ESG Trends and Hot TopicsMay 31, 2022
Hot Topics in ESG for Directors and Executives to Consider
This memorandum highlights key recent developments in environmental, social and governance matters of relevance to public and private companies globally. For more information on this evolving business and legal landscape, we encourage you to reach out to your regular Sullivan & Cromwell contact or the lawyers listed on our ESG practice website.
- A wave of proposed new corporate climate and sustainability reporting standards from the ISSB, EU, UK and US, among others, means companies will begin to be subject to increasingly prescriptive, and potentially divergent, ESG reporting requirements and heightened liability risks for their ESG disclosures
- Companies, particularly those operating in multiple jurisdictions, should assess what disclosure standards will apply at the parent level and to their subsidiaries and what steps will be needed to comply with the new standards when in force
- Global market for sustainable finance products like green and social bonds, loans and equity and sustainability-linked debt continues to grow dramatically, while the long anticipated EU Green Bond Standard is expected to be finalized soon
- When considering opportunities to participate in the market for sustainable finance products, companies should monitor potentially heightened market or regulatory standards
- Financial institution regulators continue to focus on climate risks and related disclosures in their regulatory and supervisory practices
- Financial institutions, including banks, insurers, and asset managers should continue to assess the impact of climate change on their strategy, governance, risk management, policies, procedures and limits, as well as their climate-related disclosure and reporting obligations
- While some board diversity laws have been subject to challenge and a range of US diversity-related lawsuits have been dismissed, investors and regulators continue to focus on companies’ board and workforce diversity policies and practices
- Companies should continue to monitor whether their policies and practices are aligned with the latest investor and regulatory requirements
In this Issue
- Disclosure and Governance Updates
- Litigation Developments
- Sustainable Finance Developments
- Shareholder Engagement Developments
- Financial Institution Developments
- Competition Law Developments
ISSB Proposes Sustainability Reporting Standards. On March 31, 2022, the IFRS Foundation’s International Sustainability Standards Board (ISSB) published two draft standards aimed at providing a global sustainability reporting baseline for organizations. The ISSB is a standard-setting board for ESG reporting established in 2021. The ISSB’s first proposed standard would require reporting entities to disclose material information about all significant sustainability-related risks and opportunities to which they are exposed, where “materiality” would be determined in the context of information necessary for users of general purpose financial reporting to assess enterprise value. The second proposed standard is specific to climate and would require disclosures on climate-related governance and management, identification of significant climate-related risks and opportunities (within a time horizon over which each could be expected to affect an entity’s business model) and qualitative disclosure on current and anticipated effects of significant climate-related risks and opportunities on an entity’s value chain. The ISSB’s draft climate standard builds off of the existing Task Force on Climate-Related Financial Disclosure (TCFD) framework. The ISSB aims to finalize the new standards by the end of 2022. However, it is unclear the extent to which the standards will be incorporated into or aligned with regulatory requirements, given the US SEC’s own proposed climate rules and the EU’s proposed CSRD requirements (each discussed below) do not currently reference the ISSB standards.
Beta Release of Taskforce on Nature-related Financial Disclosures (TNFD) Framework. On March 15, 2022, the Taskforce on Nature-related Financial Disclosures (TNFD) released the first “beta” version of its Nature-Related Risk and Opportunity Management and Disclosure Framework. The TNFD launched in 2021 with the endorsement of the G7 and the G20, and its Taskforce Members consist of 34 senior executives from global companies such as AB InBev, AXA, BlackRock and UBS. The TNFD draws inspiration from, and aims to co-exist alongside, the highly influential TCFD. The three core components of the proposed TNFD framework are: (1) a series of recommended fundamental concepts and definitions for understanding nature-related risks and opportunities; (2) draft disclosure recommendations similar to the TCFD framework; and (3) guidance for the incorporation of nature-related risk and opportunity assessment into corporate and financial institution decision-making. A final version of the TNFD framework is scheduled to be released in September 2023. Also in March 2022, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), members of which include the US Federal Reserve, the Bank of England and the European Central Bank, issued a statement highlighting the importance of improving disclosure of, and the need for further study and scrutiny of, nature-related financial risks.
