For major companies, environmental, social and governance issues are not a new phenomenon, but the spotlight has intensified. There is now a raft of ESG-related regulations and legal risk issues that did not exist ten years ago. That is likely to escalate, leading to greater investigations and enforcement risk, alongside the potential for litigation and reputational damage.
We look here at some key trends underlying the ESG enforcement agenda, including new laws on the horizon and the way prosecutors and regulators are approaching existing laws via an ESG lens—and we set out some ideas on how existing risk mitigation efforts can be reframed with this in mind.
Scrutiny of company disclosures and public statements
There is a strong focus on what companies are saying about their ESG efforts and the impact of the ESG agenda on their business and outlook. As with all company disclosures, public statements about ESG issues need to be carefully calibrated and reflect the reality to avoid any allegations of fraud or breach of market regulations.
Across many sectors, regulatory scrutiny of “greenwashing” is intensifying. Various consumer protection and advertising standards agencies have issued guidance, commenced sector-wide reviews, and started investigations into the sustainability claims of specific companies (see, for example, our blogs on greenwashing in the UK and the Netherlands).
Given the increasing investor focus and reliance on climate and ESG-related disclosures and the growing demand for investments that are ‘ESG-friendly’, market regulators are also paying attention to company statements on ESG. This is likely to lead to an uptick in investigations and penalties using tools already available. For example, the US SEC’s Climate and Environmental, Social and Governance Task Force, within its enforcement division, is focused, amongst other things, on identifying material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. Watch this space for our upcoming article on the SEC´s new climate disclosure proposal.
Assurance and verification are therefore key. Companies may want to consider if they are aware of all the ESG disclosures that are required and all the places where they are making public statements about ESG. Understanding the overall landscape will help ensure consistency and reliability across the board. Senior management and boards may also want to consider what data and verification efforts support those statements.
A focus on transparency and due diligence within supply chains
There is an increasing focus on the impact of companies’ supply chains. Some laws, like the UK Modern Slavery Act, focus on transparency within the supply chain and create an obligation to report. Others, like the French Duty of Vigilance law and the German Supply Chain Duty of Care Act, go further, creating a positive obligation to take action to identify and address adverse environmental and human rights impacts within company supply chains.
This trend is likely to increase and, with it, more potential for investigations and enforcement.
For example, the UK and EU are at different stages in introducing laws aimed at ensuring that products containing certain commodities (e.g. beef, cocoa and palm oil etc.) do not contribute to illegal deforestation internationally. Alongside an obligation to publish a public statement, companies would have to conduct due diligence on their supply chains to check the relevant commodities are deforestation free and have been acquired in accordance with applicable laws in their country of origin. Penalties for non-compliance are expected, although the levels of penalties are yet to be confirmed. Similar proposals have been put forward in the US, although they are at an early stage and it is unclear if the proposed bill will gain sufficient legislative support to become law.
Similar risk arises from the European Commission’s proposal on Sustainable Corporate Governance, which includes a proposed Directive that would create obligations on large companies (and smaller companies in particularly sensitive sectors) to carry out due diligence in their global supply chains aimed at identifying, preventing, and mitigating actual and potential adverse impacts on human rights, including labour rights, and the environment.
With a proliferation of laws relating to supply chain due diligence, some with significant penalties attached, companies will have to consider if they need to adapt their existing supplier management processes to meet the differing requirements of the various laws to which they may be subject.
Greater focus on criminal law
ESG issues do not exist in a vacuum. They are interrelated with, and in some cases are a rebranding of, many other risks, including market abuse and fraud risk relating to company disclosures, public statements, and regulatory filings; sanctions and export control risks; and money laundering. All of which can engage criminal risk. Many prosecutors will be looking at these existing laws through an ESG lens.
We can also expect to see a greater focus on specific environmental offences, whether existing or newly introduced. Many jurisdictions, for example, already have laws relating to the protection of endangered species or water pollution. And an upcoming EU directive on environmental criminal compliance is expected to have a major impact on the use of criminal law in the environmental sphere within EU member states. The proposed EU directive would seek to tighten compliance with environmental laws across the EU through new criminal offences and increased sanctions and enforcement at Member State level.
NGOs and activists are alive to this and are increasingly lodging criminal complaints against companies. NGOs in France, Germany and the Netherlands have filed criminal complaints against large companies alleging, for example, forced labour and enslavement within their operations overseas or that the companies knowingly benefitted from the proceeds of such crimes. These complaints are often based on principles of international criminal law, such as crimes against humanity, as well as domestic laws like those focused on anti-money laundering.
Increased criminal risk creates additional complexity and companies should assess ESG risks (and their prevention and investigation procedures) with this in mind.
Leveraging existing approaches to manage ESG-related enforcement risk
The need to investigate ESG concerns and the potential enforcement risk will only grow, but legal and compliance teams can take heart from the fact that existing risk management frameworks can help manage emerging ESG risks.
All of the following are as relevant to ESG as they are to more familiar risks like bribery: risk assessments, clear policies; the communication of expectations and training; monitoring; appropriate due diligence and oversight of third party suppliers and agents (and due diligence within the M&A and joint venture context); whistleblowing policies and hotlines; effective triaging of issues; robust and proportionate investigation procedures; processes to ensure appropriate remediation and lessons learned; and regular board reporting and engagement and overall ‘tone from the top’.
Documentation should also be kept front of mind: with so much scrutiny on ESG issues, the quality of the Board’s and others’ decision-making process may come under the microscope, and any perceived discrepancies in public and internal statements may be seized upon. Time taken to document the rationale for decisions and to ensure reasonable steps are taken to check that public statements are accurate, reliable, and consistent with internal messaging, will be time well spent.
This is the tenth in our 2022 Global Enforcement Outlook blog series, which looks at key enforcement and investigations trends. All other blogs in the series will be made available here.