ESG View - September 2022

Welcome to our September edition of ESG View. It’s back to school after the summer break! To kick off the new term, early this month we were delighted to partner with the Alternative Investment Management Association (AIMA) once again for its flagship AIMA: Putting ESG into Practice 2022 conference in London. It was a great opportunity to delve into how ESG is impacting the hedge fund sector. What’s clear is that there is a growing ESG appetite from fund allocators globally although the regulatory fragmentation (not least in the USA – more on which below) is proving particularly challenging. Thankfully, this fact is not lost on the UK FCA. Speaking at the conference, the FCA’s ESG chief, Sacha Sadan, indicated that regulators are actively collaborating on ways to maintain consistency on ESG enforcement including leveraging AI and other technologies to regulate greenwashing.

In other news, I was in New York last week meeting clients just as the city kicked into high-gear for the meeting of the UN General Assembly and Climate Week. The acronym that best captures the politicisation playing out in the US is not so much ‘ESG’ as ‘OMG’. From the SEC’s strident steps to enforce and legislate on ESG, to the US Supreme Court’s conservative ruling against the Environmental Protection Agency to the backlash by Republican-led ‘red’ states penalising companies for not doing enough to support fossil fuel mining (and in some cases, firearms!). Some ‘blue’ states have now rallied together to publish a response to this ESG backlash, which hopefully helps balance the debate. We will do a deep dive on these and other developments from Climate Week in our next edition, so stay tuned!

In this edition, we discuss the new UK Government’s sustainability agenda, some (much needed!) clarifications coming on SFDR, key ESG dispute cases, the impact and response to the energy crisis, and an update on human rights and responsible supply chains.

Sonali Siriwardena
Partner - Global Head of ESG
sonali.siriwardena@simmons-simmons.com

1. What does the new Government mean for the UK’s sustainability agenda?

Whilst the UK’s new Government was only formed early this month, it has wasted no time in bringing forward some key decisions on the UK’s sustainability agenda. These include dropping the UK Bill of Rights, taking some swift energy crisis actions (including a pledge to expand oil and gas production from the North Sea) and ending the ban on fracking. The new Prime Minister, Liz Truss, announced, a plan to review the UK’s Net Zero strategy, to ensure it is delivered in the most economically efficient way that is both “pro-business” and pro-growth”. Whilst the appointed Cabinet contains some with powerful green credentials, there are concerns that it is not pro-climate enough which could result in the UK losing its green agenda momentum. It will take some time to see how the actions of the new Government will impact the UK’s ultimate net zero road map. We will be watching this closely - not least given the High Courts’ ruling earlier this year.

2. SFDR – clearing the muddy waters

SFDR continues to be a key focus for many of our financial sector clients and a challenge to navigate as the clock continues to tick toward the January 2023 deadline. Some welcome developments this month:

CBI-Authorised Funds to file SFDR updated documents by 1 December 2022 (CBI authorised fund managers)

• What: The CBI has confirmed it will operate a fast track process for SFDR Level 2 compliance. More details are to follow, but financial market participants will need to file updated prospectuses along with the pre-contractual disclosure annexes by 1 December, to ensure approval before 1 January 2023. The pre-contractual disclosure annexes need to be filed separately from the prospectus updates as standalone pdfs for technical reasons.

• Surprising news: The CBI will allow fund re-classifications under the fast-track process provided the financial market participant explains the rationale in a covering letter. For further details, see our briefing here.

Q&A on SFDR published by the BaFin (German-domiciled financial institutions)

• What: BaFin has published a Q&A document to provide clarifications on how to interpret aspects of the SFDR as well as the Q&A documents published by the European Commission in July 2021 and May 2022.

• Good news: In a welcome move, BaFin’s Q&A provides some detailed guidance on the application of SFDR, ruling independent financial advisors out of scope. It also clarifies its wider understanding of the term ‘promotion’ for Article 8(1), and provides guidance on a firm’s best approach to pre-contractual/ periodic disclosures. For a full analysis, see our briefing here.

ESA’s Q&A’s submitted to the European Commission

• What: The ESA’s have published an additional 8 questions which have been submitted to the European Commission but to date remain unanswered. The publication raises some critical questions that industry has been grappling with and the hope is that the European Commission will be swift in its response.

• Demystifying some key uncertainties: The request covers two of the biggest unanswered questions, the definition of “sustainable investments” and what it means to “consider” principal adverse impacts. Other questions cover the definition of Article 9(3) products which have the objective of reducing carbon emissions, the timing of periodic reports for portfolio management services, and the 500 employee test for mandatory PAI compliance. We have produced a detailed briefing note here, which sets out key issues around each question and what we are seeing as current market practice.

