In a reflection of the growing influence of stakeholders including shareholders, investors, customers and employees, the management of environmental, social and governance (ESG) risks as part of an integrated approach to strategic decision-making and operations is now commonplace for corporate organisations.Regulators globally are placing an increasing focus on the management of sustainability risks, reporting and disclosure. This is particularly the case for so-called 'greenwashing'– where inflated or misleading claims about sustainability credentials are made to attract or retain customers and investors.
Over the past five years, the conversation in boardrooms around the world has centred largely on the duties that corporations have in respect of climate change risks in the context of their ongoing operations and strategies. In the last two years, the focus for regulators has pivoted from issuing various notes and guidance to their regulated markets to enforcing prudent management of sustainability reporting and disclosure using existing legal frameworks.
A number of jurisdictions are also seeking to clarify and codify the obligations on companies to explain how ESG risks are factored into strategic and operational considerations through regulation. It therefore seems inevitable that a wave of enforcement activity will follow in the near future, targeting those entities that embellish their sustainability credentials and reporting and that ignore the clear signals from regulators at their peril.
Recent global developments
On 10 March 2021, the European Union (EU) Sustainable Finance Disclosure Regulation came into force, requiring asset managers, pension funds and insurers to disclose how they consider ESG risks in their investment decisions in order to prevent greenwashing of financial advice.
In February this year, the European Commission released its long-awaited draft regulation on corporate sustainability and due diligence, which appears to be the current high watermark in proposed ESG regulation. The draft regulation has been met with some opposition, with critics suggesting it is not risk-based and may pressure some businesses to simply withdraw from certain markets rather than address the more stringent regulatory expectations. As drafted, it would require businesses to assess the actual and potential environmental and human rights impacts of their operations and supply chains, take action to mitigate and remedy those impacts and communicate these matters publicly. A failure to comply could result in administrative penalties and civil liability.
In July 2022, the Monetary Authority of Singapore released new disclosure requirements for ESG funds, which come into effect from January 2023 and specifically seek to reduce greenwashing risks. This follows an observation by Reuters that there has been a sharp increase in money flowing into funds that promote misleading ESG credentials.
In 2021, following the creation of a Climate, Environmental, Social and Governance Task Force, the US Securities and Exchange Commission (SEC) proposed standardised climate-related disclosure rules for public issuers. The SEC may also require domestic and foreign private issuers to include climate-related disclosures in registration statements and periodic reports.
The UK Competition and Markets Authority published its Green Claims Code in 2021, and has commenced a review of environmental claims in the fashion retail sector. It has signalled a plan to evaluate other sectors in due course, warning that where there is evidence of breaches of consumer law, it may take enforcement action.
Authorities in Germany and the United States have announced investigations into alleged greenwashing claims connected to the promotion of ESG financial products by a large global bank. In May 2022, an investment adviser firm agreed to pay a fine to the US SEC that was associated with allegations that the firm had incorrectly stated all investments in a fund had undergone an ESG quality review when that was not always so.
What does this mean for Australia?
The influence of a stricter global ESG regulatory regime and increasing enforcement activity overseas is likely to flow through to Australian companies, particularly those operating internationally or trading offshore. It also makes the prospect that a similar regulatory framework will be introduced here more likely. There are early indications that the Federal Government may be considering legislation about ESG definitions for investment products in the new year. The Australian Securities and Investments Commission (ASIC) has also suggested that some form of mandatory ESG regulation appears to be inevitable. 1
In the absence of regulation (or while it is under development), Australian boards can look to the standards being mandated overseas for the kind of sustainability measures they should consider incorporating into their decision-making, risk processes and approach to disclosure. At the very least, organisations should adopt the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) as the primary framework for voluntary climate change-related disclosures.
However, the adoption of elevated levels of sustainability-related disclosures comes with increasing expectations on Australian directors to take responsibility for ensuring sustainability-related statements made publicly are truthful, supported by evidence and take into account the material impacts the organisation has on society and the environment.
The duties imposed on directors under section 180 and 181 of the Corporations Act 2001 (Cth) (Corporations Act) require the exercise of care and diligence of a reasonable person in their position and that decisions be made in good faith, for a proper purpose and in the best interests of the company.
Applied to non-financial risk, a director's duty is to take reasonable steps to prevent foreseeable risk of all harm to the company's interests, including its reputation. 2 Sustainability reporting can be a powerful tool in this respect, holding organisations accountable for actions taken to ensure the company fulfils its ESG commitments and ambitions. However, over-statement of sustainability credentials may expose directors to action from regulators, shareholders and activists. Directors must also be alive to the risk of being found to be personally liable under the Corporations Act or Australian Consumer Law (ACL) for disclosures that are false or misleading.
