Why financial institutions need to oversee and address their ESG agenda

There is an increasing likelihood in the US, UK and EU that financial institutions (FIs) will be exposed to enforcement actions as well as criminal and/or civil liabilities in relation to how they deal with environmental, social and governance (ESG)-related issues. 

FIs would thus be well advised to actively address and oversee their ESG agenda – regarding both their own activities and the conduct of those with whom they have business relationships. While FIs must ensure what they say regarding ESG is accurate, they should also make sure it is not misleading. 

False ESG statements 

As investors and consumers have an increasing interest in investing in companies that have strong ESG credentials, FIs, asset managers and other major corporates have been busy branding their products and services with ESG certificates and labels. This can be done by, for example, product labelling and company disclosures. 

According to recent estimates, more than $1tn has been invested in ESG funds globally over the past two years – big money can be made if one sells investors what they wish to hear, even if it may be far from reality. Under pressure to enhance their ESG performance, there is a high risk that corporate actors will attempt to artificially improve their ESG credentials. This is often done either by “greenwashing” – falsely conveying that the company follows environmentally sound practices – or by manipulating underlying ESG data.

As an added difficulty, the term ESG is imprecise and broadly used. Guidance in each country varies and is not understood in a consistent way. Nevertheless, those in the financial world must ensure they are fully compliant in relation to ESG, especially in an environment where ESG-related enforcement is gathering pace.

US enforcement activity 

In a recent example, in late April 2022 the US Securities and Exchange Commission (SEC) charged Vale, a publicly traded Brazilian mining company, with misleading stakeholders through the company’s ESG disclosures regarding the fragile condition of its Brumadinho dam. The dam’s failure in 2019 killed 270 people and caused a more than $40bn loss in Vale’s market capitalisation. 

In another example, the SEC launched an investigation into Deutsche Bank last year, which was followed by a separate investigation by German authorities, leading to a police raid on the bank’s Frankfurt headquarters in May 2022. Deutsche Bank allegedly made misleading statements in its 2020 annual report, where it claimed more than half of its $900bn in assets were invested based on ESG criteria. Yet an internal assessment of Deutsche Bank Group’s ESG capabilities found that only “a small fraction” of its investment platform applied a necessary process known as ESG integration. The investigation continues.

In a third case, the SEC said BNY Mellon Investment Adviser had paid $1.5m to resolve charges that it had misstated ESG investment policies for a number of mutual funds it managed, where “misstatements and omissions about ESG considerations” were involved. And on June 10, 2022, the SEC announced that it was investigating Goldman Sachs regarding whether investments in two of its funds violated ESG pledges made in marketing materials.

Such cases are a strong reminder – if any was needed – that the financial world cannot cut corners when it comes to ESG.

UK enforcement activity 

Although the UK’s Financial Conduct Authority (FCA) has not sanctioned any advisory firms for greenwashing to date, it has announced an action plan to tackle both capital-raising firms that make misleading environmental claims and any external consultants that aid them in doing so. It would be wise for those in the financial sector to take note.

Furthermore, the UK Competition and Markets Authority (CMA) issued guidance to help businesses understand and comply with their existing obligations under consumer protection law when making environmental claims. In relation to this, the CMA recently launched an investigation into whether eco-friendly and sustainability claims made by three fast fashion chains – Asos, Boohoo and George at Asda – constitute greenwashing, with the authority noting it is concerned that clothes, footwear and accessories are being marketed as eco-friendly with language that seems too vague and misleading.

And it was reported in April that HSBC faced scrutiny from the Advertising Standards Authority over adverts promoting green initiatives that excluded the information that it is financing companies linked to substantial emissions from the oil, gas and coal industries.

Potential criminal and civil liability

Legal liability can vary, depending on the relevant governing law. As well as the possibility of regulatory proceedings, both in the US and UK, altering ESG disclosures so that they do not truly reflect the activities or progress of an organisation, or making misstatements about a company’s disclosures, might easily result in criminal fraud proceedings.

These could even lead to individual criminal liability if the board of directors and compliance officers have personally certified the accuracy of the company’s annual reports and the effectiveness of the company’s compliance programme. For FIs, such events could be hugely damaging, both financially and reputationally.

In the UK, investors have the capacity to bring statutory claims under the Financial Services and Markets Act 2000 regarding allegedly misleading ESG-related statements made by firms. These claims provide possible remedies for investors in listed firms who have suffered losses because of false or misleading statements in (or omissions from) a prospectus or listing particulars (section 90), or other company announcements (section 90A).

Further claims regarding negligent misstatement or negligent misrepresentation might also be available. However, a claimant will need to prove to a certain extent – and depending on the circumstances – reliance, causation and loss. 

The directors of a company have a duty to promote the success of it for the benefit of its shareholders. But, in doing so, they must be mindful of the impact of the company’s operations on the community and the environment.  They are obliged to exercise reasonable care, skill and diligence (sections 172 and 174 of the Companies Act 2006).

Failure to proactively take action on how their company’s activities affect environmental and societal issues may expose directors to the risk of derivative actions being brought by shareholders. Furthermore, if there is a change of control in a board, a company may sue its former directors for breaching their duties.  

To take an example, in its capacity as a shareholder of Shell, ClientEarth, an environmental law charity, has started legal action against the oil and gas giant, alleging that its directors are mismanaging the risks of climate change through an inadequate energy plan. Shell’s energy plan leaves its long-term commercial viability and competitiveness in danger due to the UK government’s net-zero strategy, with ClientEarth asserting that this is in breach of the directors’ statutory duties.

Although it is questionable whether this claim will be successful, as it needs to overcome certain procedural hurdles, it does, nevertheless, show the appetite of non-governmental organisations and shareholders to hold boards of directors liable for their approach to environmental and societal issues.

Reputational risk 

In today’s world, consumers and investors are more mindful than ever of a company’s statements and dealings when it comes to climate change, potential environmental pollution and damage at home and abroad, child labour and modern slavery supply chains, human rights violations and corruption.

An FI’s failure to address these issues (or its painting of an incorrect picture regarding them) can lead to a loss of market share, falling customer numbers and liability to action from shareholders or authorities – all of which of course are harmful to its future prospects. 

Any FI’s very existence is based on all-important financial figures. Any ESG shortcomings can lead to these figures looking far less satisfactory, which is why the financial world cannot afford to ignore such matters.

Dr Angelika Hellweger is legal director of law firm Rahman Ravelli.