ESG investing is a term that has begun circulating around the commercial sector for the last few years. As firms become more aware of the term and begin to implement it into their practices, it has become equally important for commercial lawyers to be able to understand and navigate their way around the concept, so as to advise their clients on this subject.
What is ESG Investing?
ESG stands for Environmental, Social and Governance. Essentially, the concept accounts for a more responsible, sustainable method of investment. ESG investment is meant to be a lens for businesses to analyse their practices and evaluate whether their corporate behaviour promises to create positive returns, not only for their own needs, but to benefit the world around them. Importantly, ESG investing is not necessarily financial indicators of success, but are a subset of indicators that revolve around sustainable development. There are three essential categories of ESG considerations:
Environmental risks: essentially, environmental risks are concerns regarding air pollution, land and water usage as well as general population health. The implementation of ESG consciousness would, very simply, be the reduction of negatively impacting the environment in corporate dealings. This has emerged more as public attention has turned towards protecting the climate and demanding big corporations, such as oil production companies, to become more mindful of their carbon footprint. For example, earlier this year, BP declared they would become a “net zero carbon company” by the end of 2050, or sooner in response to ESG demands. Their operations seek to produce a net of no carbon dioxide, as well as cut their amount of carbon in their products. Furthermore, companies are working on investing more in renewable energy sources, including oil giant Saudi Aramco.
Social risks: the social risks are associated with how corporate dealings have an affect on society in the form of health and safely, labour-management, protecting human rights and production integrity. For example, clothing store H&M are committed to ‘supply chain transparency,’ publishing a list of 98.5% of their suppliers to allow their customers and investors to see where they are sourcing their products from. This is all part of making sure the company is held publicly accountable. Given the recent criticisms of the fashion industry, it is likely that this trend will continue. Gucci have recently committed to carbon neutral production, being the first luxury brand to commit to sustainable investing and releasing a ten-year sustainability plan to substantiate their promise.
Governance risks: finally, governance risks are associated with the way a company is run and addresses diversity, corporate risk management, board accountability and protecting shareholder rights. Corporate governance is a regular part of the requirements of a business, and countries do have existing corporate governance codes. Applying them under the ESG umbrella simply seems to bring stronger attention to the importance of corporate accountability and ensures a cooperative, reliable company to work in. Unilever is credited with having strong corporate governance and solid accountability regimes and in 2018, BlackRock publicly committed to the ESG goals. Many law firms, including White & Case LLP, Clifford Chance, Norton Rose and Latham & Watkins, commit themselves to ensuring diversity in the workplace, all of which contribute to ESG accountability.
Why is ESG Investing on the rise?
As we are all probably aware, public attention has turned towards factors like climate change and corporate accountability as companies and institutions have become increasingly criticised for their lack of ethics. The rise of millennials is certainly a contributing factor to this change, as millennials and younger generations have taken it upon themselves to repair the damage of corporate irresponsibility. Studies have found younger generations are more likely to trust and deal with companies that are committed to ESG goals, supported by the surge of vegan products, the rise in ethically responsible meat sources and the critique of companies with large carbon footprints. Essentially, the next generation cares deeply about these issues, so if companies want to continue to be successful in the next wave, they need to cater to the client’s wants. At the heart of ESG investing is the reputation of the business, and as the value of ESG responsibility becomes more important in the consumer’s eyes, corporations are beginning to realise the consequences of not meeting these expectations. Thus, the adoption of ESG factors is becoming more important across all industries.
So, this seems to be an issue for businesses, to take responsibility for their actions in a changing world. But what is the lawyer’s role in this climate?
What does this mean for lawyers?
Traditionally, the regulation standards have been set by governments, where the role of lawyers was to ensure regulatory frameworks were being followed, and to take action should they be breached. But the constant criticism for ESG investment is that governments are not acting fast enough, yet the pressure continues to mount. The government is not initiating programmes or releasing frameworks to guide corporations, so they need to figure out what to do themselves should they wish to keep their consumer base happy. So who do they turn to when they need guidance? Lawyers! The lawyer’s role is to research and use their legal and commercial skills to find solutions to the ESG knowledge gap, define targets, assess the credit risks of ESG investment, understand the future regulatory environment and make sure their clients are ready to face that.
A final trend to note in the sphere of ethical consciousness is the role of Climate Change Litigation. This new form of litigation has been on the rise for some time now, where corporations are being held accountable through the courts for their imposition and threat to the climate. The formal driving forces behind Climate Change Litigation are the Paris Climate Agreement and the UN Sustainable Development Goals. With these documents, plaintiffs have taken on governments, accusing them of breaching their constitutions and human rights ratifications. This is a merging of constitutional and human rights law, where the insensitivity towards the climate, for example, in cases where governments have subsidised fossil fuel production knowing the effects would be harmful, have resulted in legal action, and in some cases, success! Thus, lawyers are being called upon in cases of climate action litigation as well as traditionally corporate regulation cases and guiding corporations to becoming more ethically conscious.
The Bottom Line
The new generation cares very deeply about ESG factors, and as such businesses have to step up and meet these demands to continue to be successful. Increased transparency and harsh criticisms have led to businesses moving towards wanting to be more responsible, but the delayed response from the government as well as general uncertainty means businesses have to turn to lawyers to guide, advise and defend them on this new territory.