ESG View - February 2023

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Welcome to another edition of ESG View! This month, a global ESG development of note was the announcement by the International Sustainability Standards Board (ISSB) of the imminent release of its long awaited climate and sustainability global disclosure standards, which are set to come into force in early 2024.

There were also several ESG highlights from the UK. Litigation was front of mind for many, with the launch of two noteworthy cases by the environmental law charity, ClientEarth: one against Shell’s corporate board of directors and another against the UK FCA. On a less contentious note, this month saw a welcome focus on the ‘G’ of ESG by the UK FCA, which issued a discussion paper (DP) on the role of governance and culture in the management of sustainability related risks and opportunities for financial firms.

As promised, this edition includes a summary of the key outcomes of the World Economic Forum meeting in Davos last month. We also have an update on the complexity of carbon markets, regulatory updates from the EU, and ESG developments from the Middle East and Asia.

For our readers who are ocean fans, be ‘shore’ to keep an eye out for the next edition of ESG View where we will give you an update on ocean news including outcomes of the current UN convening to discuss the high seas biodiversity treaty.

As a reminder, there is still time to register for our annual flagship Global Legal Business Outlook 2023 event taking place from 28 February to 2 March, which this year will focus exclusively on ESG. You can find the full details of the agenda and the registration link here. We have some fantastic virtual sessions lined up for you so please do join us and encourage your colleague to do so too – you are all most welcome! If you’re in London on the evening of 2 March and have an interest on DE&I, don’t miss our in-person panel discussion titled: Diversity & inclusion: deliberate for decades or disrupt the status quo?. Contact our ESG Team to get your invitation.

Best wishes,

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

Global Developments

1. World Economic Forum (WEF) Meeting Davos 2023 (multi-sector)

The theme for this year’s WEF meeting was “Cooperation in a Fragmented World” and given the ongoing war in Ukraine, the global energy crisis continued to be top of mind for world leaders.

A key outcome of WEF was the EU Green Deal Industrial Plan, which some have described as the start of a “subsidies arms race”, with the EU looking to compete with the US Inflation Reduction Act. The EU plan has four key pillars: ensuring faster access to green funding; creating a conducive regulatory environment for green growth; closing the green skills gaps and opening trade in support of the transition. The impact of the plan is yet to be seen as it is still under discussion until at least the end of March.

Another highlight concerned the insurance sector: the Net Zero Insurance Alliance published its Net Zero Target Protocol, by which its members have committed to transitioning their insurance and reinsurance underwriting portfolios to net zero greenhouse gas emissions by 2050. Insurers as investors, underwriters and risk managers, play a key role in encouraging the management and mitigation of ESG risk, therefore this Protocol is a pivotal step in the sector’s net zero journey.

WEF week is usually accompanied by the publication of numerous market reports and this year was no exception. One publication that received much attention was the Global Risks Report 2023 – which ranks global risks by severity over the short and long term (over a 2-year and 10-year period respectively). Environmental risks appear most concerning as they make up half of the list both for the coming 2 years, as well as the coming 10.

Post Davos, the European Securities and Markets Authority (ESMA) issued its “Risk Monitor” which struck a similar tone in its discussion of broad risk and vulnerability trends by zooming in on specific sustainable finance risks, like greenwashing and product labelling.

2. IFRS ISSB Sustainability and Climate Reporting Standards update (financial institutions)

What: The ISSB announced on 17 February that its long anticipated sustainability and climate global reporting standards are to be released by the end of Q2 2023 and take effect in 2024. The announcement also noted that the European Sustainability Reporting Standards (ESRS) will be included in the appendix to the general sustainability reporting standard (“S1”) as a source of guidance for companies, in the absence of specific ISSB standards. The first set of draft ESRS were released in November 2022 and will form a part of the EU’s upcoming Corporate Sustainability Reporting Directive (CSRD) disclosure regime. Prior to the release of the new reporting standards, the ISSB will focus its efforts to build capacity to ensure the standards can be implemented globally. We will continue to watch this space closely for further developments.

3. Continued complexity within carbon credit markets - and a solution (multi-sector)

What: We have supported Climate Solutions in producing an introductory guide to carbon markets, in order to create one central resource to help readers understand the fascinating world of carbon markets.