SEC Proposes Expansive New Climate-Related Disclosures. In March 2022, the SEC proposed new climate-related disclosure requirements that would require SEC reporting companies to dramatically expand the breadth, specificity and rigor of climate-related disclosures in their SEC periodic reports and registration statements. Among other new requirements, the proposed rules would require that companies calculate and disclose their greenhouse gas emissions (scopes 1 and 2 and, if certain conditions are met, scope 3); applicable climate-related risks; any climate transition plan, internal carbon price, climate-related targets or goals adopted by the company, and progress against such plan, targets and goals; how a company’s board and management oversee climate-related risks; and audited, disaggregated climate-related impacts on existing financial statement line items if the aggregated impact is 1% or more of the total line item. S&C’s memo on the proposed rules is available here. Our memo analyzing the impact of the proposed rules on foreign private issuers is available here, and our memo analyzing certain key implications for financial institutions is available here.
SEC Reopens Comment Period on Pay Versus Performance Rule. On January 27, 2022, the SEC announced that it was reopening a comment period on its proposed “pay versus performance” rule. The SEC’s 2015 proposed pay versus performance rule would have required disclosure of: the CEO’s total compensation and the CEO’s “actual” pay; the average of named executive officers’ total compensation and the average of the named executive officers’ “actual” pay; and the registrant’s and its peers’ annual total shareholder return. In reopening the comment period, the SEC is proposing to expand the required disclosures to include, among other things, a company-selected performance metric, that, in the registrant’s assessment, represents the most important performance measure used to link compensation actually paid to company performance. Our client memo on the reopening is available here.
Supply Chain Due Diligence – Enactment of the Uyghur Forced Labor Prevention Act. On December 23, 2021, President Biden signed into law H.R. 6256, known as the Uyghur Forced Labor Prevention Act (UFLP). The UFLP requires companies to avoid importing goods into the US made with the forced labor of Uyghurs and other minority groups in China’s Xinjiang Uyghur Autonomous Region (XUAR). The UFLP creates a rebuttable presumption to be applied by US Customs and Border Protection starting from June 21, 2022 that any goods produced wholly or partly in XUAR result from forced labor and are therefore prohibited from entering the US. Additionally, any goods produced by entities identified by an interagency Forced Labor Enforcement Task Force (FLETF) are also subject to this presumption, irrespective of whether they are produced in XUAR or elsewhere. A US importer may rebut this presumption by, among other things, establishing “clear and convincing evidence” that an imported good was not made with any forced labor.
California Board Diversity Laws Invalidated. On April 1, 2022, a California Superior Court ruled AB 979, one of California’s two board diversity statutes, violated the California Constitution. AB 979 would require publicly held California corporations and publicly held foreign corporations whose principal executive offices are located in California to have a minimum number of directors from “underrepresented communities,” which includes racial minorities and members of the LGBTQ community, on their boards. See our full memo on this decision here. Subsequently, on May 13, 2022 a California Superior Court also invalidated the other diversity statute, SB 826. SB 826 would require publicly held California corporations and publicly held foreign corporations whose principal executive offices are located in California to have a minimum number of female directors on their boards. See our full memo on this decision here. Both decisions may be appealed.
UK Expands TCFD-Aligned Disclosure Requirements. The UK has taken several steps towards requiring TCFD-aligned reporting for all large UK and UK-listed companies:
- On December 23, 2021, the UK Financial Conduct Authority (FCA) adopted new rules that require issuers with a UK standard listing of shares or GDRs representing equity shares on the main market of the London Stock Exchange to either provide TCFD-aligned disclosure or explain why such disclosure has not been provided. The new rules took effect with respect to accounting periods beginning on or after January 1, 2022. Equivalent rules have applied to issuers with a UK premium listing from January 1, 2021.
