Corporates have been promoting their green credentials for some time. Environmental, social and governance ("ESG") investments are the fastest growing sector of the asset management industry. Yet the area has been largely unregulated. However, the net is closing. The recent swathe of investigations by global regulators into greenwashing by major corporations has marked an inevitable turning point in the regulatory landscape of ESG investment. Alongside this, we are seeing increasing interest in individuals, shareholders, investors, other corporates, as well as NGOs seeking to bring proceedings to call out green claims.
Introduction
As a result of the global shift in attitude towards ESG issues in recent years, particularly climate change, ESG investment is now the fastest-growing sector of the asset management industry, having boomed to US$2.7 trillion globally by the end of 2021. Corporates have been quick to jump onto the ESG bandwagon in order to attract capital and customers, but until recent months have operated in a sector that has been largely unregulated.
Regulation of ESG investment
But the catch-all nature of the definition has meant the sector has come under significant criticism for enabling corporations and investors to overinflate their ESG credentials (or "greenwash"), misleading the market and their investors. Regulators are increasingly stepping in and investigating greenwashing claims. The most recent example of this is the police raid of DWS (Deutsche Bank's asset management arm) amidst allegations of greenwashing and prospectus fraud in the US and Germany, prompting the resignation of DWS' CEO. This alone marks a stark turning point in the regulatory trajectory for ESG investment, being the first instance of an asset manager raid in an ESG investigation. Other recent action includes HSBC's suspension of its global head of responsible investing after he stated in a speech that climate change does not pose a financial risk to investors and the US$1.5 million fine issued by the US Securities and Exchange Commission (SEC) to BNY Mellon for allegedly misstating and omitting information on its ESG investments.
It is clear is that the regulatory net is now closing on ESG investments. Only two days after the SEC fined BNY Mellon, the agency announced proposals to enhance disclosures by investment companies and advisors in relation to their ESG investment practices. Across the Atlantic, both the UK and the EU are similarly considering tightening ESG criteria for rating agencies assessing ESG credentials. In November 2019, the EU implemented the Sustainable Finance Disclosure Regulation, based on the goals established by the 2015 Paris climate accord, which imposes disclosure obligations on funds claiming to be sustainable. The European Securities and Markets Authority also announced this year that it would be defining greenwashing for future legislation. It is worth noting, however, that the German financial regulator investigating DWS, BaFin, recently postponed its plans to regulate the classification of sustainable funds, opting instead to wait until the sector is more stable to effect permanent regulation.
In the UK, the Financial Conduct Authority (FCA) published a policy statement in December 2021, setting out rules of a new climate-related disclosure regime for asset managers and asset owners. These rules came into force on 1 January 2022 for firms with over £50 billion in assets, taking effect through a new ESG sourcebook in the FCA Handbook. Firms subject to these rules are due to file reports by 30 June 2023, reflecting the 2022 calendar year. Meanwhile, firms with assets over £5 billion will be subject to the new rules from 1 January 2023, with reports due in June 2024. The FCA has estimated that, once fully implemented, the rules will be applicable to 140 UK-based asset management and 34 asset owner firms, representing 98% of the UK asset management market.
Misstatements and mis-selling
Aside from specific regulatory rules, corporates in the UK should be mindful of potential statutory liability for ESG misstatements in financial reports or information relating to securities, which could be used a basis for investors to bring ESG-related litigation:
- Issuers located or operating in the UK with securities traded on any UK market are liable under the Financial Service and Markers Act 2000 (FSMA) (s.90A and Schedule 10A) for publishing untrue or misleading statements, or omitting or delaying publishing relevant information, and must compensate a person who suffers loss by acquiring, holding or disposing of securities as a result. Issuers may also be civilly liable for misrepresentation, breach of contract or inaccuracy/incompleteness of the information, and subject to criminal penalties.
- Directors are liable under the Companies Act 2006 (s.463) to compensate the company for loss suffered by it as a result of a misstatement or omission in a directors' report, directors' remuneration report, strategic report of the company, or a corporate governance statement, which they know to be untrue or misleading, or dishonestly concealed. Directors will also liable to civil and criminal penalties under the UK Market Abuse Regulation and FSMA.
In addition, it is possible that widespread misstatements in relation to ESG products could lead to a raft of mis-selling claims by investors against asset managers. Such claims have not yet reached UK courts, however an Italian court last year ordered a manufacturing company to stop making “vague, false and non-verifiable green claims”.
Whilst it will not always be straightforward for a claimant to demonstrate an actionable loss, one can see how almost paradigm s.90A FSMA claims could be formulated: a UK plc suffers a fall in share price, ostensibly tied to revelations about alleged misleading statements as to its ESG investment strategy. Whilst the component parts of the claim would need to be established, it would appear that, where investors relied on the ESG strategy, there would be a prima face case against the UK plc.
Other measures to tackle greenwashing
Outside the ESG investment sphere, clamping down on greenwashing is similarly pervasive. Last year, the Competition and Markets Authority issued its Green Claims Code, which set out principles for how businesses should make claims about ESG. The Advertising Standards Agency is scrutinising advertisements of sustainability more rigorously, rebuking Tesco earlier this month for its plant-based foods advert. The OECD has announced that it will investigate a landmark complaint made against Drax Group plc for misleading claims as to its carbon neutral status (Mishcon de Reya is representing the environmental groups which filed the complaint). By the same token, in October 2021 the UN Human Rights Council recognised for the first time that having a clean, healthy and sustainable environment is a human right, calling on member states to work together (taking "bold actions") to implement this newly recognised right. In France, a greenwashing test case has been brought against TotalEnergies by campaigners, for breach of European consumer protection law by claiming to be carbon neutral by 2050. The judgment is expected in 2023.
The future
As an increasing number of corporates are being held to account, we expect to see an uptick in regulatory sanctions and in ESG litigation being brought by shareholders, prompting substantive regulatory changes in the sector. While the shape of regulation on ESG statements is not yet clear, it is evident that clearing the murky waters of ESG credentials and enhancing the transparency of sustainable funds is at the forefront of regulators' and lawmakers' minds.