Global enforcement outlook
Sustainability – an emerging theme
Even throughout the challenges of 2020, environment, social and governance (ESG) issues, such as climate change risks and modern slavery in the supply chain, garnered increasing attention from company boards, regulators, legislators, investors and consumers. This is likely to intensify as the focus shifts towards the recovery and ‘building back better.’
In the US, for example, President Biden has identified environmental protection as a key priority: he plans to create an environmental and climate justice division within the DOJ and will direct the Environmental Protection Agency and DOJ to pursue cases of corporate pollution “to the fullest extent permitted by law and, when needed, seek additional legislation to hold corporate executives personally accountable.”
The impetus for stronger enforcement is also being driven by governments strengthening their own international ESG commitments, exemplified by the unprecedented embedding of net-zero and environmental non-regression obligations in the EU-UK Trade and Cooperation Agreement. COP26 in November 2020 may intensify this pressure.
That said, we are unlikely to see a wave of enforcement action related to ESG issues in 2021. Instead governments and regulators will be busy putting in place mechanisms to drive corporate action in this area and sanction those who fail to meet the standards set.
There’s little doubt the ESG agenda over the past few years has been driven by developments outside the US. But rejoining the Paris climate agreement on President Biden's first day in office shows that his administration has moved tackling climate change to the top of its policy objectives. Over the next four years we can expect more regulation (as well as incentives) to accelerate the US’s move to a lower carbon footprint and deeper engagement in global efforts.
A strong focus on ESG disclosures
Central banks and financial services regulators around the globe are increasingly focusing on how financial institutions manage and disclose climate change risks.
On one level, this new type of regulation is tackling a potentially material risk head on. On another, it is increasing pressure on corporates in the real economy, through their touchpoints with financial services firms, to aid the transition towards a low-carbon economy.
While Europe’s central banks and regulators have the most developed plans for the financial sector so far, there have also been important developments in Asia and the US, with regulators such as the US Commodity Futures Trading Commission and the Hong Kong Monetary Authority turning their attention to climate change risks.
If they are not already doing so, financial services firms should be thinking about the practical steps that they can take to mitigate their risk of ESG disputes. Strong governance and risk management processes around sustainability and ESG, and accurate and thoughtful public disclosures, are a good place to start.
But the increasing scrutiny of companies’ environmental disclosures is not limited to large financial institutions. The EU Non-Financial Reporting Directive (NFRD) requires certain companies to include in their annual reports ESG information, such as their record on environmental protection, diversity and respect for human rights. When transposing the directive into domestic law, some countries, such as Germany, chose to classify false corporate reporting on non-financial issues as a criminal matter.
The NFRD currently only applies to large public-interest companies with more than 500 employees. But in 2020, the Commission consulted on changes to the NFRD, which include expanding its remit to businesses under that threshold.
In the UK, the finance minister announced at the end of 2020 that it will become the first country in the world to require mandatory disclosure of climate-related financial risks across all sectors in line with the recommendations of the Task Force on Climate-related Financial Disclosures.
The UK’s plans mean that mandatory disclosures will apply from next year to all listed commercial companies, UK-registered large private companies, asset managers, life insurers and other occupational and FCA-regulated pension schemes. This will be extended to nearly all large companies by 2025. It’s a major change – and we expect other countries to follow the UK’s lead.
Regulations and action against ‘greenwashing’, where companies make misleading sustainability-related claims about their products and services, are becoming more prominent.
In November 2020, the European Commission launched its New Consumer Agenda, which aims to increase consumer protection against such claims and ensure companies are truly acting on their sustainability commitments. Actions it proposes include greater regulation of company websites and encouraging investigations and enforcement action against companies that fail to comply.
At a national level, the Netherlands’ Consumer and Markets Authority published its final guidance for companies making sustainability claims in January 2021 while the UK’s competition authority is examining how products and services claiming to be ‘eco-friendly’ are being marketed.
The Dutch guidance says that sustainability claims should be specific, clear, accurate and evidence based. While it is not yet clear how the regulator will take action against allegedly misleading claims, the development may serve as a template for other jurisdictions where consumer protection and sustainability issues are also high on the authorities’ agendas.
Supply chain due diligence
Transparency in supply chains has been a focus of lawmakers for some time, with the California Transparency in Supply Chains Act of 2010 and the UK’s 2015 Modern Slavery Act early forerunners of more stringent laws that have followed, such as the French Duty of Vigilance Law.
The EU is set to take this trend forward in 2021 with a proposed directive that would oblige companies to conduct due diligence on human rights, environmental and governance risks within their supply chains.
The European Commission's official legislative proposal is expected in early 2021. According to the European Parliament’s current draft proposal, authorities could – in cases where non-compliance could cause irreparable harm – impose interim orders on the companies. In the most egregious cases, such orders can include measures such as temporarily suspending business operations. The Parliament’s draft proposal also endorses potential criminal sanctions for any serious, repeated non-compliance.
Deforestation in the supply chain is also on the agenda. The Commission consulted on the issue in 2020 and the UK government has proposed legislation requiring larger companies carrying out commercial activities in the UK to assess the risk of illegal deforestation in their supply chains. These companies will also have to publicly report on their efforts, with fines for non-compliance. The UK proposals form part of the Environmental Bill 2019-21, which is expected to be passed in early to mid-2021.
With a proliferation of regulation and more enforcement agencies turning their attention to this area, as well as a growing risk of litigation, an important task for GCs and compliance officers will be to ensure their compliance procedures and controls cover ESG as well as other risks, including potential enforcement.