Forum magazine: ESG compliance — Legal risks grow as regulators focus on explosion in sustainable investing

Environmental, social and corporate governance (ESG) issues have become a strategic priority for many corporate executives and boards around the globe

Almost every industry is impacted by the collective efforts of governments to tackle climate change, the effects of which have become all too stark in 2021. The recent scientific report from the United Nations further underscores the limited options that nations and organizations face in forestalling future catastrophes, with the UN Secretary-General calling the study a “code red” for humanity.

Financial services have a critical role to play in the climate battle. As capital providers to industry and channels for investing individual wealth, the industry plays a pivotal role in managing the transition from a fossil fuel-dominated economy to one supported by renewable energy. Given this responsibility, financial authorities across all regions have underscored how a broad range of issues including climate change, human rights and human diversity need to be managed along with other traditional risks.

For investment management and brokerage firms, global and regional financial authorities have put forward proposals on common standards and metrics for sustainability-related disclosure rules to help investors understand the opportunities and risks of ESG investing. Such disclosure requirements come as ESG-related investments have exploded, with sustainable investments totaling $35.3 trillion in 2021, or more than one-third of all assets in five of the world’s largest markets, according to estimates.

With sustainable investing being relatively new, however, there is concern among international regulators whether investors – particularly smaller, retail investors – understand what they are buying and that the firms offering such investments are providing adequate disclosure.

“Greenwashing”

One major concern is so-called greenwashing, or the marketing of products as being environmentally sound when in fact they are not. In the European Union (EU), many of the measures being developed are designed to reduce the likelihood that greenwashing could occur. That said, greenwashing remains a concern.

In January 2021, the results of a website screening exercise conducted by the European Commission and national consumer authorities, reported that they “had reason to believe that in 42% of cases, the claims were exaggerated, false or deceptive and could potentially qualify as unfair commercial practices under EU rules.” The “sweep” analyzed green claims made online from various business sectors such as garments, cosmetics and household equipment.

Further, in July the UK’s Financial Conduct Authority (FCA) issued a Dear CEO letter to chairs of authorized fund managers setting out expectations on the design, delivery and disclosure of ESG and sustainable investment funds. The FCA report said that “we have seen numerous applications for authorization of investment funds with an ESG or sustainability focus. A number of these have been poorly drafted and have fallen below our expectations. They often contain claims that do not bear scrutiny.”

In the US, environmental activists have taken up a more creative approach in their targeting of companies believed to be engaged in greenwashing. Large oil and gas companies that increasingly tout their green credentials have come under fire from activists who say such claims are misleading.


It is important that compliance officers have a senior position within a firm so they may have input and influence on the firm’s future ESG strategy.


While several US states and cities have filed lawsuits against fossil fuel firms over greenwashing in recent years, three environmental groups took a different tack earlier this year when they launched a landmark complaint against Chevron Corporation. Rather than going through the courts, the green activist groups – Global Witness, Greenpeace and Earthworks – filed a false advertising complaint against Chevron with the US Federal Trade Commission, which enforces rules against deceptive ads.

The three organizations are hopeful that their complaint to the federal agency will gain more traction than a lawsuit filed in a federal or state court and lay down a marker for further action against greenwashing.

Then there is the growing interest among US regulators. A recent risk alert by the US Securities and Exchange Commission (SEC) put a spotlight on the most common issues related to statements made about ESG practices. Some of the major themes and concerns included the relative inadequacy of compliance programs addressing ESG issues, with compliance staff lacking sufficient understanding of issues concerning disclosure and marketing of products. The SEC also found that internal controls were inadequate to maintain and monitor ESG-related mandates, guidelines and restriction

There’s some evidence financial institutions are taking notice. After recent reports suggesting that the SEC and other US authorities were investigating Deutsche Bank’s asset management arm, DWS, the unit’s former head of sustainability said DWS had overstated its adherence to ESG principles.

ESG as a strategic priority

ESG is a cultural undertaking for financial services firms, and corporate governance is a primary component. It would be impossible to achieve the sustainable finance objectives if all firms did not embed the necessary approach at the heart of their culture and strategy. This makes the “G” in ESG fundamental to the success of future gains on sustainable finance.

Governance is the part of ESG that makes the whole package hang together. Without governance the environmental and social aspects are not achieved and the ESG initiative fails. ESG requirements need to be embedded in a firm’s strategy, culture, risk management and operational control arrangements like data governance, third-party management and more.

Strategy, culture and policy

Boards need to ensure that within their organizational structure there is clear accountability for ESG-related matters. This is vital to embedding ESG in a firm’s culture. Communicating the right tone from the top is important when determining a firm’s ESG approach.

Further, boards need to promote a culture that is ESG-friendly, one that not only addresses the environmental benefits of the firm but also promotes a socially diverse environment. Corporate policies should be amended to reflect support for ESG-related issues, and these should be documented, communicated and trained in a clear and understandable way that all staff can access.

Firms should also consider the overall impact of ESG requirements on their strategy and culture. Areas like the products they sell; the services they provide; the costs they incur through staff, real estate, the supply chain and other items should all be reviewed from an ESG perspective. Then, a conclusion can be reached about the profitability and ethical nature of current strategy and operations – what needs to change and how this change should happen.

Compliance arrangements

Compliance departments should be seen as key controls in a firm’s approach to ESG. It is important that compliance officers have a senior position within a firm so they may have input and influence on the firm’s future ESG strategy. Effective identification and assessment of upcoming ESG regulations and best practices can be used by a firm to shape this strategy. Indeed, forward-thinking firms can use the compliance function and their relationship with regulators to influence future regulations on ESG.

The compliance department itself needs to have sufficient skills, knowledge and experience of ESG matters to advise the firm appropriately. Training and competence schemes, personal development plans and recruitment strategies all need to be reviewed in order to determine whether the firm has adequate ESG compliance resources.

[View source.]

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Thomson Reuters Regulatory Intelligence and Compliance Learning
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