3. ESG Litigation - A stark warning (multi-sector)

We continue to see a rise in ESG disputes as courts and public authorities are increasingly willing to hear proceedings and hold companies accountable for breaches of their ESG obligations.

UK Reinstatement of claim against BHP for 2015 Brazil dam collapse

• What: The Court of Appeal has held that claims brought in the English court by over 200,000 claimants arising out of the 2015 collapse of the Fundão Dam in Brazil can proceed. This overturned the High Court’s decision which had struck out the claims as an abuse of process in light of concurrent proceedings and compensation schemes in Brazil. The Court of Appeal considered the ‘significant and unresolved uncertainties’ around the claimants’ ability to access justice in Brazil, including the availability of legal aid, the viability of claims, and evidence that existing compensation schemes had not been working. The Court concluded that the remedies available in Brazil were not so obviously adequate that it was ‘pointless and wasteful’ to pursue proceedings in the English Courts.

• Our View: This judgement shows the direction of the UK judiciary in ESG litigation, continuing a trend set by cases including Vedanta v Lungowe and Okpabi v Shell. UK companies should see it as a stark warning - they can be held to account in the English Courts for the actions of their foreign subsidiaries and joint ventures.

Complaint vs Glencore Australia for misleading net zero statements

• What: A legal complaint has been filed by the Environmental Defenders Office (supported by ClientEarth) in Australia alleging that Glencore’s net zero claims are misleading to investors and the public. The complaint has been lodged with the Australian Competition and Consumer Commission and the Australian Securities and Investments Commission. It alleges that in spite of its stated Paris-aligned targets to decarbonise, Glencore is using an emissions pathway that fails to represent its coal business, which is the largest driver of its emissions, in violation of Australian consumer law. In addition, given Glencore plc is listed on the London Stock Exchange, ClientEarth is urging the UK FCA to support ASIC in a hard-line response. If the Australian authorities find that Glencore has violated the Corporations Act 2001 and/or Australian consumer law, the company could face financial penalties and injunctions to prevent it from making misleading claims in the future.

• Our View: The voices of groups such as ClientEarth are getting louder, and they are increasingly supporting formal action against multi-national companies. If they haven’t already, businesses should be looking to integrate ESG litigation risk into their ESG policies, strategies and governance.

4. Japan’s Guidelines on human rights in responsible supply chains (multi-sector)

What: As part of the Japanese Government’s National Action Plan on Business and Human Rights, it has released Guidelines on Respect for Human Rights in Responsible Supply Chains. These are the first guidelines (English draft) in Japan that set out specific guidance for companies to establish human rights due diligence processes and remedies up and down their national and global supply chains in line with international standards. Whilst, the guidelines are not legally binding, the expectation is that all businesses in Japan regardless of size should comply.

5. UN High commissioner for Human Rights report on China’s rights violations (multi-sector)

What: On the 31st August 2022, the UN High Commissioner for Human Rights (OHCHR) released a damning report finding numerous human rights violations committed in the Xinjiang region of the People’s Republic of China. The report describes large scale discriminatory detention of Uyghur and other minority Muslim communities, as well as reports of torture, gender-based violence and restrictions on privacy and movement. The report goes so far as to say that the detentions ‘may constitute crimes against humanity’. We will be keeping a watchful eye on the outcomes of the UN Human Rights Council 51st session, closing on the 7th October, to see whether the UN will act upon the report and demand action from China.

6. European energy market – more responses to the impact of the war in Ukraine (multi-sector)

What: Earlier this month, the European Commission set out proposals to mitigate the effects of high energy prices in Europe. At the time of writing, these are currently being debated by member states. The Commission’s proposal is to cap prices chargeable by generators that do not use gas – primarily renewables and nuclear, with the difference between the cap and the market price. In parallel, discussions are underway to cap natural gas prices, though it remains unclear how such caps would work. The electricity price cap proposals will be finalised on 30 September, but since the original proposals were made, more flexibility is likely to be given to member states to implement their own measures. Watch this space to see how things develop but the implications of price caps on existing contracts such as power purchase agreements will need to be examined closely.

7. Major report from the IEA on the energy transition (multi-sector)

What: On 20 September 2022, the International Energy Agency released a detailed report on the actions needed to scale up the energy transition and bring about carbon reductions through new technology. Whilst the report notes some progress, the key message is that much more remains to be done. The report recommends increased international cooperation and includes twenty-five specific steps ranging from cross-border supergrids to purchases of low carbon steel and new agricultural standards. Whilst many such reports have been published by different bodies in the past, it is interesting that this comes from an intergovernmental body like the IEA, which was previously often criticised as hostile to renewables and alternatives to fossil fuels.

Finally, in breaking news, last week ESMA published its Final Guidelines on MiFID Suitability Requirements. We will be publishing a detailed briefing note on this and looking at what changes firms need to focus on in the coming days.