Lawyers See ESG Risks as Central to Clients’ Interests

 

By Emmanuelle Haack

Last October, the 28 EU member states adopted the binding EU Directive on disclosure of non-financial information. More recently, a new French proposal for a binding new reporting framework is signaling further regulatory upswing.

Two years after the Rana Plaza tragedy, the French proposal seeks to make parent companies liable for their global supply chain -- representing a move to a full liability regime with fines of up to 10 million euros (US$11.2 million).

Until recently, the law has played a limited part in the push for corporate transparency on environmental, social and corporate governance (ESG) issues, a space that has been largely unfocused and undefined. Transparency on these issues was, until recently, fueled by NGO and corporate initiatives to “do good.”

Consequently, many companies were blamed for greenwashing, as their reports lacked rigor and were disconnected from the business.

During the 'voluntary days,' lawyers were seen as “discouraging too much disclosure on these issues,” consistent with guidance to keep reports uncluttered, whereas corporate communications and sustainability professionals were advocating greater transparency. This type of transparency was most often incorporated into sustainability reports that were less likely to be subject to the same level of rigorous verification as an annual (financial) report.

But the time has come for the inevitable friendship between lawyers and corporate ESG experts. Our latest research shows a 45 percent growth in the number of ESG-related regulations calling for more robust corporate transparency worldwide since 2012.

As Vanessa Harvard-Williams, head of global law firm Linklaters’ sustainability practice and co-head of its risk and governance team, explains: “Regulatory developments around ESG should be watched closely by business and lawyers alike – we are now making the transition from a normative to a compliance framework. Although the regulatory risks of non-compliance with these regulations are often quite limited, the potential reputational and commercial damage from being seen not to comply can be significant.”

With ESG issues becoming regulated, business has to be in a position to provide the required information in a timely and accurate way. Non-compliance with these new regulations is likely to bring with it reputation risks, in addition to triggering potential regulatory fines and, in a few cases, litigation threats. Over time, it may also give rise to procurement issues where business or government purchasers apply ESG criteria.

Companies have to ask themselves: how do we understand these new regulatory risks and opportunities, and are our legal teams and advisors equipped with the right information to respond?

Incoming regulations in this area are often less developed than in more mature areas of law; this causes problems in determining what information is required, and in drawing the line between “nice-to-have” and “must-have.”

Take conflict minerals as an example. This topic gained importance in 2012 with the U.S.Dodd-Frank Act. On May 20, 2015, the EU Parliament received400 positive votes that EU importers sourcing in conflict areas should disclose this information. More regulation seems likely, though the capacity of businesses to supply demonstrably conflict free minerals remains very restricted at present.

In the meantime, EU-registered large or listed companies engaged in extractive activities are preparing to report on any payments within certain categories made to government or government owned entities above 100,000 euros (or around $112,000) with respect to these activities. Reporting will commence in financial year 2016 for the UK and in financial year 2017 for the rest of the EU.

Companies active in the U.K. with a turnover of 36 million euros will also be required to report on the steps taken to ensure that their own activities and those of their supply chains are free from modern slavery and human trafficking, under a reporting obligation that takes force October 2015.

Let’s look at the broader momentum for more robust disclosure.

Governments are increasingly enacting transparency requirements within their legal regimes. This is, in part, a move to contain global corruption risks, as well as a response to pressure from civil society and to the eroding tolerance of the public for governance failures in the private sector.

In some cases, countries perceive that having strong regulatory frameworks will help them to benefit from the soaring amount of cross-border investments that are happening nowadays. Maybe they understand that in today’s hyper-connected world, the reputation of a country cannot be seen separate from the reputation of the companies driving its economy.

With the Toshiba scandals spread all over major headlines last month, Japan suffered. In Japan, regulatory changes are a fundamental part of the process to restore trust following a series of governance failures.

It is no coincidence that the new Japanese Corporate Code of Governance was recently revised: the country is moving towards building a new corporate governance image following high profile challenges, including Toyota in 2010, Olympus a year later, the management of the Great Earthquake in 2011 and, most recently, the Toshiba issues.

