What is ESG & ESG investing?
Environmental, Social and Governance (“ESG”) is a set of standards measuring business’ impact on society, the environment and how transparent and accountable it is. Individuals and companies are now making investment decisions with these factors higher in mind and it is expected that ESG mandated assets will represent half of all professionally managed assets globally by 2024.
What is the FCA’s position on ESG investments?
The FCA confirmed back in 2021 that it is committed to helping investors put ESG matters at the heart of their investment decisions. However, if the financial sector is to respond effectively to this growing demand and help encourage positive change across the economy, consumers need high quality information and clear standards. Despite this, it is clear that the FCA is growing concerned that some claims about ESG and sustainable investing are misleading or inaccurate.
Just last month, the FCA issued a ‘Dear CEO’ letter confirming that ESG matters are high on their regulatory agenda. The FCA criticised ESG benchmark administrators, warning that it will consider enforcement action if administrators do not fully implement ESG disclosure requirements and do not sufficiently detail and describe the ESG factors considered in benchmark methodologies. A list of outlier firms, whose ESG fund claims have raised concerns, has also been compiled by the FCA.
The FCA’s consultation focused on providing substantiable investment labels, disclosure requirements and restrictions on the use of sustainability-related terms in product naming and closed earlier this year. The FCA are intending to publish the final rules in the coming months which will further protect consumers by setting more robust standards in this area.
The FCA is clearly under considerable pressure to address ESG concerns. It is therefore only reasonable to assume that legal obligations and regulation are also expected to progressively tighten to ensure companies are not insincere or misleading in touting in their ESG accomplishments. This will very likely increase the scope for disputes to arise.
Mis-selling or greenwashing claims
“Green” products such as ethical savings accounts or green bonds are becoming increasingly popular, which means financial institutions, financial advisors and asset managers may face mis-selling claims based on the “greenwashing” of financial products. “Greenwashing” refers to organisations purporting to be environmentally conscious for marketing purposes and exaggerating or misrepresenting the ESG credentials of an investment product.
One of the more extreme examples of “greenwashing” which the FSCS has confirmed it has seen examples of is the case of Global Forestry International (GFI) – a Brazilian Teak Forestry Fund who marketed a “green” retirement pension scheme, which had underlying investments in the Brazilian teak forestry fund. The scheme was presented as a secure, well-managed, ethical investment scheme that would help protect the Amazon rainforest and support local communities. The investment was a fraud and attracted approximately £37m of investment before going into liquidation.
With the FCA looking to implement new rules for investment product sustainability labels and disclosure requirements as part of its efforts to reduce “greenwashing”, we expect complaints to the Financial Ombudsman Service and the Courts to increase if individuals and shareholders believe they have been misled as to the credentials of a particular investment product, particularly as more “green” products enter the market.
Claims arising from reporting/disclosure obligations
Whilst there are no reported cases yet, it seems very likely that we will see shareholders in listed companies bringing claims on the basis that they were misled into relying on false ESG information. Sections 90 and 90A Financial Services Markets Act 2000 gives investors the right to sue public companies for misleading statements for example, exaggerating or misreporting progress on tackling climate change or listing particulars or a dishonest delay in publishing information such as annual reports and accounts which are required to contain ESG related information. Shareholders in private companies cannot bring claims under FSMA 2000 but they can rely on s2(1) Misrepresentation Act 1967 and bring a claim for negligent misstatement.
If fines/penalties are introduced for failing to comply with disclosure obligations, they will likely be made public. This publicity will lead to substantial reputational consequences for the firm involved as well as open the floodgates to further claims being brought against the firm because their failures have been highlighted.
Section 172 of the Companies Act 2006 states that directors have a duty to promote the success of the company. A director must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In doing so, directors are required to have regard to the impact of the company’s operations on the community and the environment.
Business owners and directors can expect to be held to account as investors increasingly scrutinise the credibility of their proposed energy transition and emission reduction strategies. Claims are likely to arise if directors fail to take into consideration various ESG matters as part of their decision-making processes. These include matters such as climate change and maintaining biodiversity.
Recently, we have seen ClientEarth filing a world-first lawsuit against the directors of Shell plc for a breach of s172 on the basis they failed to manage the material and foreseeable risks posed to the company by climate change. The claim marks a potential milestone in an emerging movement toward recognising that directors have a duty of care in relation to ESG matters.