ESG disclosure investigations – Are you ready?

This article explores how the proliferation of ESG and climate-related disclosure requirements has focused regulatory minds on enforcement in relation to sustainability claims and how investigations in the area are on the rise globally. Please refer to our ESG blog here for previous instalments in this series.

The general landscape

Listed companies across various sectors and industries are grappling with how to manage and disclose ESG issues, particularly relating to climate. These issues include:

• Accounting for carbon and other greenhouse gas (GHG) emissions of their business, suppliers and value chain partners.
• Considering the downstream effects of their products and services.
• Integrating energy transition plans and climate targets into their business strategy.
• Deciding how best to communicate these plans and targets and their progress in relation to them, to all their stakeholders – shareholders, consumers, employees, lenders, investors and the wider public.

This communication of ESG targets and performance is attracting considerable interest from regulators tasked with managing and enforcing increasing levels of mandatory disclosures on ESG factors, climate change and GHG emissions. This has changed regulators' approach to greenwashing and enforcement in relation to sustainability claims and regulatory investigations into ESG disclosures are rising globally.

Disclosure requirements underpinning regulatory investigations

Risk of regulatory investigation has increased, alongside the development of various mandatory disclosure regulations and voluntary frameworks across the globe, trends that look likely to continue.

To date, the EU has led the charge by developing various mandatory ESG disclosure regulations. These include:

• The Corporate Sustainability Reporting Directive (CSRD), which requires companies domiciled or operating within the EU, and above a certain size threshold, to report on a broad range of sustainability-related matters, including climate-related targets, policies, governance and progress in their business and across their value chain.
• The Sustainable Finance Disclosure Regulation (SFDR), which requires asset managers to disclose the extent to which they consider ESG and climate factors in their entity-wide strategies and each of their funds.
• The EU Taxonomy Regulation, which classifies all economic activities according to their contribution to six environmental objectives, with this classification feeding into various disclosures made by companies.
• The upcoming Corporate Sustainability Due Diligence Directive (CS3D), which will require companies domiciled or operating within the EU, and above a certain size threshold, to conduct mandatory due diligence with respect to human rights and the environment in relation to their business and across their value chains.

We have also seen the development of international voluntary disclosure frameworks, including the Task Force on Climate-related Disclosures (TCFD), which is mandatory for UK listed entities; the Task Force on Nature-related Disclosures (TNFD); and the International Sustainability Standards Board's (ISSB) standards for broader sustainability-related disclosures. These standards have been developed to facilitate companies in establishing methodologies of assessing their impact on (among other things) the climate and environment, and vice versa.

In the US, the Securities and Exchange Commission (SEC) has proposed new rules that would require US listed companies to provide significant climate-related disclosures in their filings and audited financial statements. These proposals are partially modelled after the TCFD framework and GHG Protocol, with final rules pending. In California, two recently signed laws require some private and public US formed business entities to make significant disclosures regarding GHG emissions and climate-related financial risks, including reporting of indirect emissions.

In Australia, the federal government is finalising a mandatory climate reporting regime, which will be based on the ISSB’s standards and apply to Australia’s largest companies from 1 July 2024, with a phased introduction to other companies over the following three years.

You can read more about the development of international sustainability disclosure regulations here.

Potential avenues of investigation

Markets regulators have the role of ensuring clean markets and that disclosures are made correctly and on time. Due to increasing ESG disclosure requirements for companies across the globe – and the resulting increase in data available to stakeholders – regulators are looking to ensure these disclosures are done correctly, using the array of tools at their disposal. This may range from making compulsory requests for information to threatening or taking enforcement action.

Where companies appear to have missed the mark on disclosures, two primary avenues of investigation may be pursued by regulators:

• Non-compliance and/or inadequate disclosures: Regulators will consider companies' adherence to relevant listing and disclosure rules, and other relevant mandatory climate-related disclosure obligations. Regulators may consider the (i) adequacy of companies' disclosure systems, procedures and controls, (ii) existence of any false, misleading statements or omissions, and (iii) completeness of relevant disclosures in companies' annual reports.
• Market manipulation: Regulators will increasingly scrutinise public statements that may impact company stock price, including false or misleading statements or omissions made in annual reports, company websites, adverts and other media. Indeed, the EU Parliament and Council have reached provisional agreement on new rules banning misleading advertisements in relation to greenwashing that Members of the European Parliament are expected to vote on in November 2023.

Findings of wrongdoing following either of these avenues of regulatory investigation could lead to a wide range of consequences on the affected companies, including fines, public censure, restitution orders, public restatements and suspensions from trading, and significant reputational harm.

While beyond the scope of this article, there is a significant interrelationship between regulatory findings and potential litigation claims, with each acting as a catalyst for the other and the underlying facts leading to action in both arenas.

When considering their risk exposure in this area, companies should remember to check how their insurance might respond to such scenarios. For example, does current insurance have adequate limits or sub-limits for defence costs or investigation costs or, in the event of a claim against them, does the company need to consider making a notification to its insurers?

Enforcement so far – Case studies

Different regulators are at different stages in their ESG journeys, but the severity and frequency of regulatory investigations is expected to rise globally.

Case studies focusing on the approaches taken by regulators in the UK, Australia, and the US are set out below.