Carbon markets play a critical role in combatting the climate crisis as they support countries and companies to reduce their emissions by trading emissions/offsets in return for credits, as part of their wider carbon reduction and net zero strategies. In January, a Guardian article called into question the effectiveness and validity of carbon credits. The article revealed that more than 90% of rainforest carbon offsets issued by Verra, were likely to be “phantom credits”, exaggerating the level of emission reductions actually achieved. Verra approves three out of every four voluntary offsets globally hence the article sparked great debate and confusion around carbon credits.

Admittedly this is a complex topic. For example, there are three carbon markets: mandatory/compliance carbon markets, voluntary carbon markets, and the sovereign carbon markets. As such, not all carbon credits are the same. This is why we decided to create a primer to help you better understand this nuanced subject. We believe that our introductory guide to carbon markets is an excellent starting to point to develop the knowledge required.

Looking ahead: Given the news surrounding Verra credits, there has been increasing demand to regulate voluntary carbon markets to improve the quality and credibility of the market. It is also likely that carbon credit buyers will look to diversify the types of carbon credits they purchase.

EU Developments

1. French Regulator proposes minimum sustainability criteria for SFDR funds (asset managers)

What: On 10 February the French regulator, Autorité des marchés financiers (AMF) published the position paper on proposed minimum sustainability criteria for Article 9 and Article 8 funds under the EU SFDR and an accompanying press release on 13 February. The AMF’s action picks up on one of the topics that has long been discussed in the market, which is that the EU might bring in a set of minimum sustainability criteria to address the issue that the SFDR, even though it is a disclosure regime, is being used by investors as a labelling regime.

The paper proposes:

• Minimum environmental criteria should be established for the classification of products as Article 9 or Article 8. Compliance with these criteria would be subject to national supervision. The criteria for Article 9 should continue to be more stringent than those for Article 8.
• minimum proportion of portfolio assets for Article 9 funds should consist of investments aligned with the Taxonomy. This percentage could increase over time as the European economy advances towards sustainability.
• Financial market participants that manage Article 8 and Article 9 funds should adopt a binding ESG approach in their investment decision-making process. The EU framework for minimum criteria should identify a set of acceptable ESG approaches that can be implemented by financial players.
• Article 9 funds should exclude investments in fossil fuel activities that are not aligned with the Taxonomy. Investment in such activities would be possible for Article 8 products provided that they meet strict conditions that ensure that these activities are engaged in an orderly transition.
• In a more exploratory approach, the AMF also proposes to introduce the concept of transition and engagement policies. It has identified possible avenues for a quantitative definition of assets in transition.

Looking Ahead: As a position paper, it has no legal or regulatory status, not even as a form of guidance, but it is indicative of some of the approaches that the EU could consider. It is worth noting that the AMF did state in their press release that they had discussed this with the Commission prior to publication – as we wait for the Commission to respond to some key interpretative questions on SFDR it will be interesting to see whether the AMF’s position paper has any impact.

2. In other SFDR news (asset managers)

• The Level 2 SFDR RTS have been updated to take into account amendments regarding fossil gas and nuclear activities, with effect from 20 February. The amendments to the SFDR Level 2 RTS brought about as a result of the Complementary Delegated Act (CDA) under the EU Taxonomy, which covers fossil gas and nuclear activities, have now been published in the Official Journal - they come into effect on the third day following publication. Learn more here.

• The Commission de Surveillance du Secteur Financier (CSSF), the financial regulator in Luxembourg announced on 1 February the intention to launch a data collection exercise for investment fund managers (IFMs) related to SFDR. IFMs captured are required to complete a questionnaire on their organisational arrangements via a “SFDR-IFM disclosures” digital module and the deadline for submission is 2 March. There will be future calls for further information to collect data from Principal Adverse Impact (PAI) statements and data within precontractual and periodic disclosure templates. Be sure to keep an eye on developments as further details on the timing and practical procedures for data collection will be announced at a later date.

3. European Commission renewable hydrogen rules (multi-sector)

What: This month the European Commission adopted two Delegated Acts required under the Renewable Energy Directive, defining what it considers as renewable hydrogen and what can be counted towards a Member State’s renewable energy targets. Hydrogen production requires significant energy consumption. Therefore there were questions surrounding how to prevent hydrogen from putting a strain on scarce renewable energy resources and on energy prices.

One of the Delegated Acts defines under what conditions hydrogen can be classified as “Renewable Fuels of Non-biological Origins” (RFNBOs) and clarifies that where production is not from a dedicated renewable sources, then the principle of additionality comes into play. Hydrogen production must be matched by additional renewable energy production on an hourly basis by 2030 and until then on a monthly basis, which incentivises an increase in renewable energy available on the grid. The phased in approach gives time for the hydrogen market in the EU to grow. The additionality rule contains an exemption for countries with a low-carbon electricity mix that can show that production power came from renewable sources.

