Greenwashing raids and litigation will shape ESG competitive advantage
CEOs, CFO’S, fund managers and investors should be paying attention to the recent ‘greenwashing’ raids and penalties on both sides of the Atlantic. We are moving from an ESG market constructed on ratings and ‘good intentions’ to one which will be more focused on regulation, impact and science-based targets. The tightening of the market will address current market flaws, drive competition and start the process of fund managers and investors picking ESG winners and losers.
Creating value
The shift will correct the frail capital markets access points which was created by ESG ratings preceeding science based targets. It also makes it clear that high faluting ‘net zero’, ‘green targets’, or ‘sustainable ambitions’ used to market and promote a company or fund will no longer be accepted. This opens the door for competition and value investors, turning carbon, climate and biodiveristy from factors once considered negative, into a potential positive and if managed and measured correctly, factors which add value to a portfolio.
Lull before the storm
The substantial regulatory and investor scrutiny creates a moment for boards to pause. In the lull before the storm clouds of ESG litigation which are destined to lash the market, issuers should consider their position. Being proactive in addressing any miscalculations or overstatements in current ESG disclosures will safeguard against litigation on the basis of abuse of fiduciary duty.
Moving to the next phase
The next phase of the ESG transition will be marked with increased scrutiny of disclosure, increased regulation, the litigation of funds, financial institutions, and boards deemed to have disclosed and misled the market. A very positive step in creating a competitive market with a ‘referee’ the lack of which Tariq Fancy, Ex-CIO of Blackrock, has been critical. They may also go some way to addressing, what Simon Mundy in the FT has called the “harsh fact that, as things stand, financial markets have not been treating climate risk anywhere near seriously enough to pump sufficient capital towards the investments needed to tackle the crisis, and away from those that are driving it”.
The game is changing
With the rate and pace of disclosure requirements and the work of the IFRS, it looks as if it will be fast. ESG decisions are now the focus of regulators and are part of a board or fund fiduciary duty and no longer vague ‘green rating’ backed intentions.
The SEC fined BNY Mellon $1.5mn for misstating ESG information on its mutual funds in the US. While in Germany, police raided DWS and Deutsche Bank over greenwashing allegations of misleading statements in its 2020 annual report putting the spot light on more than half the group’s $900bn allocations.
EU is gearing up for more regulation
The raid in Germany came on the same day the European Securities and Markets Authority (ESMA) published a supervisory briefing on Sustainable Finance Disclosure Regulation (SFDR). The recommendations included that ESG products should only disclose those E/S criteria binding on the fund manager in the investment decision-making process and avoid vague language around objectives and impacts.
What does it all mean?
For the last year, governments and regulators have been questioning whether voluntary standards are appropriate. Given the critical role of the green bond market in achieving the transition to a low-carbon economy and the fund market to gain investor capital into new technology, it was inevitable that change would come. These actions are significant because they pose a fundamental question which many critics of the current ESG capital markets are right to ask: Can a market deliver a science-based impact, create real competition, develop new and profitable market segments and industries, unless constructed to a scientific measurement to which capital will be allocated? Which essentially goes to the heart of the transition question and the need for change.
Fiduciary duty takes in ESG factors
In the UK, fiduciary duty is governed by section 172 — of the companies act 2006 — and it is becoming more apparent that this includes climate and other risk factors. As such sustainability reports, which translate into ESG disclosures can no longer be waived through by the board. Tangible steps to consider include reviewing existing or contemplated public disclosures in light of known information and risks and after considering recent regulatory actions.
Increasing cycle of regulation is driving disclosure
At this point, don’t expect the rate of change to stop. There are at least four or five significant pieces of regulation under consultation. (EU SFDR, Corporate Disclosure, SEC etc.) all are pointing in the same direction. The emerging disclosure process is creating a system of downward disclosure, from large entities to smaller entities, from big finance to smaller finance. It is like a game of pass the parcel played at childrens parties. No one wants to take carbon or climate risk into their portfolio. Investors want to reduce financial exposure to the capital and ESG factors, so they push it downward putting pressure on the next line of finance, a company or entity to respond. This is why CFOS are getting increasing ESG related questions from their funds and investors.
Disclosure is driving litigation.
An increase in market disclosure, the raids, and the move against greenwashing will drive the rise in litigation based on abuse of fiduciary duty. Where fiduciary duty traditionally would be defined as ‘misleading the market’, for example, if a board overstated their traditional assets and revenues they would expect a day in court. With the implementation of frameworks and standards, and the IFRS seeking for companies to assess forward looking ‘risks and opportunities’, it is becoming more and more apparent is that regulators and the courts will consider ESG disclosures no different and this does include the climate and other risk factors.
Many legal angles of attack
As the market sorts itself out, and as noted in the March 2022 issue of, Butterworths Journal of International Banking and Financial Law, there will be an increase in regulatory sanctions imposed for breaches of listing rules, transparency rules or market abuse. There is enough case law and regulation to mount multi targetted cases againset companies and individual directors. Criminal liability cases can be taken against funds and companies for breach of various provisions of the company’s legislation. Civil liability cases can be raised against companies under statute or general tort principles. Civil liability cases targetting the directors to a company or a fund are permissible under company law.
Increase board protection
With the mounting disclosure regulation and the threat of litigation boards can take this as an opportunity for reviewing or implementing policies relating to the board’s consideration of ESG-related risks and opportunities. Now is the time to engage climate, carbon, biodiversity and social impact experts, both as directors and officers and by retaining outside consultants as appropriate. Now is the time to ‘restate’ calculations, metrics and data. This is a moment of reflection for the board to consider what has been communicated via ESG disclosures to date. If aspect have been overstated, perhaps now is the moment to address the potential concerns from investors and regulators before a problem arises.
