Navigating the ESG risk landscape
Laws to protect the environment, promote sustainability and to ensure good governance have long been a feature of the corporate regulatory landscape, but with the spotlight on ESG shining ever brighter, business leaders must now devote greater attention to the ESG risk landscape.
COP26 in Glasgow at the start of November has moved ESG conversations to the front page of newspapers and public consciousness just as tackling ESG issues becomes increasingly important on the corporate agenda. While businesses have long been prohibited from polluting their environment, discriminating against minorities and engaging in bribery and corruption, the reputational risks associated with failing to combat these issues are now greater than ever.
"The discussion about consumer protections when making environmental claims and allegations of corporate greenwashing has become increasingly prevalent in recent years,"
says Alex Sharples, a senior associate in Trowers & Hamlins’ litigation department. "Businesses operating in financial services or consumer-facing businesses need to be increasingly aware of the impact that their products have on the planet and what they have said about what that impact will be."
In September 2021, the Competition & Markets Authority in the UK published a Green Claims Code aimed at protecting consumers from misleading environmental claims. The Code hopes to tackle greenwashing, which refers to overstated or unsubstantiated green credentials attached to products and services, by helping businesses understand and comply with their existing obligations under consumer protection law when making green or ethical claims.
The new Code is particularly focussed on sectors such as retail, transportation, and consumer goods, where customers are particularly worried about misleading claims. Several high street brands have already suffered damaging headlines in recent years following revelations of poor environmental or labour practices across their supply chains.
Lucy James, a partner and national head of commercial litigation at Trowers & Hamlins, says: "The underlying legal issues aren’t necessarily new, but boards need to start looking at the way they conduct their business through an ESG lens. An example is human rights issues which should now be part of general ESG compliance for businesses. Historically, these things may have been the remit of central and local government bodies, but the ESG conversation is bringing a human rights focus to the way businesses operate. What is going on in your supply chain? Do you know that the people you are doing business with really adhere to appropriate standards? There are a lot of reputational issues at stake if you are not asking these questions."
The public can be a harsh judge, and James points out that it will not be good enough for boards to respond to accusations of failings by attempting to explain that something that happened was actually the fault of a supplier: "There needs to be collective responsibility," she says.
The need for companies to convince customers, employees, investors, potential recruits and other stakeholders that they are taking ESG seriously is one thing, but there are further legal and commercial risks increasingly coming into play too. Government bodies entering into contracts with suppliers are now looking much more closely at their private sector partners and expecting them to meet certain ESG standards or uphold certain policies and practices, for example. Asset managers are no longer willing to commit funds to companies without first conducting ESG due diligence.
And COP26 has shown that governments are committed to setting more rigorous environmental targets, which will only be met through new rules.
"This movement will only lead to further legislation, regulatory guidance and standards,"
says James, "which will come through in lots of different ways. New regulation will be needed to deliver on the commitments that governments are making. Where we are now, the legal landscape has not moved a great deal on this yet, but where there is increased legislation and regulation coming through, it will be incumbent on boards to keep up with such developments."
Meanwhile, consumer groups and activists are also making use of the courts to bring claims against companies that do not uphold environmental standards. In May 2021, a Dutch court ruled that carbon major, Shell must cut its carbon emissions by 45% by 2030, in a landmark case brought by activist groups including Friends of the Earth and Greenpeace on behalf of 17,000 Dutch citizens. The claimants argued Shell’s policies on emissions were not good enough to be able to meet the targets set under the Paris Agreement; Shell said it will appeal.
Sharples says: "We haven’t seen anything of that magnitude yet in this country, but we are seeing growing activism and groups specifically trying to affect climate change through the courts. The direction of travel is that this form of action is on the rise and goes beyond the historical focus on government and the oil & gas industry"
On large infrastructure projects, the legal route is increasingly used to challenge planning decisions on the grounds that approvals have been given without proper regard to climate change.
"For a lot of clients involved in such projects, that means an extra layer of due diligence is required to make sure that decision makers have taken all relevant considerations in to account," says James. Many local authorities have themselves declared climate emergencies and set targets for cutting emissions, while at the same time granting permission for projects to expand airports or build new roads. They can expect to be held to account by non-governmental organisations and we could see far more litigation (including judicial review applications) on ESG-related topics.
The costs and risks to businesses of getting this wrong are potentially significant, not just in the form of reputational damage or regulatory enforcement action, but also in projects being delayed or shelved and even entire business models being challenged, as in the case of some of the big corporate emitters.
Another case in point is the Volkswagen emission scandal, which involved mis-selling on a grand scale to try and cheat emissions tests for its new cars. The company had to recall millions of cars, pay billions in regulatory fines, penalties and legal settlements, and saw its corporate and reputational value plummet as a result.
How can boards ensure they don’t fall foul of this swathe of new ESG risks? The first step might be appointing a director to take an oversight role on ESG. Then, many of our clients are now approaching us to explore us undertaking ESG audits of their businesses, focusing on the impact their operations are having on the environment and society, ensuring good governance, and checking compliance of their practices and policies with all the current regulations.
A proper assessment of business specific ESG risks might also be necessary, covering everything from exposures related to upcoming regulatory change, risks associated with extreme climate events, or commercial risks linked to climate change protesters blockading roads or airports. ESG is a topic which is here to stay, and it is essential that businesses proactively engage with these issues now.
The key thing is to have awareness of exposures and to be in a position to take action when required.
James says: "If you’re starting from a good place in terms of policies and procedures, then you are much more able to adapt as the legislation changes or the regulatory framework evolves. But if you’re not already up to speed, or where you should be, on things like anti money laundering or combatting bribery and corruption, then you’re starting from a few steps behind. It’s only going to get harder to keep up with a pretty fluid situation. The fundamental legal risks may not change but there will certainly be more regulation to come."
There are huge advantages to be had by companies that seize the initiative and get ahead of the game, with consumers, investors and talented employees increasingly favouring those businesses that exhibit strong ESG values.
"Fundamentally, these are all good things that companies should be doing," says James. "You don’t want to be left behind or end up being a test case; you need to get on the front foot."