- On December 24, 2021, the FCA adopted new rules requiring large asset managers (with assets under management over £50 billion) and life insurers and FCA-regulated pension providers (each with assets over £25 billion) to publish annual entity-level and product-level reports with TCFD-aligned disclosures. The first reports are due June 30, 2023. Other asset managers, life insurers and regulated pension providers (subject to a £5 billion exemption threshold) will need to report from June 30, 2024.
- Lastly, for accounting periods starting from April 6, 2022, all qualifying UK-registered companies and LLPs will need to report TCFD-aligned disclosures in their non-financial information statement. The new regulations cover, among others, UK companies with more than 500 employees and £500 million annual net turnover (in each case on a consolidated basis).
European Commission Proposes Corporate Sustainability Due Diligence Directive. On February 23, 2022, the European Commission published a draft Directive on Corporate Sustainability Due Diligence (CSDD) which, if implemented, would require in-scope companies to both identify and prevent, end and/or mitigate adverse impacts of their global operations and activities on human rights and the environment. The scope of the proposed CSDD Directive is broad and, as envisaged, would extend to in-scope companies’ subsidiaries and global value chains, and extraterritorially, applying to non-EU companies generating significant revenue in the EU. Certain in-scope companies will also be required to adopt a corporate climate plan to ensure that their business model and strategy are compatible with the Paris Agreement goals of limiting global warming to 1.5°C. S&C’s memo on the proposed CSDD Directive can be found here.
Publication of EFRAG Draft EU Sustainability Reporting Standards. On April 29, 2022, the European Financial Reporting Advisory Group (EFRAG) published its exposure drafts for the European Sustainability Reporting Standards (ESRS). The ESRS constitute the first set of standards that will be required under the proposed EU Corporate Sustainability Reporting Directive (CSRD). Following its implementation, the CSRD will require large EU and EU-listed companies to comprehensively disclose how sustainability considerations are integrated into their businesses and how material ESG impacts, risks and opportunities are identified and managed. The European Parliament and Council are currently negotiating the final legislative text for adoption of the CSRD, which is expected by the end of 2022. The draft ESRS would require companies to report sustainability matters on the basis of the “double materiality” standard, disclosing both the material risks posed by their operations to society and the material environmental and other ESG risks facing their own business and operations. Certain requirements would be subject to a rebuttable presumption that they are material to all companies.
EU Taxonomy Update. Following significant political debate within the EU, in February 2022 the European Commission proposed to include certain fossil gas and nuclear power activities within the scope of the EU Taxonomy. New nuclear power plant projects for energy generation and modifications and updates of existing nuclear installations would be covered as “nuclear-related activities” and certain electricity generation and heating and cooling from fossil gas would be covered as “gas-related activities,” which could each be counted as Taxonomy-aligned activities for the purpose of the reporting requirements under the Taxonomy Regulation. The EU Parliament is expected to vote on this proposal by July 2022. A second delegated act establishing technical criteria for the remaining Taxonomy environmental objectives (regarding water and marine resources, circular economy, pollution prevention and biodiversity) is expected to be published before the end of 2022.
EU Proposes New Anti-Greenwashing Consumer Protections. On March 30, 2022, the European Commission proposed a series of changes to existing EU consumer rules, aiming to help consumers make informed and environmentally sustainable product-purchasing decisions. The Commission has proposed amendments to the Consumer Rights Directive to require traders to provide consumers with information on the durability and reparability of products. Additionally, the Commission has proposed changes to the Unfair Commercial Practices Directive, including expanding the list of product characteristics about which a trader cannot mislead consumers to cover environmental or social impacts (and durability/reparability). Furthermore, the proposals widen the list of prohibited unfair commercial practices to include certain forms of “greenwashing” (e.g., making generic, vague environmental claims; and displaying a voluntary sustainability label which is not based on third-party verification).