These examples shed light on the importance of an effective regulatory framework to facilitate a country’s ability to prevent serious wrongdoing, subsequent cover-ups and severe financial consequences.

Integrating ESG and transparency is without question becoming the new normal – and not just from a compliance standpoint. Companies that dare to ignore those developments are at high regulatory, reputational, and competitive risk. As a business, it vital to understand which countries are pushing the envelope.

Here are a few tips for being prepared.

First, look at voluntary guidance. Many regulations derive their inspiration from already existing international standards and voluntary guidance, such as the Ruggie Principles, the Global Reporting Initiative Guidelines, the 2015 OECD Principles of Corporate Governance or the ILO Declarations.

Helle Bank Jorgensen, chairman of eRevalue, CEO for the advisory firm B. Accountability and a facilitator for U.N. Global Compact Board Program, confirms the development from soft to hard law over her 25-year-career: “When I studied business law and trained to become a state authorized public accountant, it was legal to deduct bribery in tax-returns, though not well-regarded.”<

“Today,” she explains, “MBA students are shocked that it has ever been legal. The late Ray Anderson, founder of Interface might have said it best: ‘In the future people like me will go to jail.’ He was referring to the environmental harm companies could legally do.”

“Another example,” Jorgensen continues, “is the above-mentioned French law proposal. Since the mid-nineties, I have helped many leading brands in building responsible supply chain programs; however, it all started because stakeholders wanted to hold companies to a higher standard, while the CEOs originally said this is not our responsibility – it is that of our suppliers. So yes, stakeholder dialogue and keeping an eye on soft regulations is a must for companies that want to last in this fast-changing environment.”

Second, watch the courts. TheDutch Court breakthrough judgement in June added a momentum to climate change that is now reverberating in global civil movements worldwide. By ruling that the government was knowingly contributing to a breach, the Hague allowed a group of citizens to sue their government over its inaction on climate change.

With Belgium, Norway and the U.K. already embracing similar initiatives, it is said that the Urgenda Climate Case could act as a powerful precedent for more cases to be triggered.

Third, watch how companies and law firms respond to a new compliance regime. These new laws and rulings need to be implemented by putting company secretaries and general counsel front and center.

Sustainability issues are no longer dealt exclusively with by the corporate responsibility committee or corporate communications professional. Business need to understand the issues from a legal perspective, and prepare to respond accordingly.

More broadly, sustainability and business’ role in society are increasingly important issues for boards to consider and manage together with other enterprise risks and opportunities.

Last week, for instance, we witnessed the launch of a Campaign urging listed company’s board of directors to issue an annual Statement of Significant Audiences and Materialityin order to communicate publically who their stakeholders are and what are the material issues or objectives of the company.

The American Bar Association, U.N. Global Compact General Counsel Ursula Wynhoven and Professor Robert Eccles initiated a knowledge sharing project to enable this project.

Through notes posted with the ABA, law firms around the world have explained the treatment of sustainability issues under corporate law relating to directors’ duties and company reporting. The focus of this exercise, much like the work done by law firms in support of Professor Ruggie’s U.N. Guiding Principles on Business and Human Rights is to define the parameters of those legal duties.

In particular, there was value in clarifying that social and environmental risks can form one of a range of factors to be considered in the discharge of fiduciary and other duties, demonstrating what is known in the U.K. as “enlightened shareholder value.”

The template for these notes was developed by the team with Harvard-Williams of Linklaters.

The above examples reinforce the growing regulatory push for more robust transparency, and the resulting complexity of understanding the evolving changes and high cost associated with keeping up.

What’s next? Some questions we’re thinking about include: How is the sharing economy going to be regulated? What about the circular economy? Are there going to be further rulings on supply chain responsibility? Or, as questioned in this week’s FT article, are stock exchanges going to tighten up their listing requirements on ESG?

Emmanuelle Haack is a Regulatory Analytics Associate at eRevalue.

Learn more about how we’re staying on-top of today’s rapidly changing regulatory landscape aboard Datamaran.

We’d like to thank Vanessa Harvard-Willams (Linklaters) and Helle Bank Jorgensen (eRevalue, B.Accountability, UN Global Compact) for their contributions.