The year ahead in ESG

What ESG issues should companies be focused on in the year ahead? Our global team explored this question in a recent webinar, ‘ESG distilled, the legal priorities for 2022’. Here are the highlights

By Tim Wilkins, Pamela Marcogliese, Deba Das, Vanessa Jakovich, David Mendel, Peter Allen, Moritz Becker and Simon Duncombe

Introduction – Tim Wilkins, Global Partner for Client Sustainability, New York 

For the coming year, as a result of regulatory, investor and customer pressures, sustainability will continue to rise as a strategic issue for boards and the C-suite across sectors. Legal risks and opportunities will reflect these macro-trends as sustainability is increasingly built into policy and legislation, investors show greater appetite to integrate ESG considerations within investment decisions, and the demand for enhanced transparency and more uniform disclosure grows.

1. ESG and the board – by Pam Marcogliese, Partner, New York

ESG issues raise a host of risks and opportunities for companies, and are therefore a critical consideration for boards. In the US we’re seeing more ESG-linked shareholder proposals, which are generating a significant amount of support. Activists are also focusing on ESG, both in in a direct sense but also by leveraging ESG themes to support more traditional campaign objectives. If a board isn't sufficiently diverse, an activist may use this to install its own directors because the issue resonates so well with the company’s other shareholders.

We’re advising our clients – who are putting huge effort into their ESG agendas – that this work can help them manage risk. It gives them a fantastic platform to develop a proactive narrative about what they’re doing in the space and how that connects to their wider corporate strategy. This can be invaluable when it comes to engaging with a broad set of stakeholders, not least because it puts the company in the driving seat from a messaging perspective. That said, boards need to ensure the company has implemented proper processes to diligence its ESG statements, similar to those they have around their financial-related disclosures.

Front-foot narrative can help address shareholder proposals

If a company has a clearly articulated strategy and is using it to engage its stakeholders, it should be better placed to avoid shareholder proposals because its investors will have a good understanding of what issues the board and management see as material. But where proposals arise, this messaging can help the company negotiate with the proponent to try and have them passively withdrawn.

Most of our rules here require boards to focus on shareholders rather than stakeholders. But directors have to think about this broader group because they influence the performance of the business. Take workers - we’re in the tightest talent market in years, so boards need to be scrutinizing the company’s approach to attracting and retaining the best people. Critically, boards must understand that the ESG landscape is evolving fast. They need to work closely with management to stay on top of developments and adapt their strategy and messaging in response.

2. Human rights and the supply chain – by Deba Das, Partner, London

Looking ahead to 2022 and beyond, we can expect closer scrutiny of what companies are doing to identify and mitigate human rights risks in their supply chains. Regulatory and legislative standards have been developing in this space since the UN Guiding Principles were introduced a decade ago. The UN GPs are voluntary standards that state companies should take steps to avoid causing or contributing to human rights violations, and where they are directly linked to an adverse impact through their relationships with third parties they should seek to exercise any leverage they have to mitigate those risks. The UN GPs direct companies to engage in human rights due diligence across their supply chains and report on what they find – and were the first step in holding businesses to account for human rights issues beyond their own operations.

In recent years these soft law commitments have evolved into hard law obligations through legislation such as France’s Duty of Vigilance Law, the Dutch Child Labour Due Diligence Act and Germany’s Supply Chain Duty of Care Act, which threaten civil penalties for non-compliance and in some cases have broad extraterritorial reach. And there’s more change coming - the EU has recently published the proposed text of its mandatory due diligence directive which will see further legislation introduced by member states. NGOs, too, are turning up the pressure on companies around human rights, drawing attention to perceived failings and threatening litigation.

So, what should companies be doing in response? Firstly, taking steps to understand their own human rights risk profile as well as that of their business partners. If they identify any issues in their supply chain, they may need to increase their leverage to address them, for example by embedding specific human rights audit requirements in key agreements, implementing measures to ensure staff are trained in risk mitigation, and creating escalation processes so any violations can be flagged. This can seem daunting but it doesn’t necessarily mean you have to rip up your compliance manual – human rights processes and practices can be built into existing risk management frameworks for other issues such as bribery and corruption.

3. Disclosure and ‘greenwashing’– by Vanessa Jakovich, Partner, London

With stakeholders more focused than ever on ESG issues, companies need to reflect this in their reporting. But while reports are a great opportunity to articulate strategy, they also carry risks. From a regulatory perspective, a company’s disclosure obligations will vary according to its geographical footprint and where it’s listed. In the UK for example there’s a heavy emphasis on climate change reporting for businesses on the premium segment of the London Stock Exchange, which now have to ‘comply or explain’ in relation to the Task Force on Climate Change Financial Disclosure framework. Mandatory requirements are also being introduced around the information in climate transition plans, while the Financial Conduct Authority has issued binding guidance on how ESG risks should be handled in mainstream filings.

