In recent years ESG has become integral to most businesses strategies. As a result, more and more General Counsel are finding the need to understand this area in order to properly support their companies. Taylor Root Partner, Sarah Ingwersen, recently caught up with Herbert Smith Freehills Partner, Rebecca Perlman to learn more about how General Counsel can influence and support ESG strategies.
What do General Counsels need to know about ESG?
A lot of businesses are still grappling with why ESG is important, what it means for them and what it is that they need to be doing. GCs have a critical role in helping their organisations to engage with this changing landscape and meet fast-developing stakeholder expectations, not least because the ESG agenda is fundamentally underpinned by legal requirements.
Businesses operating in, or with links to, developed economies have been regulated in areas such as anti-bribery and corruption, anti-money laundering, health & safety and environment, and employment matters for many years. However, these obligations are now accompanied by disclosure and reporting requirements that are aimed at driving greater transparency regarding ESG factors. With greater levels of disclosure comes increased levels of activism and litigation risk, as it becomes easier to scrutinise corporate behaviour.
In this context, GCs are required to not only manage the legal risks relating to the ESG agenda, but they must also navigate potential ethical and reputational risks regarding the company’s ESG commitments and performance. Many of the large ESG failings globally over the past few years have not involved breaches of law, but rather a failure to meet community expectations or manage reputational risk exposures. It’s a skill to be able to explain these risks, bottom line implications and the changes needed to business teams, while also having an eye to the opportunities that ESG can bring.
Where should responsibility for ESG strategy and implementation sit within a company? What role can a General Counsel play as a convener of ESG?
In light of the prevalence of ESG risks facing various industries, as well as new and pending disclosure requirements in the EU and more broadly, many companies are considering the appropriateness of current governance structures for dealing with emerging ESG issues. One area of focus is the concept of establishing a dedicated ESG Committee, which has emerged as a tool to ensure boards have clear oversight of ESG issues affecting the company.
ESG is a broad area of governance that spans various sub-areas in a business. The establishment of an ESG Committee can be beneficial in sharpening a board’s attention on important ESG matters and directing appropriate attention to governance, environmental and social topics impacting the company. However, a dedicated ESG committee will not be the right governance model for every company and boards take different approaches to the oversight of ESG matters. A key part of developing a strong ESG framework and strategy is understanding whether a dedicated ESG Committee would assist the company with its governance, or whether ESG issues, risks and opportunities are better dealt with by integration with existing governance structures.
The task of designing a fit-for-purpose, best practice ESG framework is challenging in a context where there is no uniform definition of ‘ESG’ and where the regulatory landscape is continually evolving. It is therefore not surprising that there is no uniformity in relation to ESG governance across organisations, particularly in respect of board oversight of ESG issues.
What is clear, however, is that GCs are often natural conveners given their position at the nexus of law, policy, investor relations, risk management, and business operations. This is particularly the case for the risk management and regulatory compliance aspects of ESG but also more broadly.
If a company doesn’t have an ESG strategy and framework in place, how can a General Counsel influence the business to implement one?
For listed companies, the common practice of GCs holding company secretarial briefs and positions on ExCos gives them considerable influence as members of senior leadership teams, including on strategic planning. Co-sec roles also provide GCs with material exposure to the investors increasingly pressing C-suites on their ESG commitments. GCs are also often called upon to bring together the disparate strands of ESG policy for boards and educate senior leadership on fast-moving regulatory requirements.
One of the key challenges of the area is to turn a huge range of issues, opportunities and risks into a coherent strategy. The traditional compliance and risk aspects of their roles, combined with the huge scope for GCs to roam across departments and tap external stakeholders and peer networks, ensures they are well placed to take on this challenge. After all, many of the metrics and mechanisms needed to develop and implement an ESG strategy likely already form part of the GC’s risk and compliance toolkit.
It’s important though to focus on the opportunities, as well as the risks. This includes the potential to realise commercial upside by driving operational efficiencies or developing/ supplementing existing products and services, as well as the role that strong ESG performance plays in terms of supporting the recruitment and retention of top talent and increasing customer engagement.
Fundamentally, GCs need to be able to have a conversation and convince their businesses that an ESG strategy is critical to the business’s own long term success. Perhaps the answer is to convincingly present a model of gains from the strategy, while highlighting the risks that may arise without the strategy. The risk of reputational loss with customers and investors tends to be an intuitive motivator for most. We also see businesses who sit up and think about their ESG strategies when a competitor or fellow industry player suffers some loss for their performance on ESG markers – if the GC has that strategy mapped out, that’s another possible moment or avenue for discussion, even if a little belated.
