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Freshfields Sustainability

| 6 minutes read

ESG regulation and litigation in 2024: what’s on the horizon for UK financial institutions?

ESG continues to be a priority for financial services firms in the UK this year, both at a strategic level when forward-looking decisions are being made, and on a day to day basis as firms get to grips with new disclosure and labelling rules, and try to minimise greenwashing and other ESG-related risks.  In this post we’ve outlined the key ESG developments recently and how those developments will shape ESG in 2024. 

Areas of strategic focus 

Many financial services firms are considering three particular areas as a strategic focus this year: net zero transition plans, management of climate risks generally, and biodiversity-related policies and reporting.

The Transition Plan Taskforce (TPT) has been working to develop a “gold standard” for climate transition plans since its creation in 2021, publishing its finalised framework in October 2023. The FCA is now expected to consult on its proposed rules for listed companies in the first half of this year and further rules directed at financial services firms may follow.  In the meantime, the FCA has encouraged firms to plan their transition to net zero carefully and publish transition plans in advance of mandatory rules if possible. A small number of firms have done so already.  In the meantime, firms should also be considering whether they are caught by other transition planning-related requirements, such as in the Listing Rules, and in the proposed CSDDD originating in Europe. 

Any transition plan will take into account climate-related financial risks, but the management of these risks is likely to be a particular focus this year. The PRA has indicated that it expects firms to step up their efforts in terms of identifying, measuring, managing and mitigating climate-related financial risks; in its “Dear CEO” letter setting out its 2024 priorities for international banks and designated investment firms, it noted that while firms are progressing their understanding of climate risks, there is still “considerable work for all firms to do” in developing climate-related financial risk management capabilities and “linking these more concretely into decision-making”.   

While climate change will remain at the top of the ESG agenda for financial institutions, nature and biodiversity risks, impacts and dependencies have become an important strategic area in their own right, as explained in our interview.  In September 2023, the Taskforce on Nature-Related Financial Disclosures published its final recommendations and specific guidance for financial institutions to help companies begin to report on nature and biodiversity (much like the work of the TCFD on climate disclosures). We can expect these recommendations to be an impetus for financial regulators to introduce additional reporting obligations, and it seems that many firms are keen to be at the forefront of efforts on biodiversity, building on the knowledge gained through work on climate disclosures (see here for more information).

Regulatory developments 

On 31 July 2024, the FCA’s new labelling regime for asset managers and UK funds comes into force to help consumers navigate the sustainable investment market. Firms can apply four different labels (“sustainability focus”, “sustainability improvers”, “sustainability impact” and “sustainability mixed goals”) to products with different profiles of assets and investment aims, provided that they meet the FCA’s requirements, as explained in more detail here.

In addition, the FCA is implementing additional naming and marketing rules for asset managers to help consumers understand products that use sustainability-related terms (such as “sustainable”, “sustainability”, “impact” and “green”) and have sustainability characteristics but do not use or qualify for a label. From 2 December 2024, where a UK asset management firm or UK fund wants to use a sustainability-related term they must meet the requirements in the new rules which are, in short, that the product must have sustainability characteristics and the product name must reflect those characteristics.

The FCA’s much-talked-about anti-greenwashing rule also comes into force in 2024. From 31 May 2024, all FCA-authorised firms will be required to ensure that any reference to the sustainability characteristics of a product or service is consistent with the sustainability characteristics of that product or service and is fair, clear and not misleading, as explained in more detail here. A consumer will have a right of action under section 138D of FSMA for perceived breaches.

Regulators are also paying closer attention to ESG ratings and data product providers. In December 2023, the International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) launched a voluntary code of conduct for ESG ratings and data products providers.  The FCA welcomed the launch of the voluntary code and in the meantime has stated that it is considering next steps along with the UK government. 

Litigation

On the litigation front, there is still an increasing number of ESG-related cases being brought globally, most recently against the former directors of a Polish energy company for alleged lack of due diligence over a coal power plant investment.  Importantly for financial institutions, this is the first ESG-related case in Europe in which a company’s insurers have been included in the action as defendants.

In terms of overall trends, there appears to be a theme emerging of courts requiring claimants to adhere to strict legal requirements and refusing to second-guess defendants’ climate-related decisions where those decisions have been properly made and where the decision-maker has an element of discretion. 

For example, in July last year, the UK’s Court of Appeal upheld the High Court’s dismissal of a climate-related multiple derivative action against a pension fund’s corporate trustee in McGaughey v Universities Superannuation Scheme LimitedThe Court of Appeal agreed with the High Court that the claimants had failed to prove standing or loss and, even if they had done, the corporate trustee had not committed a breach of its director’s duties by taking the view that divestment was not an appropriate way to achieve net zero. Lady Justice Aplin went as far as describing the claim as an “attempt to challenge the management and investment decisions of [the corporate trustee] without any ground upon which to do so”, and concluded that there was nothing in the pleadings or the evidence which suggested that the trustee had exercised its powers in an improper fashion. 

Similarly, in December 2023 the High Court dismissed ClientEarth’s renewed application for permission to bring a judicial review of the Financial Conduct Authority’s (FCA’s) decision to approve the prospectus of an energy company. As explained in more detail here, ClientEarth’s case was that the FCA had approved the prospectus unlawfully as the company had not disclosed its transition risks in sufficient detail or explained how its future plans aligned with important sustainability objectives, which it said was in breach of the Prospectus Regulation.  However, the Court dismissed the application, accepting the FCA’s arguments on the interpretation of the Prospectus Regulation in full.

Both of these cases come in the wake of the Court’s dismissal of ClientEarth’s action against the directors of Shell, explained in more detail here, in which the English High Court also concluded that it did not wish to second guess the decisions of directors.  

Last year also saw the settlement of O’Donnell v Commonwealth of Australia, a long-running case concerning Australia’s non-disclosure of climate risk in the documentation for its sovereign bonds.  As is common on these types of cases, the settlement involved Australia publishing a statement acknowledging its ongoing work to ensure that climate risk is disclosed to investors.  Interestingly, in approving the settlement, the Judge commented on the difficulties that the claimant faced in establishing her claim.

Conclusion

This year we will see the coming together of several strands of ESG, with pressure from various routes for firms to put ESG-related matters at the heart of their decision-making, whether it be in setting the firm’s direction and objectives, the way that products and services are labelled and marketed, or managing ESG-related risks. There are also increased expectations of specificity in all aspects of ESG: firms must deal with detailed rules and when and how firms will achieve climate goals.  Scrutiny from regulators, investors and strategic litigants will continue, and will likely focus on the way that financial institutions are handling and disclosing climate risks and strategies, as well as the biodiversity and human rights risks associated with the companies that firms finance or support in other ways, such as via capital markets transactions.

Tags

climate change, financial institutions, litigation, regulatory