The rise and rise of ESG; a focus on disputes and managing risk

Introduction

We expect 2021 to bring a significant re-set of ESG expectations on businesses, to include a wider range of ESG targets, a greater focus on managing climate change impacts and more scrutiny over corporate purpose. For those that adapt to this challenge, there are likely to be significant benefits. For those that do not, there is a greater prospect of civil litigation and increased regulatory and conduct risks. Increasingly, investigations and/or civil litigation (see below) run in parallel, or in close succession, and the risks arising from parallel proceedings will need to be managed very carefully. Our Investigations Outlook 2021 can be found here.

Although the risk implications of E (environmental), S (social) and G (governance) issues vary from sector to sector and business to business, there are some general themes.  In particular, 2021 is likely to bring increased regulatory focus on ESG, a rise in ESG reporting obligations and a continued increase in consumer and shareholder activism around ESG topics. Consequently, all businesses need to identify and manage their ESG risk. Aside from ensuring compliance with legal obligations, commercial pressures and reputational risk may mean that changes to corporate behaviour are needed.

We consider below some of the key trends we consider will be very significant in 2021 and beyond.

Climate change risk

While we are seeing increased focus on ESG issues across the board, climate change has been identified globally as a key issue of our time. Businesses (and their insurers) will increasingly face both 'physical' and transition' risks, which will in turn threaten financial stability.  

In the UK, the government announced ambitious emissions targets in December 2020, with the Climate Change Committee recommending actions for every sector of the economy. The agenda for Davos 2021 includes a number of ESG topics, particularly focussing on environment and sustainability. The postponed COP26 will take place in Glasgow in November 2021, and we expect this will generate a significant increase in the focus on businesses' approach to climate change. The election of Joe Biden into the White House, who immediately took steps to rejoin the Paris Climate Agreement, and his appointment of special climate change envoy John Kerry will only increase the attention in this area. Consequently, we expect a very rapid increase in global focus on corporate climate change issues in 2021.

There is recognition that the financial sector has a huge role to play in tackling climate change:

• In its Sixth Carbon Budget the UK's Climate Change Committee recognised the strategic importance of the financial sector in achieving the UK's emission targets, recommending that the UK should commit to be the world's first 'net zero' financial system.

• The UK's financial regulators, the FCA and the PRA, consider "climate change is of paramount importance to [their] missions". They established the Climate Financial Risk Forum (CFRF) (which held its fifth meeting in November 2020) as a forum for senior financial sector representatives to explore the risks and opportunities of climate change. The CFRF emphasises that all levels, from board level down, need understanding, oversight and accountability for financial risks arising from climate change (as differentiated from broader sustainability/ESG risks). The CFRF's June 2020 guide to climate-related financial risk management offers practical guidance to the financial sector.

• The FCA has introduced new climate-related disclosures for premium listed companies that apply on a 'comply or explain' basis - see our commentary here. In its Interim Report and Roadmap, the Government's Taskforce on Climate-related Financial Disclosures (TCFD) set out the process by which the Government aims to achieve its commitment to ensuring that the UK becomes the first country to make TCFD-aligned disclosures fully mandatory across the economy by 2025. A company's disclosures will be scrutinised by supervising authorities and market participants (including activist investors). 

• Our piece on the publication by the Asset Management Taskforce of 20 recommendations aimed at increasing stewardship activities and ensuring that they are focused on delivering long-term, sustainable benefits for investors, the economy, the environment and society can be found here. The FRC's UK Stewardship Code took effect on 1 January 2020 and sets expectations for those investing money across all asset classes on behalf of UK savers and pensioners, not limited to but including in relation to climate issues.

We highlighted here the risk of entities in financial services facing regulatory investigations as a result of climate risk. Similarly, where entities in any sector fail to manage their climate change risks, litigation may follow.

• In 2020, we saw the McVeigh litigation in Australia, where an individual pension fund member bought a claim against a superannuation fund (Rest), challenging the fiduciary duties of the fund's trustees in relation to climate change. On settlement, Rest agreed that its trustees have a duty to manage the financial risks of climate change, and that "climate change is a material, direct and current financial risk to the superannuation fund". Rest also agreed to manage its investments with a goal of net-zero emissions by 2050.

• We expect to see more mass claims against greenhouse gas (GHG) emitters.  A group of activists have brought a claim against Shell in the Hague, asking it to cut its total carbon dioxide emissions by 45 per cent by 2030, compared with 2019 levels, and to eliminate them entirely by 2050.  If successful, the claim could have wide ranging implications regarding corporate responsibility and climate change.   It is worth noting too that emitter claims, once reserved for oil and gas companies, could now find other targets, such as technology companies whose operations result in significant carbon emissions. Developments in emissions data mapping mean that it is becoming easier to establish a link between an emitting corporate and loss or damage caused by global climate change or weather events.

• In the UK, climate activists took their opposition to a third runway at Heathrow airport all the way to the Supreme Court, which gave its decision in December 2020. Whilst the ultimate outcome did not result in preventing the runway development, the scope for future cases is clear.