US Supreme Court Hears Greenhouse Gas Regulation Lawsuit. On February 28, 2022, the Supreme Court heard oral arguments in West Virginia v. US Environmental Protection Agency, which raises the issue of whether the EPA has the power to regulate greenhouse gas emissions. The plaintiffs (twenty Republican-led states) argued that the EPA has exceeded its statutory authority under the Clean Air Act by implementing measures such as emissions caps. Many large power companies sided with the EPA in amicus briefs. Although the oral argument focused largely on the EPA’s remit, the Court may avoid reaching the substantive question on standing grounds.
US Courts Dismiss Board Diversity Lawsuits. A group of high-profile suits in US federal courts brought by private plaintiffs claiming that directors of public companies had breached fiduciary duties and/or made misstatements in securities filings as a result of inadequate diversity policies or discriminatory practices have ended in dismissals. In one of the latest examples, Kiger v. Qualcomm, a derivative action brought against Qualcomm’s directors decided in November 2021, a Delaware federal district court found that, among other things, defendants’ statements about having “goals” of assembling a diverse board were not actionable under US securities laws and the plaintiff failed to identify any specific violations of anti-discrimination laws to support a breach of fiduciary duty claim. The dismissals indicate there is a high hurdle for derivative lawsuits challenging US board diversity going forward.
Vale S.A. SEC Enforcement Action. In April 2022, the SEC filed a complaint in a New York federal court against Vale S.A., alleging it made false and misleading claims about the safety of its dams prior to the January 2019 collapse of its Brumadinho dam. The SEC’s complaint alleges that Vale knew about safety shortcomings in its Brumadinho dam, but continued to assure investors in presentations and sustainability reports that all of its dams were in stable condition. The complaint alleges breaches under Sections 10(b), 17(a) and 13(a) and Rules 10b-5, 12b-20 and 13a of the Securities Exchange Act of 1934. When announcing the charges against Vale, the Director of the SEC’s Division of Enforcement noted that investors rely on ESG disclosures in sustainability reports, signaling an early focus of the SEC’s newly created Climate and ESG Task Force.
ClientEarth Pre-Action Letter to Shell plc. On March 15, 2022, ClientEarth, an environmental law non-governmental organization, announced that it had sent a pre-action letter to Shell plc’s board of directors. ClientEarth stated that it intends to seek permission from the UK High Court to bring a derivative action against Shell’s directors for breach of their statutory duties under the UK Companies Act 2006 to act in a way that promotes the company’s success, and to exercise reasonable care, skill and diligence. ClientEarth alleged that Shell’s long-term viability is endangered by the board’s alleged failure to properly manage climate risks, leaving Shell ill-prepared for the energy transition to net zero. If ClientEarth brings a derivative action in the UK High Court, it would be the first such case in the UK which seeks to hold directors personally liable in this way.
EU Green Bond Standard Developments. The European Commission initially proposed a EU Green Bond Standard (GBS) in July 2021 as a voluntary standard for issuers wishing to align with best market standards. On November 30, 2021, the Rapporteur for the Committee on Economic and Monetary Affairs of the European Parliament proposed changes to the EU GBS which, if implemented, would significantly depart from the Commission’s initial EU GBS proposal. Most notably, the amendments would expand the scope of the EU GBS to include transparency requirements for all bonds marketed in the EU with a sustainable objective and would eventually require mandatory EU GBS designation for all environmentally sustainable bond issuances. Negotiations are currently ongoing between the Commission and the European Parliament and Council to agree the final version of the EU GBS.
