors focus on their personal priorities for corporate ESG efforts.  

Industry-wide applicability

Although requirements might effectively be developed on an industry-specific basis, the overall applicability of new regulations should be as broad as possible. For example, reporting requirements for small businesses could be less, or requirements could be modular so that private companies could also choose to participate on a voluntary basis. The EU Corporate Sustainability Reporting Directive provides a useful framework for possible industry-wide standards.

As more states legalize cannabis, it is likely that ESG reporting requirements will continue to play an important role in ensuring that the cannabis industry operates in a socially and environmentally responsible manner. So far, experience with cannabis social equity requirements provides some important lessons that wider ESG regulatory initiatives might also adopt.

Henry Silcock

Henry Silcock is the founder of TwoRabbits Advisors which provides cybersecurity, regulatory compliance, and strategic advice for high-tech businesses. He was formerly a veteran defense industry executive and CTO of two startups. He is a member of Sanford Royce and Ithaca College (NY) Cybersecurity Advisory Board.

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