ESG liability risk

Other ESG risks to be aware of, and seek to manage, include:

• Misselling and greenwashing: Claims may arise where there are allegations of mis-selling and greenwashing of ESG credentials. These claims are a particular risk for financial services, as we note here and here. The increasing responsiveness of the market to climate (and wider sustainability) issues, combined with new financial disclosure obligations will increase the risk that financial institutions and asset managers will face claims based on the "greenwashing" of financial products and breaches of investment mandates.  This is particularly so given the uncertainty that remains around the criteria by which products qualify as socially responsible or ethical, and how those criteria are translated into investment decisions.  Some of our commentary on the SFDR can be found here and, for the impact on non-EU managers, here.

• Company and directors' liabilities: Companies and their directors in England & Wales owe fiduciary duties to pursue a long-term increase in financial value for the company (other than in an insolvency situation).  As ESG factors directly impact on both the financial bottom line and a company's reputation, to the extent they are not doing so already, companies and their directors need to ensure they take ESG factors into account.  At the same time, consumers and investors increasingly expect responsible, transparent conduct by companies, focussed on long term sustainable success rather than short term gain. Failures in this regard may lead not only to claims against the corporate, but also to director liability.

  Stakeholders may seek to hold a company to account through investment/purchasing decisions, pressure on reputation, exercising shareholder voting rights and/or civil liability actions.   A failure to assess and manage ESG-related financial risk could expose the company and/or its directors to liability.

  The section 90A/schedule 10A FSMA regime gives investors the right to sue public companies that publish misleading information to the market, such as in a company's financial reports and RNS-announced press releases (published information). You can access our series of articles looking at different aspects of the s.90 regime, starting here.

• Implementing ESG strategies and corporate purpose: Regulators, investors and consumers are asking for greater transparency on a company's ESG footprint. Organisations which fail to adopt and implement both ESG standards and a clear corporate purpose can expect to have their feet held to the fire; our piece on considerations for organisations in relation to corporate purpose can be found here.

• Sustainability, supply chains and human rights: There is increasing focus on whether a business is conducting its operations in a sustainable way, and without violating human rights. There are significant risks here, which will differ depending on the sector in which the business operates. Business and human rights issues extend beyond supply chain management into general corporate conduct. For example, Rio Tinto, whilst operating within the law, was recently forced to unreservedly apologise for the destruction of ancient sites with cultural significance during its mining activities in Australia.  On 29 January 2021, the Dutch appeals court held that Shell Nigeria was liable to compensate local farmers for the consequences of two oil spills.

  Those with lengthy supply chains will need to review their exposure, and ensure that proper due diligence is conducted down the line. As boohoo found to its cost when implementing a review in 2020 into the treatment of workers who make its clothes, the discovery of "supply chain malpractice" can be costly, significantly affecting reputation and sales, as well as share values.

  Commercial organisations that supply goods or services, carry on business in the UK and (together with their subsidiaries) meet the annual turnover threshold of £36m or more must publish an annual slavery and human trafficking statement. In September 2020 the UK government announced ambitious plans to "strengthen and future proof the Modern Slavery Act's transparency legislation" - see our commentary here.

  The Environment Bill is described by the UK government as a "vehicle for delivering the bold vision set out in the 25 Year Environment Plan". It sets public environmental governance targets which will undoubtedly translate into obligations for private entities, and will bring changes to planning laws. Proposed amendments include a mandatory environmental and human rights due diligence obligation; and a prohibition on using illegally produced forest risk commodities or embedded products.

• Parent company liability risk

  All of the above ESG risks are relevant not only to the operations of the parent company but also to their subsidiaries and wider supply chain. For example, in the Dutch decision referred to above, Royal Dutch Shell (the parent company) and its subsidiary were both ordered to install warning equipment in case of another spill.

  A series of recent cases in the English courts, culminating in the Supreme Court decision of Vedanta (see our article here), have made it possible to hold a parent company to account  for the acts of its subsidiaries abroad.

  A series of mass tort claims have been launched in the English Court for harms conducted by subsidiaries of a UK parent company overseas. These include claims for environmental damage, use of child labour in the supply chain and human rights violations. Such litigation can cause significant financial and reputational harm for companies.

What does this mean for your business?

The importance of assessing and managing your exposure to risks across all three limbs of ESG cannot be overstated:

• The time to conduct internal due diligence, anticipate risks and put in place robust processes and data management is now. Businesses should consider auditing their operations, supply chains and/or investments. 

• Firms will need to implement quality controls and governance (top down) to ensure that they adhere to any standards adopted, as well as any ESG-related targets they may have, or due diligence or disclosure obligations. 

• Firms will also need to consider what reputational risks they are exposed to and what they are willing to accept as part of their model and culture.

• As noted above, the nature of many ESG risks means that, if not managed, they bring the potential for regulatory enforcement, civil claims and criminal sanctions, potentially all at once. Managing this pressure on multiple fronts, including the potential for complex, cross-border and multi-party litigation, may be very familiar to the team at Simmons, but is not a prospect which most businesses relish. Discover some of the key issues in parallel proceedings here or contact us for a discussion specific to you.

• Simmons & Simmons can assist you with training and advice in relation to all of the above.