Post By: Kamal Hossain Meahzi
ESG issues are fast growing in importance and profile. It is now associated with the sustainability of business and corporate sustainability is increasingly linked up with the better financial returns. As its demand continues to be rising, ESG compliance is increasingly becoming the regulatory imperatives, which obliges companies to disclose their environmental, social and governance (ESG) standards. It means ESG disclosures by companies are not a voluntary undertaking anymore. Also, ESG integration into the business decisions is being viewed as a part of fiduciary duty of the managers, that is, maximization of the shareholders profit, disregarding stakeholders’ interest, is not the only purpose of the businesses.
With the growing demands for ESG and because of its increasing regulatory requirements, the litigation risks for the businesses are equally rising. There have been a number of cases brought in recent years in the EU, UK and US jurisdictions. In almost all cases, the litigants either challenged the businesses’ failure to make disclosures and public statements regarding ESG-related risks or they questioned ESG statements alleging that the same were erroneous, incomplete, or misleading for the investors. Therefore, it is needless to say that the businesses will be facing the increasing number of similar litigations in future. The focus of this article is to define ESG and briefly discuss its disclosure regime in the global context to show how the current ESG trends may give rise to new litigations and, finally, a few basic questions has been suggested, the quest for answers to them can help the businesses to be ESG compliant.
What is ESG and ESG Disclosures
ESG concept spans over a wide spectrum of areas. Environmental criteria examines and evaluates how a company performs as steward of the nature. It refers to the performance and contribution of a company towards climate change, greenhouse gas emission and deforestation etc. Social criteria assess a firm’s policy and behaviour towards employee relations and diversity, health, and safety issues, working conditions including child labour and modern slavery etc. The third pillar refers to internal governance of a company. G in ESG speaks for the board diversity, corruption and bribery policy, executive compensation etc.
ESG disclosures means communication of ESG related information to the public. By their statements, filings and disclosures, companies inform the investors and public that they carry on business activities adhering to ESG standards. Historically, companies viewed these ESG issues as a voluntary undertaking and pursued their environmental, social goals without any legal and market risks. However, thanks to the growing demand for ESG standards, companies are now under pressure to integrate ESG considerations into their business decisions. Additionally, by regulations, governments are increasingly turning this voluntary scheme into mandatory disclosure obligations, which has subjected companies to greater public scrutiny and provided a fertile ground for litigants to sue companies for violation of ESG promises.
ESG Frameworks and Regulatory Mandates
In the last two decades, corporate world has witnessed the rise of several voluntary frameworks which require companies to adopt and report on ESG standards. For instance, after the launch of the Global Reporting Initiative (GRI) in 2000, corporate disclosure on ESG issues has gradually improved. Currently, GRI standards are being used by many global corporations. In the recent past, the International Integrated Reporting Initiative (IIRC) and the US-based Sustainability Accounting Standard Board (SASB) have helped to advance industry sector-specific reporting and its relevance for investors. By and large, the market for ESG information is growing rapidly and maturing and the pressure is mounting on the global conglomerates to recognize and manage ESG risks across all their subsidiaries and supply chains.
The EU, through new and proposed legislations, is currently leading the way on ESG reporting standards and harmonisation. Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (SFDR) requires financial advisers and other financial market participants to accurately disclose how ESG factors are handled at both entity and financial product level, in accordance with prescriptive ESG reporting criteria. Legislations, both in the US and UK, either having entered into effect or on the horizon, which seeks to bring the businesses within the purview of mandatory ESG disclosure regime.
Risks of Facing Increased Litigations
As the scope and dimensions of ESG disclosures have expanded, companies are likely to face litigations which may arise from companies’ ESG related statements and their conducts. There is risk of facing litigations for doing wrong inside their organizations and also for wrongs done in the supply chains. Because, under the ESG regime, it is no longer sufficient for a company to consider, and address, ESG issues within its owned and controlled organizations. They are increasingly expected to account for performance, and deficiencies, of associated enterprises operating within its supply chains. Failing which, an individual or entity may approach courts with different claims and find grounds to sue companies for appropriate reliefs.
For example, under English Law, litigants may approach courts with claims in tort (negligence, nuisance, conversion of property, trespass etc), equitable claims (unjust enrichment and breach of fiduciary duties by directors or trustees), criminal claims (modern slavery or child labour, money laundering etc), statutory claims (human rights claims under the Human Rights Act 1998, claims under consumer protection legislation, claims against issuers of securities who may have misled investors about ESG risks under section 90 or 90A of the Financial Services and Markets Act 2000, and claims based on breaches of directors’ duties under the Companies Act 2006), administrative law claims, workforce claims and climate change litigations etc.
Mitigation Strategies
The businesses should include ESG issues in their risk management strategies and consider the ESG matters with due importance and seriousness. They should understand the scope and extent of ESG litigations; what is it? how it may arise? What are the existing regulatory requirements for ESG? What regulatory changes are forthcoming? Who might be the potential claimants in ESG litigations? What are their relationships with the suppliers, subsidiaries and third parties and how they have described relationships with them in their contracts, prospectus, memorandum, or websites etc.? Also, the companies should review and verify their public disclosures or statements to make them compatible with the ESG requirements.
About the Author: Kamal Hossain Meahzi is pursuing an advanced Masters in Compliance at the University of Fribourg, Switzerland, and a practicing lawyer of the Supreme Court of Bangladesh.