Professions and Financial Lines Brief July 2021: environmental social governance market insights
A summary of ESG developments, including two perspectives of the impacts of Milieudefensie et al v Royal Dutch Shell plc [26.05.21] on financial institutions and insurers – one from the UK and one from the USA; the latest update on sustainability reporting; and the Department for Business, Energy and Industrial Strategy proposals to strengthen the UK’s framework for corporate governance.
Climate litigation is heating up across the board
The recent decision by a Dutch court against Shell (Milieudefensie et al v Royal Dutch Shell plc [26.05.21]) (the Shell decision) has expanded the imposition of positive duties on companies in respect of their future actions.
Until now, climate litigation involving companies concerned compensation for the environmental damage companies have caused. The Shell decision has broken new ground in this regard, as it is the first case that imposes a duty of care on a company’s business and operating model prospectively, rather than focusing on damages caused by past behaviour.
No doubt the Shell decision is likely to increase climate litigation against companies, be it by environmental activists or shareholder action. The legal basis for these claims has widened considerably and moved away from compensation claims for environmental damages to a regulatory and rights-based approach. Losses incurred will also increase. It is estimated that the required cuts in fossil fuel production could cost Shell US$6 billion a year. Hence, climate action has become a major financial risk.
The increase in risk generally and the need for insurers to assess a company’s ESG performance in the underwriting process in view of these developments is clearly self-evident.
Related item: Climate litigation is heating up across the board
Storm clouds ahead: the US Supreme Court sidesteps ESG issues and climate change, while international and other pressures on corporate and D&O disclosures continue to mount
The US Supreme Court is trying its best to sidestep any material rulings on climate change decisions in view of the recent BP P.L.C. et al. v Mayor and City Council of Baltimore judgment and its more recent refusal to review the Chevron Corp. v City of Oakland, California case, wherein the Ninth Circuit held that climate change cases against large oil companies belong in state court.
Although the US Supreme Court has avoided opportunities to tackle climate change issues head on, it recently reviewed the case of Goldman Sachs Group v Arkansas Teacher Retirement System and indicated that companies and directors and officers (D&Os) could potentially be liable under US securities laws with respect to generic aspirational statements a company may make about its conduct if they can be shown to have impacted a company’s share price. It further held that the burden of establishing such statements had no impact on the share price was on the defendants.
In the meantime, international pressure appears to be increasing to hold companies accountable for statements made about climate change. A Dutch court recently addressed the issue head-on by requiring Royal Dutch Shell to reduce its carbon emissions by 45% before 2030. Moreover, pressure on companies to make proper disclosures about carbon emissions will continue to gain momentum in the US through the Securities Exchange Commission’s expected ESG reporting requirements, as well as social accountability, state regulation, and civil and criminal litigation. The combination of these factors require that companies and D&Os more carefully scrutinize any public statements they make addressing ESG-related issues and climate change going forward.
Climate change: sustainability reporting – what insurers need to know
Expectations around the reporting of climate-related issues have grown in recent years, particularly the expectations of investors and other stakeholders. Insurers will be aware of the increasing focus on sustainability reporting which requires companies and financial organisations to assess, quantify and manage climate related risks and to transparently report on such.
Following a 2020 status report by the TCFD indicating more progress is needed to speed up sustainability reporting, the Chancellor has stated that climate-related disclosures (in line with the TCFD recommendations) will become mandatory for large UK companies and financial institutions by 2025.
However, there are currently no agreed global reporting standards and thus no consistency in sustainability reporting. This leads to uncertainty not only for the companies concerned, but also for investors and insurers.
Until consistency in sustainability reporting is achieved, insurers will have to develop an understanding of where the key climate-related risks of their insured organisations lie, and put a financial value on such risks. Failure to comply with climate-related disclosure obligations might serve as a red flag to underwriters as well as potentially leading to regulatory action against an insured for failure to comply with regulatory obligations.
BEIS publishes audit reforms and corporate governance proposals – considerations for D&Os and their insurers
The Department for Business, Energy and Industrial Strategy (BEIS) has recently published its white paper which sets out proposals aimed at strengthening and improving the UK’s framework for audit, corporate reporting and corporate governance systems. The proposals made are with a view to strengthening internal company controls, and are open for consultation until 8 July 2021.
The proposals include a new directors’ responsibility statement requiring D&Os to acknowledge their responsibility for establishing and maintaining adequate internal controls and procedures for financial reporting; an annual review of internal control effectiveness and new disclosures; and a further directors’ statement about the legality of proposed dividends and the effects on the future solvency of the company.
These proposals suggest the conduct of D&Os will be under greater scrutiny, whether via claims by relevant stakeholders or investigations brought by a new regulator with a broader remit. If the proposals are implemented, it is hard to see anything but an escalation in D&O exposures.
Contacts: Dónal Clark and Maya Rubinstein