ESG in focus for 2022 proxy season

As featured in Global Risk Regulator

As the dust settles on the 2022 proxy season, the time is ripe for banks and other financial services institutions to explore investor sentiment arising from the annual roundtables. By James Norden and Simon Taylor at Forensic Risk Alliance.

ESG remains a hot topic for public company stakeholders, with intelligence firm Georgeson finding 55% more ESG proposals voted on in the US compared with 2021.

Emboldened by increasing regulation and better access to funding, the steady increase in ESG-related claims presents heightened legal risk to corporates and financial institutions. The Grantham Institute recently found that a quarter of all climate-related cases since 1986 were filed in the past two years.

For financial institutions, the risk of litigation stems not only from their own direct activities, but also the implications of financing and investment decisions. Investment funds are already targeted through so-called ‘portfolio emissions’, i.e. the “value chain emissions associated with…investment decisions”. As fund managers continue to reposition their portfolios towards ESG compliant investments, Bloomberg Intelligence projects global ESG assets will exceed $50tn by 2025. At this scale, closer scrutiny is inevitable.

Public financial institutions are equally being held to account for investments with climate-related commitments. For example, UK Export Finance (UKEF) is awaiting the Court of Appeal’s judgement regarding whether its investment in a liquefied natural gas project in Mozambique violated climate commitments. The case has parallels to developments last year in Australia, where ANZ Bank returned profits to populations found to have been displaced as a result of the bank’s investment in a Cambodian “blood sugar” plantation, despite initially claiming it had not directly funded the project.

The financial services industry finds itself amid a perfect storm of increased ESG public pressure, governmental action, regulation and litigation. Against this backdrop, we have identified five key initiatives that financial institutions should seek to implement before 2023’s proxy season.

• Due diligence scope

The ANZ and UKEF cases show how lenders that fail to consider the environmental and social impacts of their investments risk reputational damage and potential enforcement action. Lenders must ensure that effective and thorough due diligence and impact assessments are conducted in respect of all affected parties, and must be refreshed throughout the lifespan of longer-term projects.

• ESG risk assessments

Only by adding ESG as a data point to risk assessments will financial institutions be able to manage the risk of exposure. Goldman Sachs recently voted on measures that would ensure its financing does not contribute to fossil-fuel proliferation, while Citigroup’s institutional investors have called on the bank to produce an audited report confirming the same. The SEC reaffirmed its support for concrete green standards when it blocked a request from Citigroup and two other major banks to avoid environmental audits.

• Grievance frameworks

Companies with the channels for stakeholders potentially affected by business activity to air ESG-related grievances are more likely to address those issues in a timely manner and avoid litigation. By taking the initiative to establish a human rights grievance mechanism framework, ANZ has taken a positive step towards promoting responsible business conduct by its borrowers. Progressive financial institutions should seek to establish similar frameworks to address environmental abuses too. Doing this proactively will allow companies to prevent and detect abuses. Employees too should have the means to raise concerns via whistleblower systems so that issues may be resolved in-house.

• Accurate ESG reporting

2022 has seen regulators continuing to intensify corporate accountability for ESG issues. For example, the US SEC’s support for mandatory climate-risk disclosures draws upon Task Force on Climate-related Financial Disclosures recommendations already adopted in countries such as the UK, where qualifying companies are now required to report annually on climate risk.

With more reporting comes increased risk that disclosures, if inaccurate, will be ‘actionable’ via class actions from shareholders claiming losses when greenwashing emerges. In the US, BNY Mellon’s $1.5m fine in April for falsely claiming that all of its funds had historically undergone ESG quality reviews may be a turning point for greenwashing. Meanwhile in Germany, BaFin’s raid of DWS and Deutsche Bank for “fraudulent” ESG disclosures “misleading the markets” was the first time a major regulator has raided a company for this reason.

Over the coming years, more and more companies will be required to conform to and report on ESG compliance, so making sure ESG reporting is accurate now will ensure companies avoid greenwashing and the inevitable reputational damage that follows.

• Implement ESG training

Finally, companies should introduce training to employees most exposed to ESG risk, such as those in decision-making positions. An increasing number of shareholder derivative suits have been brought against directors for failing to discharge their statutory and fiduciary duties vis-à-vis climate change. A recent EY survey of institutional investors found that more than 70% expected ESG to be a more important factor when voting for directors than in 2021. If company stakeholders expect directors to be well versed in ESG matters, it is vital that they receive appropriate training in matters such as due diligence, risk management and accurate reporting to green standards. Such training should be delivered at least annually given the rapid pace of change.