In a recent live event at our New York office, Venable partner Alex Koff led a panel discussion that explored domestic and international environmental, social, and governance (ESG) concerns. The panelists – Venable lawyers Michael Sheehan, George Kostolampros, Matthew Quandt, and Kelly Johnson, along with Katie Vickery and Matthew Germain of Osborne Clarke – examined the primary ESG concerns of clients, customers, regulators, investors, and employees; the latest best practices for addressing ESG issues; updates on enforcement actions by regulators; potential civil liability from ESG representations; and shared insights into the global strategies employed in different geographies.  The panel examined these issues both from a US as well as an UK/EU perspective.

Growing Relevance of ESG Worldwide

Between client demand and increasing regulatory oversight, ESG is becoming an issue that companies can no longer afford to ignore. ESG is an inherent component in many M&A transactions of late, and, in the past 12-24 months, significant ESG funds have been raised in the marketplace, with investors looking at companies with a high ESG performance. Certain jurisdictions, such as France, Germany, and the UK, and to a lesser extent Japan and Australia, already have advanced ESG frameworks to regulate and measure companies’ ESG activities. But in order to make prudent investing decisions, the investment community is leading the charge for more regulation around ESG activities in these and other jurisdictions with less advanced ESG systems.

Regulatory Developments (U.S.)

In March of 2022, the Securities and Exchange Commission (SEC) proposed a climate-related disclosure rule, which would require companies to disclose direct emissions that are caused by the company’s own machinery or general business activities, as well as indirect – known as Scope 3 – admissions associated with the production or transportation of goods or with third parties, such as suppliers. The proposed rule contains some exemptions for smaller companies and provides a safe harbor for forward-looking climate-related emission statements. The SEC followed up in May 2022 with proposed amendments for investment companies, which would require specific disclosures on ESG strategies and fund perspectives. The overall purpose of these proposed rules is to introduce a standard to measure both a company’s ESG rating and the activity of investors touting their ESG focus. In addition, on November 22, 2022, the SEC charged a prominent asset management firm for alleged policies and procedures failures from April 2017 until February 2020 involving two mutual funds and one separately managed account strategy marked as ESG investments.  The firm agreed to pay a $4 million penalty to settle the charges.

Regulatory Developments (EU and UK)

The proposed SEC rule in the United States has garnered a significant amount of attention in the EU and UK, particularly the emphasis on Scope 3 (indirect) emissions. Currently, the EU and UK have a Taskforce for Climate-Related Financial Disclosures (TFCD), which requires companies to provide detailed annual reporting on climate-related emissions and risk. But industry groups and investors in the EU have been pushing governments to introduce more stringent regulations, which led to the introduction of the Corporate Sustainability Reporting Directive, due to be enacted in 2024. This new directive will expand the scope of disclosure requirements for EU companies and, more crucially, will require that those disclosures be audited and substantiated. This new directive applies also to non-EU companies with a substantial presence in an EU jurisdiction or companies with securities listed on EU-regulated markets.  For these reasons, the new directive has implications for many U.S.-based businesses.

ESG Best Practices

With growing pressure from investors and other stakeholders, along with regulatory concerns, best practice is for organizations to adopt or develop better controls concerning ESG activities. Some companies are appointing chief sustainability officers or creating ESG committees or subcommittees. But as ESG touches on every aspect of a company’s business, meaningful initiatives in this area should ideally be board-led with in-house legal teams playing a significant oversight role.  Organizing ESG compliance in this manner ensures strong oversight and controls over ESG strategies.  

ESG Trends

Companies are focusing increasingly on their supply chains when onboarding or managing suppliers and examining how to best assess environmental or social impacts and foster sustainable and ethical practices. With increased regulation and oversight, substantiation is considered of increased importance as businesses turn regularly to audit and assurance companies to confirm the accuracy of data and claims regarding ESG. Similarly, regulatory changes arising out of the EU Green Deal are driving changes around packaging – for example, companies doing business in the EU are using more recycled content and to paying for the full life cycle of their packaging, including the collection by municipal waste facilities. And, finally, there is a growing move toward creating a circular economy where the emphasis is on repairing products rather than simply replacing them.

With investors becoming increasingly vigilant about where they allocate their ESG funds, companies are likely to come under more scrutiny in this space. Our attorneys are closely monitoring the ESG landscape and will continue to provide updates.