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

• The Hogan Lovells Navigating Deep Waters survey’s findings that the majority of companies do not have a mature ESG programme;

• Crystallisation of biodiversity metrics;

• The rising tide of ESG D&O coverage;

• How 50% of fund manager groups are yet to complete their disclosure tables; and

• What’s new in market practice: Changes to the UK Corporate Governance Code.

Majority of companies do not have a mature ESG programme

According to Hogan Lovells’ Navigating Deep Waters survey of 600 multinational companies, only 42% report having a mature ESG programme in place – defined as a program with ESG ownership assigned outside of leadership, ESG culture fully embedded throughout the business, and full implementation of ESG in strategic and operational decision making, including anti-bribery and corruption programmes.

The main obstacles cited include a lack of embeddedness in existing risk practices (82%), a lack of ESG knowledge and skills (78%) and a lack of engagement on ESG matters (57%).

Crystallisation of biodiversity metrics

Biodiversity is a fast growing concern amongst investors in the ESG sphere. Consequently, greater focus is being placed on providing companies and investors with consistent metrics to measure the environmental impact of their decisions and investments.

The Taskforce on Nature-related Financial Disclosures ("TNFD") has identified that there is not yet consensus on the approach to measuring environmental risks in the market and the standardisation of metrics is demanded. The TNFD accordingly aims to produce a framework to evolve nature-related risk management and disclosure recommendations in line with the Task Force on Climate-related Financial Disclosures, and plans to include both metrics and targets in its updated framework in September 2023.

The EU’s Sustainable Finance Disclosure Regulation (“SFDR”) has already introduced disclosure requirements for investment firms regarding the sustainability of financial products, including disclosure of activities that negatively affect biodiversity sensitive areas. In keeping with this requirement, a report by the Network for Greening the Financial System (NGFS) and the International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE) found that some central banks and financial supervisors have already started to measure the exposure of its banking sector to biodiversity loss.

The rising tide of ESG D&O coverage

An increasing number of directors are facing ESG-related litigation initiated by shareholders. Directors and officers liability insurance (“D&O insurance”) provides protection for directors against personal liability arising from such litigation. However, D&O insurance premiums have grown by 38.5% in 2021 alone in the United States as shareholder activism has risen, and it is predicted that premiums will similarly rise in the UK.

It is also expected that D&O insurers may start to impose more stringent diligence requirements before offering ESG coverage under their policies. These criteria could include:

• Whether a company has environmental group shareholders;
• Whether a company has been or is likely to be targeted by climate activists; and
• Whether a company has aligned its ESG policies with the transition to net zero.

50% of fund manager groups are yet to complete their disclosure tables

Amendments to the EU’s Markets in Financial Instruments Directive (MiFID II), which came into force on 2nd August 2022, now require fund managers to provide ESG-related data for all products marketed in the EU. Under the requirements, financial advisers will need to ask clients about their ESG preferences when assessing options on their behalf, and accommodate ESG-related requests from clients. However, research suggests that just a week before the deadline of 2nd August 2022, half of fund manager groups were yet to submit their ESG-related data due to confusion as to how and where to disclose.

What’s new in market practice: Changes to the UK Corporate Governance Code

The Financial Reporting Council (“FRC”) has announced in its position paper of 12 July 2022 how it will implement the proposed reforms to the UK Corporate Governance Code (“UKCGC”) set out in the Government's May publication, Restoring trust in audit and corporate governance. The proposed reforms are aimed at making boards more responsible for fraud and their company’s finances, and increasing the accountability of directors.

The FRC will do so by:

• revising and adding to the existing suite of codes, standards and guidance to implement the reforms;
• developing new standards allowing for voluntary adoption of the reforms ahead of legislation;
• setting expectations for markets to drive behavioural changes;
• developing guidance for markets to address issues set out in the Government’s response to the proposed reforms; and
• setting higher expectations to align with the proposed reforms to the existing codes, standards and guidance.

The proposed reforms will see the FRC turned into a new, more powerful regulator (the Audit, Reporting and Governance Authority (ARGA)) tasked with protecting and promoting the interests of investors and other users of corporate reporting information and will have powers to sanction directors of public interest entities (being large private companies with both (i) 750 or more employees, and (ii) an annual turnover exceeding £750 million) for breaches of their corporate reporting and audit-related duties and responsibilities.

The FRC’s intention is for the amended UKCGC to apply to periods commencing on or after 1 January 2024, giving companies and regulators sufficient time to adapt to the reforms.