UK Developments

1. FCA’s Discussion Paper on firms' sustainability-related governance (financial institutions)

What: On 10 February, the FCA published Discussion Paper (DP23/1), which opens an industry-wide dialogue on financial services firms’ sustainability-related governance, incentives, and competence arrangements. As the feedback to the DP will influence the FCA’s regulatory approach and supervisory engagement with firms, it will be of interest to regulated firms across the financial services sector.

The DP seeks industry feedback on a number of issues, most notably for firms (and their senior management):

• whether there is a need to introduce additional regulation to extend individual responsibility for sustainability-related matters to senior management and whether to set specific expectations around the roles and responsibilities of governing bodies, such as fund boards;
• appropriate metrics and weights for linking remuneration to sustainability goals and what adjustments should be made when targets are not met;
• additional regulatory measures that could be introduced to encourage effective stewardship of assets and to direct stewardship efforts towards the most pressing systemic issues; and
• introducing additional training and competence expectations within existing rules or guidance.

Read our summary of the DP here.

Our view: The DP emphasises that it is important for financial services firms to keep pace with the increased regulatory focus on sustainability. Therefore, firms should consider reviewing their sustainability-related governance, incentives, and competence arrangements to ensure that they continue to be fit for purpose and take into account evolving best practices and regulatory expectations. Given the DP’s wide application, we also strongly encourage impacted firms to consider responding to the DP either directly or through industry groups.

Timing: The deadline for responses to the DP is 10 May 2023.

2. Shell’s board of directors sued over its net zero transition (multi-sector)

What: ClientEarth has now filed its claim against the directors of Shell alleging that Shell’s current strategy to meet the targets set in the Paris Agreement and its transition to net zero is in breach of the directors’ duties under the Companies Act 2006. ClientEarth brings the claim as a shareholder of Shell and with the support of a large group of other shareholders including large pension funds and other institutional investors. ClientEarth wants to compel the 11-director board “to act in the best long-term interests of the company by strengthening its climate plans”.

ClientEarth announced its intention to launch the claim in March 2022 (see our update here for more details), following the ruling by the Hague District Court ordering Shell’s then Dutch parent company to amend its corporate policy to reduce its emissions. This case breaks new ground in that it is the first of its kind in the world to hold corporate directors directly liable for failing to properly prepare their company for the net zero transition.

Looking ahead: Whilst ClientEarth’s claim against Shell’s directors is relatively novel, we can see similar claims being brought in the future as the number of climate-related cases continues to grow at pace. Campaigners and even shareholders are likely to target the private sector from a variety of angles including challenges to how well their commitments chime with national and international climate targets, greenwashing, and breaches of corporate law.

3. ClientEarth launches claim against the UK Financial Conduct Authority (FCA) over its approval of environmental disclosures (multi-sector)

What: ClientEarth strikes yet again – this time filing a judicial review case against the FCA, seeking a declaration from the High Court that the FCA’s approval of a prospectus by oil and gas operator and producer, Ithaca Energy PLC, was unlawful and in breach of the Prospectus Regulation. The action alleges that Ithaca’s prospectus fails to adequately describe the climate risks associated with the company’s activities, which includes part ownership of the Cambo and Rosebank oil and gas fields in the North Sea.

ClientEarth alleges the following three deficiencies with Ithaca’s prospectus, which it argues are vital to allow investors to make an informed assessment of the company's financial position:

1. The risks disclosed in Ithaca’s prospectus are too general in nature to leave investors fully informed or to meet the Prospectus Regulation requirements;

1. The prospectus does not address the apparent conflict between Ithaca’s intention to develop new fossil fuel assets and the International Energy Agency’s conclusion that no new fuel fossil fuel infrastructure can be built if the world is to meet a 1.5 °C warming target; and

1. The prospectus fails to explain how the company’s business model and financial prospectus would need to change, or be affected, if the Paris Agreement goals are to be achieved and what impact that would have on their key assets.

Looking ahead: The very fact that ClientEarth has attempted to bring an action will focus the minds of companies, their advisers and the regulator to the nature of ESG disclosure in prospectuses and other public disclosure. Further, if ClientEarth is successful, this may embolden other stakeholders to pursue litigation in connection with ESG disclosures by listed companies. We will update you as this claim progresses, including whether the High Court grants permission for ClientEarth to bring the claim.

