Environmental, social and governance (ESG) issues are driving changes in corporate behaviours and businesses. However, it is not enough for corporates simply to ‘talk the talk’, they must also ‘walk the walk’.
If they do not, the prospects of being held to account are increasing, whether by investors, shareholders, trading partners, consumers, regulators or the courts.
The impact of ESG issues, particularly climate change, has been recognised by the world’s largest asset manager BlackRock.
As its chief executive and chair Larry Fink recently wrote, “climate risk is investment risk”. Driving change in the conduct of the companies in which BlackRock is invested, BlackRock is, for example, asking companies to disclose a plan for how their business model will be compatible with a net zero economy and to report in alignment with the recommendations of the Task Force on Climate-related Financial Disclosures.
In addition to asset managers, there has been an increasing number of activist investors looking at how best to embed ESG principles in a target company’s business. According to the Financial Times, a total of 21 shareholder resolutions raised at annual general meetings around the world in the first ten months of 2020 were focused on ESG issues, and had the support of a majority of investors, compared to 13 in 2019 and 2018, and five in 2017.
Banks’ ESG challenge
It is, therefore, perhaps inevitable that banks and other financial institutions will likewise be required to take ESG issues into account within their own operations, distinct from their role as asset managers.
This challenge is heightened by the pressure to make full disclosure of ESG risks and related mitigation steps pursuant, for instance, to the Sustainability Accounting Standards Board standards, the Taskforce on Climate related Financial Disclosures and emerging mandatory human rights due diligence legislation.
Activist shareholders and investors can see that the incorporation of ESG issues in a financial institution’s business can have a ‘force multiplier effect’, with the institution also driving positive change in the behaviour of the corporates it funds.
But financial institutions and corporates must ensure such issues are fully incorporated throughout their businesses, as they will be held to account for what they profess.
21 shareholder resolutions raised at annual general meetings around the world in the first ten months of 2020 were focused on ESG issues
In the UK, two recent Supreme Court judgments, Vedanta in 2019 and Okpabi in 2021, have held that a UK parent company can, in principle, be held liable for the negligent actions of its subsidiary in another jurisdiction.
While each case will turn on its facts, factors the court took into account included: the parent company’s involvement in the management of the subsidiary; the group policies issued by the parent; the monitoring by the parent of the subsidiary’s compliance with such group policies; and the parent holding out that it exercised a particular degree of supervision and control of the subsidiary.
Both cases now return to the lower courts to determine whether there is in fact any liability for the companies involved.
Similar events are happening overseas. In the Netherlands, the Court of Appeal has held that a Dutch parent company was liable for oil spills from underground pipelines operated by its local subsidiary.
Disclosure and compliance
Such judgments in multiple jurisdictions mean that corporates and financial institutions will be scrutinised not just by shareholders, investors and other stakeholders, but also the courts. In addition, regulators are increasingly looking to hold companies to the ESG standards they say they meet.
For example, on March 4, the US Securities and Exchange Commission created a climate and ESG task force which will analyse “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies”.
These developments represent a significant challenge for boards and senior leadership at corporates and financial institutions. As to how to deal with this challenge, the NYU Stern Centre for Sustainable Business published a report in February 2021 advocating that boards must:
- Understand the material ESG issues for the company, ‘today and tomorrow’;
- Understand the perspective of critical stakeholders, such as employees, civil society and long-term investors on ESG issues, and ensure their concerns are built into the culture and business strategy of the company;
- Diversify to include people with expertise in those material issues;
- Ensure that the company has a “sustainability strategy that is embedded in [its] business strategy and that key performance indicators are developed that are aligned with key reporting standards that are built into work plans and compensation, and that these are third-party assured”;
- Ask their executive team to report on the financial impact of their ESG investments in a comprehensive way, including intangible and tangible benefits such as risk avoidance, employee retention and operational efficiency; and
- Reflect the new ESG reality in the board culture, their own expertise and through proactive engagement with management and key stakeholders on its sustainability strategy.
These represent a roadmap for corporates and financial institutions to ‘walk the walk’ on ESG.
Chris Roberts is counsel and Sam Eastwood is a partner at law firm Mayer Brown.
