The rise of ESG disputes against financial institutions

Yesterday Simon Orton, Tim Mak, Anne-Laure Vincent and Anthea Bowater held a webinar on the rise of disputes against financial services firms relating to environmental, social and governance (ESG) matters. 

ESG touches on a number of key risks for financial services firms. More financial regulators around the world are focusing on sustainability and ESG – particularly climate change, as it is recognised as a material risk – and a risk on which financial services firms are in a unique position to influence the rest of the economy through the mobilisation of capital. In parallel firms are making more public disclosures about ESG, some of them mandated and some voluntary. 

ESG is also increasingly important to shareholders, investors and NGOs, who are calling for action, particularly on climate change and diversity. And the pandemic has strengthened many firms’ own resolve to focus on responsible business decisions and sustainable growth. This environment of growing awareness and increased information in the public domain through disclosures means that inevitably litigation risk increases.

The discussion yesterday focused on the drivers for the increased litigation risk in this area, the hallmarks of ESG disputes, and the key trends that Freshfields has identified. It closed with an assessment of the most immediate risks for financial institutions and some practical points for firms to bear in mind. We have captured selected parts of the discussion in this post.

Drivers of ESG disputes

The focus on ESG, and the resulting litigation risk, is being driven by a number of factors, including changing social and investor expectations (which can manifest through shareholder resolutions) and regulatory pressure. Although drivers vary between jurisdictions, a key theme across the UK, Europe and Asia is increased prudential and disclosure obligations in relation to ESG, both at a firm-wide and investor level. While the regulatory regime in the US is at the moment limited, it is now showing signs of rapid change and the Biden administration may lead to substantial developments over the next several years.

More jurisdiction-specific drivers include, for example, France’s 2017 law of vigilance, which imposes a duty on large corporates to actively identify and prevent damage to the environment resulting from their own activities and the activities of subcontractors and suppliers and publish an annual vigilance plan, targeted efforts by Hong Kong regulators on addressing ESG issues from the perspective of listed issuers, institutional investors and financial institutions, and recent diversity-related laws in California.

Hallmarks of ESG disputes

Some ESG disputes are traditional in that they will be brought by shareholders or other stakeholders seeking compensation for loss. However, cases are increasingly being brought by strategic claimants, including individuals, NGOs and other groups focused on environmental and human rights issues, and these claimants can be more interested in achieving a change in a corporate’s practices than damages. The type of claimant can influence the dynamics of the litigation, and we discussed what those dynamics might look like.

Key risk areas for financial institutions

We consider the most immediate risks for financial institutions to fall into five areas.

1. Risks around a firm’s climate risks, goals and impact

Many of the climate cases against financial institutions in recent years – mainly in Australia and the Netherlands – have focused on obtaining disclosure from firms about the climate-related risks that they are exposed to and how they manage those risks. As the regulatory environment, particularly in the UK and EU, is becoming more prescriptive about disclosing climate-risks, the battleground is likely to shift to the detail and quality of those disclosures. Firms should also be alive to the level of scrutiny that their climate disclosures about risk and impact will be subject to, as well as any commitments they make (such as net-zero commitments), as a divergence between their public statements and their practices could potentially expose them to the risk of litigation.

2. The way that sustainable products and investments are labelled or marketed

Greenwashing, ie labelling products as 'sustainable' or 'green' when that is later not considered to be the case, is a key risk. The labelling of products should therefore be carefully considered, and sustainability credentials clearly justified. This is a difficult area (and harder than it sounds) as there is a lack of consistent standards, information on the sustainability of companies in which 'green' funds may be investing is also not consistent or readily comparable, and the market’s view of what is 'green' and 'sustainable' will evolve over time.

3. Investment banking advice

Where firms provide advisory services to companies exposed to ESG risks, they are exposed to potential liability related to that advice, for example in the context of providing advice on valuation and strategy for a sale or merger, as well as reputational risk (eg if a firm’s mandates are compared with their public statements). In addition, particularly in an area where standards and market expectations are evolving, a listed issuer’s risk disclosures, including regarding ESG issues, could expose that issuer to potential claims by shareholders that such disclosures were false or misleading, and the issuer may then look to its advisors to share any responsibility.

4. Decisions of asset managers

Investors and regulators increasingly expect robust stewardship and decision-making, and transparency about whether, and if so how, ESG issues are addressed in investment decisions. Careful consideration should be given to disclosures to investors as to how ESG matters and risks are taken into account in investment processes. It remains to be seen to what extent investment decisions might be subject to criticism if they are not entirely consistent with specific disclosures and/or are out of step with the wider investment community.

5. Risks around diversity

Diversity is a prominent feature of the ESG agenda, with California (both in respect of legislation and a cluster of shareholder derivative lawsuits) at the forefront of recent developments. Nasdaq also filed a proposition with the SEC last week under which it would require companies to have at least one female board member, as well as one from an underrepresented minority group. In the absence of legislation or regulation, misleading disclosures about diversity policies could be a catalyst for litigation in other jurisdictions, and we discussed other hooks that could be used as a platform for diversity-related claims.

Looking ahead

We can expect ESG disputes involving financial institutions to continue to increase as regulator and investor expectations continue to develop and the level of ESG disclosures increases too.  If they are not already doing so, financial services firms should be thinking about the practical steps that they can take to mitigate their risks. Strong governance and risk management processes around sustainability and ESG, and accurate and thoughtful public disclosures, are a good place to start.