4. High Court rejects judicial review challenge against UK Government for failing to halt imports of cotton allegedly produced with forced labour in China (multi-sector)

What: The High Court has rejected an action brought by Global Legal Action Network (GLAN) and the World Uyghur Congress (WUC) against UK Government enforcement authorities for failures to investigate breaches of the Foreign Prison Made Goods Act 1897 (FPMGA) and the Proceeds of Crime Act 2002 (POCA) arising in connection with the import of Uyghur forced and prison labour cotton from Xinjiang, China.

GLAN and WUC relied on the evidence of widespread prison labour in Xinjiang to assert that at least some of the cotton imported into the UK had been manufactured in a foreign prison, contrary to FPMGA. Under POCA, GLAN and WUC asserted that the imported cotton represented a benefit from criminal conduct, with its acquisition, use or possession by any UK person being a money laundering offence.

The Court rejected these arguments since there was no evidence that linked a specific consignment of cotton to either prison or forced labour. In relation to the POCA argument, the Court also held that, given the availability of an adequate consideration defence, a successful prosecution required evidence that the consignment had been purchased at a significant undervalue. A particular challenge in the context of a lengthy international value chain, since the chain could be broken by any payment for market value in any of the transactions involved.

However, although the Court rejected these claims, it emphasised the judgment did not undermine the “striking consensus in the evidence that there are clear and widespread abuses in the cotton industry in [Xinjiang]”, and that other legal tools or further evidence may come to light which could meet the required thresholds.

Looking ahead: This confirmation of the high evidential threshold for investigating and prosecuting criminal offences linked to prison and forced labour will provide some reassurance to businesses with cross-border supply chains in the garment industry and other higher risk sectors, and those who finance them. However, in light of increasing focus from multiple stakeholders on modern slavery risks, businesses will need to pay continued close attention to their financial crime risks and obligations.

Middle East Developments

1. Saudi Exchange announces trilateral MoU to help implement ESG framework in Saudi Arabia

What: At the Saudi Capital Market Forum held in Riyadh on 11 February, the CEO of the Exchange, Mohammed Al-Rumaih, announced that the Saudi Tadawul Group (which operates the Saudi stock market) has signed a trilateral memorandum of understanding with the Saudi Capital Market Authority and the Ministry of Planning and Economy to assist the three partners in implementing an ESG framework in the Saudi Capital Market. Al-Rumaih noted that “ESG is very strategic to us. This is one of the areas that have witnessed the best growth” adding that the Saudi Exchange expects 30% of its listed companies to make ESG disclosures this year.

2. New Dubai Virtual Assets Regulatory Authority (VARA) Regulations

What: On 7 February, new licensing regulations were introduced by VARA, the regulator of virtual asset activities in the Emirate of Dubai (excluding the financial free zone of the Dubai International Financial Centre). Notably, the Regulations contain disclosure requirements related to ESG issues, which makes VARA the first regulator in the UAE to impose ESG disclosure requirements specifically on virtual asset service providers.

Under the Regulations, when a virtual asset service provider (VASP) applies for a licence, VARA would determine which of three ESG disclosure levels applies to them, taking into account factors such as the size and business model of the VASP and its group. These three ESG disclosure levels are: ‘Voluntary ESG Disclosure’, ‘Compliance ESG Disclosure’ and ‘Mandatory ESG Disclosure’. The Mandatory ESG Disclosure is the most onerous and would require a VASP to establish practices and procedures to raise awareness of ESG-related activities and opportunities; publish an annual ESG report disclosing and publicise information on its D&I initiatives prominently on its website.

Other notable ESG-related requirements in the Regulations include the need to publicly state the use of renewable energy and initiatives relating to decarbonisation and emission reduction when conducting mining or staking activities, regardless of a VASP’s ESG disclosure level; and the need to consider ESG issues when selecting service providers (e.g., VASPs should be satisfied that the service provider acts in an ethical and socially responsible manner). Such regulations are encouraging in terms of fostering a more ESG-friendly landscape in the UAE and for virtual asset service providers.

3. UAE Securities and Commodities Authority introduces new categories of specialised funds, including ESG funds

The Securities and Commodities Authority (the SCA) of the United Arab Emirates has recently made numerous changes to the funds regime applicable in ‘onshore’ UAE (i.e. excluding the Abu Dhabi Global Markets and Dubai International Financial Centre financial free zones). Amongst the recent changes, on 16 January, the SCA introduced a series of new specialist funds, such as ESG funds whose investment portfolio and/or fund strategy shall comply with ESG criteria to be set out in the fund’s prospectus. With its new regulations, the SCA aims to boost the number of local funds.

