What sustainability means for business
ESG, climate change and litigation risk
The legal risks associated with climate change and other environmental, social and governance (ESG) factors will continue to feature prominently in 2020 for three primary reasons.
Investors continue to request increasing amounts of information on ESG issues;
National and regional regulators are beginning to expand their ESG purview; and
Climate-related litigation is evolving beyond claims for historical emissions to failures relating to disclosures and permitting requirements.
Pressure from investors and other stakeholders grows
One of the greatest challenges that companies face regarding disclosure of environmental and sustainability issues is the lack of uniformity in what stakeholders are seeking. Sustainability is not a consistently defined term, with each stakeholder ascribing to it a different meaning and, therefore, a different set of expectations.
In recent years we have seen increasing interest among investors in these issues, yet each has a particular view of what information they would find useful and what topics they would like to discuss during their engagements. At the same time the number of stakeholders focused on ESG has spiked. For example, consumers and other customers have become very focused on sustainability, particularly in relation to packaging, water usage and energy. Employees, long focused on the mission of their companies, are becoming more vocal about ESG matters. Supply chain issues have been catapulted to the forefront of public consciousness following high-profile scandals. And regulators often find themselves squarely in the middle of the debate.
One of the greatest challenges that companies face regarding disclosure of environmental and sustainability issues is the lack of uniformity in what stakeholders are seeking.
Against this backdrop, the disclosure agenda is currently more stakeholder- than regulation-led; various constituencies are seeking more clarity on material ESG risks while the regulatory environment is still developing. In the US, there are no line-item disclosure requirements when it comes to sustainability. Back in 2010, the SEC published Commission Guidance Regarding Disclosure Related to Climate Change, which underscores that existing disclosure requirements already cover environmental and sustainability issues and that the threshold for disclosure is materiality. At the same time, several organizations, including the Sustainability Accounting Standards Board (SASB), have attempted to devise frameworks that could assist companies in determining and disclosing material sustainability risks in a way that enables investors to compare them across companies and industry sectors.
The focus on material disclosures is also reflected in the work of the Task Force on Climate-related Financial Disclosures (TCFD) which seeks to develop voluntary, consistent climate-related financial risk disclosures by which companies can provide information to investors, lenders, insurers and other stakeholders. TCFD members – which include leading corporates and financial institutions – are seeking to both show leadership in disclosure and influence regulators for pending disclosure regimes.
In some jurisdictions, stock exchanges are also steering disclosure, either by making ESG transparency a listing requirement (e.g. Euronext France) or by proposing a set of guidelines for voluntary disclosure (such as on the London Stock Exchange and NASDAQ).
So, what should companies do? In a world of overlapping (and sometimes competing) expectations, both boards and management need to determine for themselves what issues are material to their company and ensure that they satisfy their disclosure obligations and risk oversight duties. But they cannot stop there – in this ever-evolving landscape, they should also acknowledge that there are many other issues that, while not material, may nevertheless be important to investors and other stakeholders. For these issues, rather than responding to the constant requests for disparate information, companies should develop their own disclosure and define their own engagement strategies to provide stakeholders with the information they seek. Being proactive in this way gives boards and management the opportunity to have a meaningful dialogue with their stakeholders about the issues that important to them and to the company, without diluting the message with less useful information.
Regulators are catching up
National and regional regulators are looking to meet the obligations of the Paris Climate Agreement, and, to a lesser extent, the UN Sustainable Development Goals.
In some jurisdictions, especially in Europe, lawmakers are seeking to expand disclosure requirements to include ESG considerations. The EU’s Sustainable Finance Action Plan, for example, provides recommendations to companies on reporting how their activities impact climate change and the effect climate change is having on their business through a classification system (or taxonomy) of what constitutes sustainable business activity. Critics of the EU plan however question whether the detailed classification system is sufficiently clear or meaningful to guide companies or investors.
Central banks are also weighing in, driven by concerns about physical risks to assets and supply chains caused by extreme weather events and transition risks that will arise as regulators’, investors’ and consumers’ demands shift to address the threat of climate change. To date, 46 central banks and regulators have joined the Network for Greening the Financial System, launched by Mark Carney, governor of the Bank of England (until March), and his counterparts in France and China, among others.
Hong Kong regulator requires mandatory ESG reporting
In December 2019, Hong Kong’s front-line regulator, the Hong Kong Stock Exchange (HKEX), announced that boards of listed companies will now be required to issue statements setting out their consideration of ESG issues.
ESG reporting started as a voluntary exercise in Hong Kong in 2012, evolving into a “comply or explain” regime with recommended disclosures in 2016. However, a periodic review of ESG reporting by 400 public companies during the 2017/18 financial year revealed a “mechanical, box-ticking” approach that lacked “a desirable level of quality and depth of detail”. In response the HKEX imposed its mandatory reporting obligation, which establishes ESG disclosure and risk management as an issue on which boards must take the lead.
HKEX’s plea for boards to disclose what is material (or in its own words, “truly material”) is helpful, as is the regulator’s position that comply or explain are both “acceptable options”. Boards and management now need to take a thoughtful approach to reviewing all the subject areas, aspects, general disclosures and KPIs in the HKEX’s ESG reporting guide, so that the assessment, consideration, determination, and follow-through expected by the regulator can be achieved.
There is a fairly long transition period as it is acknowledged that issuers will need to put internal infrastructure in place to capture the data required. The first enhanced ESG reports will have to be published by issuers for any financial year starting after July 1, 2020 (i.e. the first reports will cover the period from January 1, 2021 to December 31, 2021 for issuers that have a December 31 year-end), although the HKEX is encouraging issuers to start the process as early as possible.
We expect more “behavior-moderating” cases in 2020 in which litigants expand the focus of their claims from past emissions to current and future corporate revenue-generating activities.
Legal risk and climate change
According to data from Columbia University and the London School of Economics, there have been almost 1,400 climate-related lawsuits launched around the world, with more than 130 aimed at companies by the start of December 2019. Broadly speaking, climate-related cases can be split into three groups.
Common law tort and public nuisance cases of the type that emerged in the US around 20 years ago and have since begun to spread in Europe. These claims are primarily designed to hold companies to account for allegations related to their past environmental conduct, and have often failed to get past initial hearings. In the US, this is primarily because federal law and regulators like the Environmental Protection Agency take precedence over state legislation – and because US courts view responding to climate change as a matter for government policy. In other countries, litigants have generally been unable to satisfy the causation and other legal tests required to bring their claims.
Cases that take aim at future corporate conduct, for example by demanding improved disclosures around climate-related risk and/or changes in strategic direction in relation to carbon emissions. These claims may be more attractive to plaintiffs where issues of material non-disclosure are present, but are still challenged by the struggle to meet strict causation tests.
Cases that involve challenges to the granting of industrial permits on the grounds that climate change impacts have not been properly considered. Although not as high profile, suits that target the “licence to operate” are potentially more significant for businesses.
There are likely to be more “behavior-moderating” cases in 2020 in which litigants expand the focus of their claims from past emissions to current corporate revenue-generating activities. Furthermore, claims will no longer be brought just by governments and NGOs; we expect a growing number of individuals to launch shareholder suits, and institutional investors to add their voices to calls for greater transparency.
For more information on legal risk and climate change take a look at our research report on the climate risk landscape, which examines the emerging threat of litigation against multinational corporations.
In some jurisdictions, lawmakers are expanding disclosure requirements to include ESG considerations. Central banks are joining in, driven by concerns about physical and transition risks.