ESG+ Newsletter – 11 January

Your weekly updates on ESG and more

As we return from our Christmas and New Year’s break, we dive straight back into a range of developments across the ESG and sustainability world. Our first newsletter of 2024 details investors utilising litigation to leverage returns, a relatively gloomy report from the UN, proposed penalties for failure to comply with CSRD requirements and supply chain risks and assessments, among others. Enjoy and happy new year!

ESG litigation threats grows, as investors seek new sources for returns

Corporate ESG transgressions are a growing source of income for investors through funding of litigation cases, according to a Bloomberg article this week. As has been widely covered in recent years, there are a growing number of lawsuits targeting big business for alleged sustainability, societal, and governance misdemeanours. Investors may be also taking up the baton, dedicating capital to mobilise negatively impacted parties, such as shareholders and customers, before making the case and receiving a settlement or compensation. Bloomberg’s article cites a number of investments that aim to create financial capacity to pursue mass ESG-related claims.

The next significant tailwind for “litigation finance” may well be the upcoming EU Corporate Sustainability Due Diligence Directive. The regulation will result in an increased breadth and detail of information in the market regarding the ESG footprint of corporate supply chains, presenting more ammo for stakeholders to pursue lawsuits or perceived transgression. On the one hand, critics oppose the idea of investors profiteering from the legal system, while insurance ramifications include a fear that claims and premiums will be impacted, with the insurance industry approaching coverage with scepticism. Supporters, however, believe holding companies to account will help to improve internal practice by adding another layer to material risk, raising the bar for what is genuinely strong ESG performance. Regardless, while some may argue it’s opportunistic to use ESG and the legal system to leverage returns, the pressure on companies will continue to pile up.

UN predicts major impact of climate risks in 2024 

The UN’s annual World Economic Situation and Prospects report was released last week and sets out the potential crises the world economy is facing, which may jeopardise progress towards the Sustainable Development Goals. UN Secretary General, Antonio Guterres, uses his foreword to the report to highlight concerns that “divisions between countries and economies are preventing an effective response” to climate change, environmental degradation, poverty, and unequal access to nutritious, affordable foods. This all sounds pretty gloomy, and it gets worse. The report predicts that the continuing impacts of El Niño, coupled with the worsening impacts of the climate crisis, will create a host of extreme weather events, from severe droughts and wildfires to flooding. Despite the report’s pessimistic outlook for 2024, there may be some positive news. While the report highlights the significant funding gap for the energy transition, the Financial Times reports that despite governments backtracking on emissions targets, the private sector is continuing to back the energy transition. This offers some hope that despite the divisions between countries hampering global efforts to combat climate change cited by Antonio Guterres, the long-term trend away from fossil fuels remains a strong investment case for the private sector. Without government action, progress will be too slow, but in the meantime, private investment may be able to spur a certain amount of change. 

In France, CSRD non-compliance penalties include jail time for corporate directors 

In December 2023, France became the first country to fully transpose the EU’s Corporate Sustainability Directive (CSRD) into national law. As a reminder, almost 50,000 EU and non-EU businesses are expected to report sustainability information under CSRD. As a first mover, France faced the challenging task of determining adequate non-compliance penalties. PracticalESG notes that it has taken a relatively strict approach with sanctions for corporate directors of up to €75,000 and five years in jail, for obstructing the work of the external auditors or refusing to share the information required to perform the audit. It is currently unclear what the penalties for not issuing a CSRD report will be, as those included in the legal text all relate to the certification of existing information. In 2024, we expect to see other countries transposing the CSRD into national law – before the deadline of July 6th – and it will be particularly interesting to observe the different approaches taken and whether some form of convergence emerges. 

Investors and new regulations continue to put pressure on companies to report Scope 3 

With the mix of mandatory and voluntary scope 3 emissions requirements emerging from global regulations and investor expectations, there is a growing need for companies to have a comprehensive understanding of – and ability to track – the sources of their emissions through respective value chains. A Responsible Investor article notes that companies are not just responding to regulations, but pressure from investors and customers. Scope 3 emissions come with their issues of inconsistency, with certain criticisms of the GHG Protocol arguing that there is a lack of specific guidance. While critiques will remain, as noted in the article, change is coming: as market practice, customer demands and procurement practices increasingly demand full scope 3 information, there is a clear expectation that companies engage with their supply chains to improve the accuracy of scope 3 figures and, ultimately, set targets to reduce them. 

