In this month’s ESG Market Alert, we cover:

• EU plans world’s first carbon border tax;
• The new German Supply Chain Due Diligence Act comes into force;
• Institutional Shareholder Services (“ISS”) updates its UK proxy voting guidelines for 2023; and
• Market Practice Development – Asset Managers have taken a conservative approach to SFDR Level 2 regime

EU plans world’s first carbon border tax

On 13 December 2022, EU member states reached a deal on the world’s first major carbon border tax, Carbon Border Adjustment Mechanism (“CBAM”).

The objective of CBAM is to prevent EU businesses from increasing their carbon emissions outside of the EU, in those regions with lower environmental standards, in order to reach carbon emission targets set in European markets. CBAM will therefore initially target products and sectors that are most carbon-intensive: iron and steel, cement, fertilisers, aluminium, electricity and hydrogen, and some precursor and downstream products. Cars could also be included following a trial period starting October 2023.

In practice, CBAM means importers will have to buy “CBAM Certificates” to equalise the price of carbon between their imports and domestically, under the EU’s Emissions Trading System (“EU ETS”). Negotiations to phase out free gas allowances under the EU ETS for the industries listed above are also ongoing.

The provisional agreement awaits further confirmations by the European Council and European Parliament before its final adoption. However, CBAM is expected to come partially into force in October 2023, during which time importers will only have to report their carbon emissions, and then in full by 2026. Several countries, including Canada and Japan, are planning similar initiatives.

See here for more details.

The new German Supply Chain Due Diligence Act comes into force

On 1 January 2023, the new German Supply Chain Due Diligence Act ("SCDDA") entered into force.

The SCDDA sets out broad due diligence obligations with the aim to prevent, minimise or end certain environmental and human rights related risks (“ESG Risks”) for companies with over 3,000 employees in Germany (and from 1 January 2024, will further apply to companies with over 1,000 employees in Germany).

The SCDDA requires that the regulated companies set up an effective risk management system (in respect of ESG Risks) throughout their supply chain, which should include a suitable risk analysis, preventative measures, grievance mechanisms and the pursuit of remedial actions where necessary. Non-compliance with the SCDDA could result in the offending company being fined up to 2 per cent of its worldwide annual turnover.

Importantly, the new law also impacts the suppliers of those companies obliged to comply with the SCDDA (including those without operations in Germany). As regulated companies are now required to identify the ESG Risks within their supply chain, suppliers are now being asked to give contractual assurances (i.e. representations and warranties) in order to encourage the disclosure of ESG Risks.

For further information on this new law and how Hogan Lovells can assist, click here.

ISS updates its UK proxy voting guidelines for 2023

On 1 December 2022, ISS published amendments to its proxy voting guidelines, which apply to any shareholder meetings held on or after 1 February 2023. The ESG-related amendments target, among other things, board diversity and include the following updates:

1. For UK standard and premium listed companies, the ISS would generally recommend voting against the (re)appointment of the chair of the nomination committee (or other directors, case-by-case) if:
   1. the board does not comprise at least 40% women with at least one woman occupying a senior board position (chair, CEO, CFO or Senior Independent Director); and/or
   2. there is not at least one member of the board from a minority ethnic background.
2. For AIM-listed companies with a market capitalisation of over £500 million, the ISS would generally recommend voting against the (re)appointment of the chair of the nomination committee (or other directors, case-by-case) if:
   1. there is not at least one woman on the board; and/or
   2. by 2024, the board has not appointed at least one member from a minority ethnic background.

Market Practice Development: Asset Managers have taken a conservative approach to SFDR Level 2 regime

On 1 January 2023, the Sustainable Finance Disclosure Regulation (“SFDR”) Level 2 rules came into force, launching a more stringent European disclosure regime, designed to prevent asset managers from “greenwashing” their asset classes.

While SFDR Level 1 required firms to publish and keep a statement on their website relating to their principal adverse impact (“PAI”) and due diligence policies, Level 2’s mandatory reporting template outlines a set of explicit indicators for the PAI statement, ensuring that SFDR classifications (and their respective sustainability claims) are properly substantiated.

However, asset managers have expressed a lack of clarity surrounding requirements for SFDR Article 9 (“Dark Green”) funds and late last year the market saw a rush by fund houses to reclassify their Article 9 funds, with Bloomberg reporting that US$125 billion of such funds had been downgraded as a precautionary measure.