Asia Developments

1. Monetary Authority of Singapore Disclosure Guidelines for Retail ESG Funds

What: On 3 January, the Monetary Authority of Singapore (MAS) issued FAQs on the circular CFC 02/2022 Disclosure and Reporting Guidelines for Retail ESG Funds that was issued on 28 July 2022. The Circular sets out the MAS’ expectations on how existing requirements under the Code on Collective Investment Schemes and the Securities and Futures (Offers of Investments) (Collective Investment Schemes) Regulations apply to retail ESG funds and the FAQs further clarify these expectations. You can read more about this in our summary of these FAQs here.

2. ISDA Publication: Regulatory Framework for Sustainability-Linked Derivatives (Singapore)

In early February, ISDA published their paper on the Regulatory Framework for Sustainability-Linked Derivatives in Singapore. The paper is the equivalent for Singapore of ISDA’s December 2021 whitepaper, on Regulatory Considerations for Sustainability-linked Derivatives (SLDs), which explored regulatory issues for SLDs in the UK, EU and US. This paper considers whether SLDs in Singapore would be classified as over-the-counter derivatives transactions or another type of regulated product, how they are regulated and compliance issues for market participants to consider when executing SLDs.

ESG Consultation round-up

Some notable ESG policy consultations in flight across the globe that are currently open for comment. Such engagement is a great opportunity to influence the direction of travel for ESG matters.

1. ASCOR Consultation to assess sovereign debt issuers on climate change (financial institutions)

What: On 7 February, Assessing Sovereign Climate-Related Opportunities and Risks (ASCOR) launched a consultation report on the first public investor framework to assess sovereign bond issuers on climate change. The framework sets out a common basis to assess individual country climate change approaches and will reinforce public disclosures to aid investors to understand sovereign action and progress. The consultation aims to engage with sovereign bond issuers, development finance institutions, investors, civil society and the wider public. It welcomes feedback on the principles underpinning the framework, on the proposed indicators, and methodology, as outlined in the report.

Timing: ASCOR will be running public webinar and regional roundtables in February and March 2023 to engage with stakeholders. The consultation closes on 31 March 2023.

2. European Commission Consultation on product categories under proposed Ecodesign for Sustainable Products Regulation (multi-sector)

What: On 1 February, the European Commission published a public consultation seeking views on the categories of new products and measures that the proposed Ecodesign for Sustainable Products Regulation (ESPR) should prioritise. It focuses on products and measures that are not currently within the scope of the Ecodesign Directive (2009/125/EC) (which only covers energy-related products).

The draft ESPR aims to make products sold in the EU, including end-use products like textiles, furniture, toys, as well as intermediary products like iron, steel and plastics, subject to performance and information-related requirements, to ensure greater sustainability. It includes a framework for setting ecodesign requirements based on multiple criteria including durability, circularity, use of substances of concern, energy efficiency and carbon footprint. The ecodesign requirements will be set on a product-by-product basis, or on the basis of groups of products with enough similar characteristics.

Timing: The consultation closes on 25 April 2023 and the Commission is aiming to adopt a communication in Q1 of 2024.

3. UK HMT consultation and call for evidence on the regulation of cryptoassets

What: On 1 February, the HM Treasury published a consultation setting out its proposal for the future regulatory regime for cryptoassets, including a chapter on sustainability and cryptoassets. The objective of the proposal is to establish a proportionate and clear regulatory framework which enables firms to innovate at pace, while maintaining financial stability and clear regulatory standards. The call for evidence specifically relating to sustainability, asks:

• What information regarding environmental impact and / or energy intensity would investors in cryptoassets find most useful for their decisions?
• What reliable indicators are useful and / or available to estimate the environmental impact of cryptoassets or the consensus mechanism which they rely on? And what methodologies could be used to calculate these indicators?
• How interoperable would such indicators be with other recognised sustainability disclosure standards?
• At what point in the investor journey and in what form, would environmental impact and / or energy intensity disclosures be most useful for investors?
• Will the proposals for a financial services regulatory regime for cryptoassets have a differential impact on those groups with a protected characteristic under the Equality Act 2010?

Timing: The consultation closes on 30 April 2023.