EU carbon tax and global trade  

With the EU planning to introduce the world’s first carbon import tax by 2026, the Financial Times has been examining its implications for global trade. The Carbon Border Adjustment Mechanism (CBAM) is seen as necessary both for European companies to remain competitive in the face of cheaper Chinese raw materials, but also as a key tool for the EU to meet the goals of the Paris Agreement. However, there are some misgivings both inside and outside of the EU about the mechanism. European producers fear that CBAM could lead to higher costs, particularly those within the renewables sector, while other countries have concerns that it will lead to a two-tier trade system with “clean” products going to the EU and those produced with fossil fuels directed to poorer nations. The UK has already announced a carbon import tax by 2027 and there are expectations that the US and Japan may follow suit. The EU is seeking to prevent retaliation from China for these measures by hosting meetings to convince officials that the carbon tax is not a penalty but rather a decarbonisation incentive. While countries argue over whether these are protectionist measures or part of efforts to address climate change, the new world of decarbonisation may well bring about further challenges for global trade, in addition to efforts to evaluate and impact fragmented global supply chains. 

EV batteries reaffirm the existence of supply chain risks

With societies and economies around the world grappling with efforts to transition to net zero and reduce carbon emissions, a clear focus has been the decarbonisation of transport, with a transition to the use of Electric Vehicles (EV) cited as playing a central role. EV sales are projected to account for two-thirds of global light-vehicle sales in 2035 which, in turn, will create increased demand for resources such as lithium, copper, and nickel for their batteries. Currently, output for lithium-ion batteries for the auto industry is at 0.30 Terawatt hours (TWh), but figures published by S&P Global indicate that demand from the auto industry will grow to 3.4 TWh. The resources to produce these batteries, however, are often found in mines in the developing world, where concerns over human rights protections may be more pronounced. Consequently, and as highlighted in a recent SupplyChain article, EV car makers should be robustly auditing their supply chains so that they are aware of which suppliers may fall short of their standards. To ensure compliance, the article notes that EV manufacturers need to continually monitor and track the progress of their suppliers across their ESG policies. Over recent years, the focus on companies’ supply chains has grown with a requirement for a greater level of disclosure regarding their suppliers and their operations, regardless of sector. Instances of human rights abuses in supply chains represent a material risk. How companies audit and monitor supply chains is more important than ever, particularly as the EU’s latest Directive, the CSDDD, increases penalties for companies and Directors. 

The potential cost of regulating ESG regulators 

After years of criticism, regulators in Europe and the UK have begun to tighten regulations on ESG ratings and their providers. To enhance competition among ESG rating providers, the proposed changes to the EU ESG Ratings Regulation include the requirement for any entity seeking to obtain more than one ESG rating to “choose at least one rating provider with a market share below 15%”, as set out in a recent ESG Investor article. Although this amendment gained support from the European Parliament in December 2023, industry experts have expressed concerns about its potential costs for investors (the largest consumers of ESG data) as “they would need to pay at least two vendors for data”. There have also been concerns that investors might be compelled to select “rating providers that do not meet their specific needs,” as noted in the same article. 

While the ESG data market has experienced significant growth in recent years, the divergence between external ESG rating providers and investors has raised further concerns about its use, especially considering the escalating costs of this data. To address these concerns and improve the usability of the data, standardising disclosure requirements to a global baseline seems to be a reasonable approach, so long as it balances corporate expectations of regulation with the needs of investors to hone in on accurate and relevant data.  

ICYMI

• ACSR to hold a public consultation in February on the use of ISSB standards in Malaysia. The Advisory Committee on Sustainability Reporting (ACSR) will be conducting an online public consultation next month, to gain feedback on critical considerations including implementation approach, timing and assurance of ISSB disclosures in Malaysia. 
• Canada consults on the launch of the new Federal Plastic Registry. The Canadian Government announced a consultation on the establishment of a new registry requiring plastic producers to report on the quantity and type of plastic they place on the Canadian market, as well as track plastic across its lifecycle in the economy, as part of Canada’s initiative to reduce plastic pollution and waste.
• Investors must respect indigenous rights to protect the Amazon. When investors fail to understand and respect Indigenous peoples’ rights, they not only risk reputational damage but also ignore material business risks, which can cost companies and investors billions. To help with this, Amazon Watch has published a due diligence toolkit for investors focused on Indigenous rights and the critical role Indigenous peoples play in protecting and maintaining the world’s biodiverse ecosystems.