With growing guidance around climate-related reporting, Schellion Horn, Tom Middleton, Riley Lovegrove and Jessica Alam explore how new rules and standards aim to bring greater transparency but may also lead to additional securities litigation.

Environmental, social and governance (ESG) matters remain high on the agenda of corporates, consumers and regulators worldwide. With new regulation comes increased pressure on firms to disclose climate and sustainability-related metrics. And with new climate reporting guidelines comes new risks, as investors increasingly hold companies to account for their climate actions and reporting.

Climate-related ESG disclosures

Sustainability and climate-related concerns are at the forefront of consumer and investor decisions. Recent studies have found that 74% of consumers in the US care about the environmental impact of the products they buy, have identified a sharp increase in those adopting a more sustainable lifestyle, and have shown consumers growing preferences for sustainability. This is a clear incentive for firms to make more effort to disclose positive sustainability and climate-related activities.

Consumers are not the only interested party: investors are increasingly concerned with creating sustainable portfolios. Preferences for sustainable investments and consumption continue to rise, making climate and sustainability disclosures crucial for consumption and investment decision making.

Companies are being compelled to disclose more ESG-related information by regulators and governing bodies, for example with the introduction of mandatory gender pay gap reporting, requirements to report emissions and carbon reporting regulations, and TCFD reporting.  

Growth of greenwashing concerns

Simply making positive ESG disclosures is not enough, however. Trust is pivotal, with many consumers and investors being concerned about greenwashing. Greenwashing arises from the combination of customer and investor preferences regarding a firm's ESG-related behaviours and activities, and inadequate deterrents in place to accurately discourage inaccurate climate-related disclosures. The term describes companies that either selectively or inaccurately report their climate and sustainability-related activities.

Recently, a variety of new guidance around climate-related ESG reporting has been published to tackle greenwashing and provide stricter guidelines for disclosure.

What is the new guidance on ESG reporting?

In June 2023, the UK Advertising Standards Authority (ASA) announced stricter guidelines for companies promoting their sustainability credentials. The guidance requires the basis of any environmental claim used in advertising to be clear, and requires consideration of the most likely interpretation of consumers. This guidance also cracks down on greenwashing, and proposes adding context to environmental claims. For example the use of terms, such as 'carbon neutral' and 'net zero', should be qualified by accurate information about whether the policy is offsetting carbon emissions or reducing emissions overall.

On 26 June 2023, new rules were set out by the International Sustainability Standards Board (ISSB) with regards to the publication of sustainability and climate-related disclosures, IFRS S1 and IFRS S2. This policy is also supported by the Financial Conduct Authority (FCA), with plans to integrate IFRS S1 and IFRS S2 into the FCA TCFD framework. 

Read an overview of IFRS S1 and IFRS S2 

On 2 August 2023, the UK government announced that there will be rules and disclosure standards set out in the UK Sustainability and Disclosure Standards (SDS), which will be based on those set out in ISSB. The Financial  Reporting Council (FRC) also advocated for increased integration of climate reporting.

Collectively, this new guidance puts pressure on companies to make detailed and evidenced climate-related disclosures in line with the guidance to avoid the risk of directors being held accountable for misleading or false statements.

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Greenwashing falls into litigation scope

With this new guidance, greenwashing becomes in scope for securities litigation. (Securities litigation is a broad term, pertinent to lawsuits filed by investors against listed corporations or professionals on account of fraud or misconduct related to securities.)

Class action suits can be brought under Section 90 and 90a of the Financial Services and Markets Act (FSMA) 2000. Section 90 creates liability for issuers and directors to pay compensation to investors who have acquired a company’s shares and suffered loss due to untrue or misleading statements in or omitted from information published. Claimants must prove, however, that investors have suffered a loss as a result of any untrue or misleading statement in publications; or the omission from the particulars of any matter required to be included by section 80 or 81 of FSMA 2000.

According to FSMA 2000 section 90 (1): "Any person responsible for listing particulars is liable to pay compensation to a person who has a) acquired securities to which the particulars apply; and b) suffered a loss in respect of them as a result of i) any untrue or misleading statement in the particulars; or ii) the omission from the particulars or any matter required to be included by section 80 or 81." This means that those that suffered a loss as a result of misleading or untrue statements or dishonest omission by the issuers of securities, can claim compensation. We note that director knowledge of misstatements and the nature of disclosures must be known in order to bring a claim. In this case, increased regulation leads to more rigorous legislation and requirements against which claims can arise.

Litigation trends around ESG reporting

ESG reporting has previously been the focus of more than 20 ASA enforcement actions related to sustainability and environmental claims, and 13 securities litigation cases under the UK’s FSMA 2000. While the majority of these have been governance or social-related cases, there are now claims before the courts that include allegations of greenwashing and misstatements, and omissions regarding sustainability claims.

Historically, greater scrutiny of ESG reporting has been followed by a rise in claims related to ESG issues, mainly in the form of securities litigation. Guidance updates have the potential to lead to the same trend.

On top of the trend of increased litigation following ESG policy tightening, investors have increased preferences towards sustainability measures. Hence it could be easier to argue that disclosures could be materially relied upon for investment decision making. This further enhances the potential risk of ESG-related securities litigation and gives rise to the opportunity for investors to hold companies to account for their sustainability-related claims should they prove false.

Growing incentive to hold companies to account

Investors benefit directly from supporting securities litigation actions through damages and this incentivises compliance with ESG regulations to avoid such claims being brought.

With increased requirements, scrutiny and accountability under the proposed regulatory changes, litigation funders have an attractive opportunity to act as a third party and take advantage of companies with reputations to uphold who fail to meet the new standards, as there remains a financial incentive to fund these disputes. However, following the Supreme Court's PACCAR decision, funding agreements must be enforceable under English law.

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Getting support with new guidance and risks 

With investor and consumer preferences shifting towards more sustainable firms, for those that do not abide by the guidance and increased reporting requirements, the risks are twofold. Firstly, losing the trust and business of sustainability-conscious customers. Secondly losing the trust and backing of investors, following a corrective disclosure for misleading statements in breach of the FSMA 2000.

In the latter case, any false or misleading disclosures made which breach FSMA 2000 could lead to artificial inflation of the share price of public traded companies. When discovered, harm can arise due to a fall in the share price as this artificial inflation is unwound.

Companies may need help to quantify this harm in the context of securities litigation, as well as support to navigate the complex regulatory changes and avoid falling foul of the evolving guidance.

For more insight and guidance, contact Schellion Horn or Tom Middleton.

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