updated on 23 November 2021
QuestionHow important are ESG policies to modern commercial relationships and how does this impact the lawyer/client relationship?
In the modern economy, there is a shift in the attitude of businesses towards a greater focus on environmental, social and governance (ESG) issues. This has intensified over recent weeks and months with COP 26 taking place in Glasgow and attention being pushed towards what we can do to increase sustainability and take more responsibility in our role in tackling the climate emergency that is facing the world. Commercial relationships are not immune to these changes; there is an ever-increasing requirement for businesses to demonstrate their ESG credentials, this extends to their supply chain and who they have relationships with.
ESG policies are an indicator of how a business wishes itself to be seen. Most businesses want to be seen to be ethical in their relationships with their employees, the companies that operate in their supply chain (eg, ensuring that they are not benefitting from exploitation or modern slavery), and their interactions with their local community. These policies can attract investment or assist with bids to win work during a tender process.
Modern investors are now taking a greater interest in where their investments are placed to ensure that they have a green portfolio or pension fund. This has been evidenced by Morningstar, whose report into sustainable funds stated that between 2019 and 2020 the number of sustainable funds increased 30% and the net flow into sustainable funds more than doubled to $51.1 billion. This has encouraged businesses to advertise their green credentials more aggressively and this will have an impact on who they establish relationships with. This can be demonstrated most clearly in the supply chain where contracts going out to tender will now often include requirements for the suppliers to meet certain criteria to enable a business to demonstrate that it is serious about tackling its net-zero goals.
COP 26 has intensified the pressure on companies to demonstrate that they are taking practical steps to assist with the efforts to achieve the net-zero targets being set and to help restrict the levels of global warming. Businesses will face further regulations in order to achieve these goals and therefore there is not only a moral imperative but a regulatory necessity for businesses to shift their practices to a more sustainable model. During COP 26, Rishi Sunak unveiled plans to force firms and financial institutions to disclose their plans regarding how they intend to help the country to reach net-zero. These proposals are in their infancy and require publication, but they demonstrate the movement towards forced disclosures of climate-relevant data.
There is a generational divide in attitudes to climate change and as companies evolve and the leadership of these companies is replaced by younger generations there will be an inevitable shift in the focus of these companies. The trend for companies to demonstrate their ESG credentials is only likely to strengthen as younger generations take the helm.
Impact on the lawyer/client relationship
What clients want from their legal advisers has changed, as can be demonstrated by the fact nearly all global law firms now include an ESG or sustainability practice area. This growth is client led and the legal industry is trying to keep pace with the changes in the ESG field and deliver for clients what they want, from clauses in contracts that require decarbonisation or modern slavery-free supply chains, to due diligence processes which include requirements to disclose any sexual misconduct allegations against senior executives involved in a merger or acquisition.
Further, there will be requirements for legal assistance in reviewing internal processes to ensure compliance with regulation and to assist with corporate disclosures. The European Commission has established a new taxonomy to assist with labelling ESG activities in order to help investors from being misled by greenwashing statements and to support companies in becoming greener. Regulations such as this will require interpretation and clients will rely on their lawyers to provide guidance on these matters.
Claims relating to greenwashing and ESG is likely to be a growing area in the next decade as companies grapple with the conflict between their public statements and the reality of their internal practices. There are calls for green investments to face regulation to prevent greenwashing. The asset management sector is concerned that exaggerated claims regarding the green credentials of funds could lead to a major mis-selling scandal, partly driven by the lack of clarity over what constitutes a sustainable investment. The UK government launched an investigation into claims of greenwashing in the UK energy sector and the Competition and Markets Authority has launched a code for businesses and consumers in the retail sector to assist with identifying genuine environmental claims.
Moreover, there is an increasingly activist investor base that is willing to take action when their investments lack their desired green credentials, for example academics are taking legal action against their pension provider for not divesting from fossil fuels quickly enough. The outcome of this potential litigation could result in a new seam of potential claims for investors unhappy with their pension provider.
All the above indicate that the commercial world is changing as focus shifts to making tangible impacts on rescuing the environment and making the workplace more inclusive. The starting point for delivering these changes is through changing the culture of a business through its values and policies to ensure that ESG becomes of central importance to a business's strategy. The legal sector is not immune to these changes and is adapting to meet clients’ needs.
Douglas Pyrke is a trainee solicitor seconded to Lloyds Banking Group from DWF.