EBA Sustainable Securitization Report. On March 2, 2022, the European Banking Authority (EBA) published a report examining the introduction of sustainability into the EU’s securitization market. The EBA Report concluded that a dedicated framework for sustainable securitization is currently unnecessary, but that the scope of the proposed EU GBS framework should instead be amended to apply to securitizations, subject to various adjustments. In particular, the EBA recommended that the EU GBS requirements should apply to the originator rather than the securitization vehicle and that the Securitisation Regulation be amended to extend voluntary disclosures relating to the principal adverse impact of securitization investments on ESG factors to all. The European Commission is expected to submit a report by June 2022 to the European Parliament and Council on the creation of a sustainable securitization framework, alongside a possible legislative proposal.
Update on Export Finance Lending Policies. Several notable recent developments in export finance have signaled an increased focus on sustainability. In January 2022, the OECD published a new version of the Arrangement on Officially Supported Export Credits which implements, among other changes, a new restriction on export credit and tied aid support for unabated coal-fired power plants - those without operational carbon capture utilization and storage (CCUS). This change closes off all avenues for OECD export finance support for coal-fired power plants without CCUS. In March 2022, the Council of the European Union issued a statement that EU Member States would, by the end of 2023, set their own deadlines for ending export credit support for all fossil fuel energy sector projects. S&C’s memo examining these and other export finance sustainability developments is available here.
ESG Activism Continues to Grow. In Q1 2022, 73 new activist campaigns were launched globally, with the US representing 60% of the new campaigns according to data from Lazard. As both activist campaigns and investor focus on ESG issues become more frequent, it has become increasingly common for activists to incorporate ESG critiques into their theses. For example, Carl Icahn recently launched proxy contests against McDonald’s Corp, and Kroger Co., seeking the appointment of two new directors at each company, based on concerns over the welfare and treatment of pigs, specifically the use of gestation crates in pork production, in the companies’ supply chains. In an open letter to McDonald’s shareholders, Icahn claimed that the McDonald’s board needs more independent directors to push for transparency and progress on the Company’s ESG goals. In Q1, Macellum Capital Management also launched a proxy contest against Kohl’s, seeking the nomination of 10 candidates to Kohl’s 14-member board. Among other critiques, Macellum has criticized the Company for its lack of diversity at the executive level and the recently-settled FTC complaint accusing the Company of greenwashing.
Implications of SEC’s Proposed Climate Rule for Financial Institutions. The SEC’s proposed climate disclosure rule (discussed above) would have particular ramifications on the cost and complexity of financial institutions’ SEC disclosures, particularly considering the significant challenges financial institutions face in disclosing their Scope 3 GHG emissions. The disclosure of Scope 3 GHG emissions, which would capture financed emissions (e.g., emissions from companies to which they provide debt or equity financing) and insured emissions (e.g., emissions of insurance and reinsurance underwriting portfolio), would likely be mandatory for many financial institutions based on the disclosure triggers under the proposed rule. Further, the increased focus of financial regulators on incorporating climate risks into their regulatory and supervisory practices as well as demands from investors and other stakeholders for more information on financial institutions’ climate commitments may lead financial institutions to take climate-related actions (such as undertaking climate scenario analysis, preparing transition plans and setting emissions reduction targets or goals) that would trigger disclosures requirements under the proposed SEC rule. See S&C’s memo analyzing certain key implications of the proposed rules on financial institutions here.
New EU Guidelines on State Aid for Climate, Environmental Protection and Energy Come into Force. The European Commission’s new Guidelines on State Aid for Climate, Environmental Protection and Energy (CEEAG) came into force on January 1, 2022. The CEEAG outline how the European Commission assesses whether to authorise State aid in the energy and environmental sectors granted by EU Member States as compatible with the EU internal market. The guidance informs aid recipients about how to structure and approach publicly financed projects to obtain the required European Commission approval. The CEEAG seeks to align the State aid rules with the new objectives of the European Green Deal of a reduction of 55% net greenhouse gas emissions and carbon neutrality by 2050. One of the ways that the CEEAG does this is by expanding the scope of investments and technologies that Member States can support to cover new areas, such as renewable hydrogen, clean mobility, resource efficiency and biodiversity.