How can an in-house team best mitigate risks related to sustainability disclosure?
As pressure increases on businesses to demonstrate their credentials as responsible employers, investors and stakeholders alike have noted the reputational dangers of overpromising but underdelivering on social as well as environmental commitments. The growing ESG reporting burden, and the readiness of regulators, investors and other stakeholders to scrutinise disclosures, requires a sophisticated and coherent approach. The challenge remains that sustainability reports are commonly prepared across a number of teams. This can create risks for the business where there are conflicting messages, forward-looking or definitive statements and a blurring of group “boundaries”.
In addition to orthodox forms of litigation alleging misleading and deceptive conduct, companies have recently been the subject of regulatory complaints, corporate activism in various forms and broader media campaigns criticising perceived inconsistencies between their public commitments on ESG issues and their actions in implementing them. Many businesses have made ambitious commitments to sustainability and human rights reporting in the last few years. The public statements set out in these reports however often serve as a hook on which class actions are brought and businesses should be cognisant of the potential risk of litigation and strategic activism if their short-term actions do not align with their ESG commitments taken as a whole.
Mounting regulation, enforcement and more aggressive litigation where the community or stakeholders feel they have been misled by ESG‑related disclosures mean that the material risk of greenwashing and social washing allegations looks set to increase. Across the globe, this has fast-become a priority focus for activists and regulators alike. GCs and in-house legal teams play a critical role in mitigating these risks. With growing divergence across different regulatory regimes, it’s important for GCs to keep abreast of fast-moving developments in this area. The challenge that GCs must now meet in adapting to mounting sustainability expectations is not only to make sound decisions in the face of uncertainty, but to ensure that their businesses publicise their expectations, actions and any foreseeable risks truthfully.
What can in house teams do to improve ESG performance in the supply chain?
Business and Human Rights landscape is evolving rapidly. Since the unanimous endorsement of the United Nations Guiding Principles on Business and Human Rights (the “UNGPs”) in 2011 there has been a steady convergence of regulations and standards in this area towards a consensus that business enterprises must take active steps to ensure respect for human rights and to avoid causing or contributing to adverse human rights impacts. This includes undertaking human rights due diligence to identify and avoid risks to human rights in business operations and supply chains.
“E” factors are increasingly just as relevant. A proliferation in net zero commitments by companies across the globe is driving businesses to focus on the practical steps they can take to achieve their targets, including through their supply chain contracts and processes. We’re also seeing businesses introduce carbon requirements into supplier selection and increase the weighting of such criteria in supplier scoring. Measures most likely to impact supply chain contracting from this perspective over the next 5-year horizon include compulsory disclosure of Scope 3 emissions, which will drive clauses that aim to cascade emissions reporting and reduction obligations throughout the supply chain, and the introduction of emissions trading schemes which will likely lead to the integration of practical, mechanical provisions to facilitate the transfer of credits down the supply chain. In house teams focused on commercial contracting and procurement should monitor these trends and start to think of ways in which supply chain arrangements can contribute to corporate climate commitments.
Undertaking ESG due diligence prior to engaging with a given business partner, and continuing to conduct such process on an ongoing basis during the course of the contractual relationship, is critical. The concept of mandatory supply chain due diligence is currently under consideration at the EU level. The Corporate Sustainability Due Diligence Directive represents a paradigm shift in global ESG regulation. By extending to businesses globally – through EU-generated turnover or supply chain cascade – and imposing hard obligations to ultimately prevent both human rights adverse impacts and environmental adverse impacts, we are looking at a new and radical phase in global ESG regulation. This seismic change will be accompanied by new and far reaching disclosure obligations.
What certifications exist to validate and signify excellence in ESG performance to the market? What’s the role of legal in obtaining these?
There are various options out there – certifications that specifically relate to the environment (LEED / ISO 14001), or for wholistic ESG performance (certification as a B Corp, for example). Many times, the journey to certification involves a due diligence exercise in order to be able to prove performance and show progress. Legal plays a large role in managing that exercise – again, often times with the support of external counsel – and in communicating the impact and obligations certification will impose on the company. B Corp certification, for instance, involves implementing a specific Legal Requirement which includes a change to the company’s articles. This has various legal implications and therefore in house teams are commonly closely involved – together with the Board – in the certification process.
Whichever accreditation is adopted, maintaining and keeping up with evolving standards in order to stay certified year on year is just as important as meeting certification standards the first time around. It’s a long term commitment the company makes – and one that legal must manage through its life.