Regulatory changes on the horizon

In the EU, disclosure rules based on the EU taxonomy are imminent, which will require companies to report across a range of sustainability metrics. The forthcoming due diligence directive will introduce additional requirements, and there are more developments on the horizon with both the EU and the UK soon to introduce mandatory disclosure obligations around corporate deforestation risk. Against this backdrop, companies need to build their capacity to measure the relevant data across all the regimes that apply – and ensure their reporting is robust.

In jurisdictions where there are fewer mandatory requirements, we see activists driving the disclosure agenda. This is less of an issue in the UK for the reasons already outlined, but a bigger challenge in the US and Australia. As far as litigation is concerned, companies face intense pressure over ‘greenwashing’, with NGOs and claimants launching publicity campaigns and threatening lawsuits against any business perceived to have overpromised and underdelivered. Here, companies need to ensure their reporting is consistent across their different stakeholder groups, with any mismatch presenting additional litigation risk.

4. Human capital management – by David Mendel, Partner, London

ESG issues are critical to the way companies engage with their workers. If a business is deemed to be underperforming on a particular metric, it may find its people are the ones highlighting the failure and advocating for change.

Increasingly we’re seeing more ‘employee activism’ around the ‘S’ of ESG, whether that’s the way a company handles claims of workplace misconduct, its diversity profile or to stop the sale of products to corrupt regimes. In recent years we’ve seen entire workforces walk out in protest, with social media amplifying their voice and shining a spotlight on the company’s response.

As Pam said, the post-pandemic labour market is really tough and human capital is increasingly critical to companies’ chances of success. They therefore need to think hard about their value proposition to ensure they can attract and retain talent. Here, robust ESG credentials could help them appeal to a more diverse talent pool - focusing on the needs of workers tomorrow can help a business stand out from its peers.

5. Sustainable financing by Peter Allen, Partner, London

The sustainable financing market is increasingly diverse, with companies able to access a range of products from traditional bonds to loans, derivatives, secured asset-backed financings and debt instruments. The objective, too, of those products has evolved over time, from the financing of specific projects with environmentally beneficial outcomes to linking investors’ economic returns to the company’s performance against ESG targets.

In recent years we’ve seen a shift from financing products with a pure environmental focus to those that combine ‘E’ and ‘S’ objectives, meaning companies can set KPIs that combine emissions reductions alongside diversity or the ethical treatment of workers. Likewise, ESG acquisition financing is on the rise as businesses look to M&A to drive their sustainable transition, which typically involves a mix of bonds, loans and/or convertible debt.

Sustainable financing platform can help change perceptions

Done right, building a sustainable financing platform can help companies improve their ESG performance, pushing them to set ambitious targets and establish infrastructure to measure their progress. It can also enhance their ESG reputation through the communications they issue around the framework and its objectives. We’ve seen companies change their entire debt structure as part of a strategy to rebrand themselves as fully sustainable, or where they’re aligning their financing portfolios as they split their business into carbon-intensive and renewable-focused entities.

The type of stakeholder pressure we see elsewhere in relation to greenwashing is equally relevant in the financing space, with companies being driven to set more challenging targets around their KPIs and to invest in more ambitious projects. There’s also debate around the severity of financial penalties companies should face if they fail to meet their targets. On the regulatory side, we’re seeing moves to establish guidelines that operate across financing markets and products globally, that will define how those products are structured and their disclosure requirements.

6. Climate change litigation – by Moritz Becker, Partner, Dusseldorf and Simon Duncombe, Partner, London

Companies need to understand that climate change litigation is strategically motivated. Any business assessing its litigation risk needs to answer three questions. Who is the potential claimant – our investors, NGOs, our business partners or someone else? What could a potential claim be about – for example damages based on past emissions or to drive faster progress on future environmental impacts? Then, where could a suit be brought, based on our global footprint? Here, jurisdictions such as France, Germany and the Netherlands are emerging as claimant-friendly destinations.

NGOs are generally pursuing two goals with their claims. Firstly, they want to win. But even if they can’t, they want to draw media and public attention to climate change. We’re also seeing unprecedented levels of collaboration and resource-sharing between claimants and NGOs – they often use the same legal and scientific experts and align their approaches for test cases. Last year there two significant decisions almost simultaneously, when Shell was ordered to accelerate its decarbonisation efforts by the Dutch courts and an NGO successfully challenged Germany’s climate protection law. Following those decisions, NGOs announced they would bring copycat claims combining the legal reasoning applied in both cases. The organisation that won the Shell judgment sent a demand letter to 29 international companies which it made public at the same time. That’s a very cost-effective way to create public awareness.

Three litigation trends to watch in the year ahead

In terms of the substance of some of the cases, there’s a focus on pushing companies to go further with their climate commitments, which is accompanied by much more detailed scrutiny of the transition plans that sit behind them. Looking at climate cases around the world, there are three key themes that are likely to continue through 2022 and beyond. First, claimants are challenging the way companies calculate their Scope 3 emissions, how they report them and what steps they’re taking to use their leverage with third parties to reduce them. Second, claimants are testing the solidity of companies’ commitments in relation to renewable energy procurement. And third, they’re looking closely at corporate disclosures around carbon-offsetting technologies.