While Australian regulation is not developing at the same pace as overseas, there are signs that this is changing. To illustrate this:
- in November 2021, APRA issued its 'Prudential Practice
Guide: CPG 229 Climate Change Financial Risks';
- in March 2022, ASIC Chair Joe Longo confirmed that
"greenwashing is very much in our
- in June 2022, ASIC's information sheet 'INFO 271: How
to avoid greenwashing when offering or promoting
sustainability-related products' was released, outlining the
existing prohibitions on greenwashing and the regulator's
expectations about how managed funds should avoid it; and
- in August 2022, the Financial Services Council released its 'Guidance Note 44: Climate Risk Disclosure in Investment Management', which similarly targets fund managers and how they can avoid greenwashing.
Enforcement action against directors
Holding directors responsible for false or misleading sustainability disclosures signals an attempt to incentivise decision-makers within companies to tackle climate-related issues in a truthful and transparent way.
A 2022 policy report by the Grantham Research Institute on Climate Change and the Environment and the Centre for Climate Change Economics and Policy into global trends in climate change litigation confirms that cases involving personal responsibility will be on the agenda in the coming year. One notable example of this trend is litigation commenced by activist shareholders overseas who are pursuing allegations that organisations are not doing enough to address climate change, that this is putting the company's long-term value and commercial viability at risk and that directors are therefore acting in breach of their duties. While these claims are unresolved, they suggest that there is an increasing appetite among stakeholders to hold directors liable where they believe the directors are not providing adequate oversight to ensure climate risks are being addressed.
In Australia, while actions have in the past been taken by the Australian Competition and Consumer Commission (ACCC) under the ACL for false representations in respect of sustainability related claims,4 in a recent development, proceedings raising allegations of greenwashing have been commenced by a shareholder advocacy organisation under the ACL. The proceedings challenge the accuracy of the company's net zero emissions target and statements about its proposed actions as part of the energy transition and seek injunctive relief and public declarations to clarify these matters and restrain further publications. The case, the first of its kind in Australia, suggests that shareholder activists may increasingly start to make greenwashing claims themselves, rather than rely on regulatory intervention to test the accuracy and validity of climate-related disclosures.
Shareholders have also sought to rely on section 247A of the Corporations Act to seek access to books that concern the commitments a bank has made in connection with the future funding of thermal coal projects.5 The shareholders are likely to be using this process, which has historically been deployed to scrutinise the propriety of board action, to seek evidence about the extent of board oversight in relation to climate related public commitments. Indeed, in their 2021 Opinion on Climate Change and Directors' Duties for The Centre For Policy Development, prominent Australian barristers Noel Hutley SC and Sebastian Hartford Davis posited that regulators may rely on 'stepping stone' liability to hold directors personally liable for exposing the entity to a risk of contravention which was foreseeable and for facilitating or failing to prevent that risk.
While each company will have a different risk framework to consider, we are strongly of the view that companies (and their directors) should not resile from their duties to consider the impact of sustainability risks on their businesses, as the failure to take proactive steps to identify and mitigate such risks could expose them to significant liability. The focus should now be on ensuring that the related disclosures are fulsome and not misleading – to falter at this juncture would lead to an unfortunate erosion of stakeholder trust and set back the company's sustainability journey.
Key takeaways for Australian directors
Ensuring sustainability reporting and disclosures are accurate, holistic and transparent is not a simple task, and increasing scrutiny in this area will be a challenge that Australian boards must be prepared for.
Attaching climate and sustainability disclosures to future enterprise value poses its own set of challenges in Australia. Boards must exercise caution when making these forward-looking statements. Recent cases illustrate the importance of having a clear, implementable plan to achieve climate-related commitments in particular, in order to demonstrate there is a reasonable basis for the view taken. Similarly, ongoing monitoring of adherence to targets or predictions is essential to avoid a need for corrective statements. Where a departure from the target is identified, negative disclosures should be addressed promptly and directly.
While this will inevitably be challenging, there is a consensus among regulators and industry professionals that transparency is what matters most.
Managing greenwashing risks – DOs and DON'Ts
1 See, for example, Joseph Longo, 'Reflections from the ASIC Chair' (Speech, ASIC, 4 June 2022). Longo alludes to the possibility that Australia may implement mandatory climate disclosures, in light of the steps taken in other jurisdictions, where climate disclosures have been mandated. See also, Karen Chester, 'ASIC update at the Financial Services Council member webinar' (Speech, 16 June 2022). Chester remarks that several jurisdictions 'have already taken steps to mandate climate disclosure', and that ASIC wants 'to make sure Australian companies keep up with international standards for climate disclosure'.
2 See Cassimatis v Australian Securities and Investments Commission  FCAFC 52 at . See also the written opinion of Bret Walker AO SC and Gerald Ng on the current interpretation of the 'best interests' duty by the Australian Courts – The Australian Institute of Company Directors, The content of Directors' "Best Interest" Duty', 24 February 2022.
3 Joseph Longo, 'ASIC's corporate governance priorities and the year ahead' (Speech, AICD Governance Summit, 3 March 2022).
4 See for example Australian Competition and Consumer Commission v Volkswagen Aktiengesellschaft  FCA 2166.
5 Guy Abrahams & Kim Abrahams v Commonwealth Bank of Australia ACN 123123124 (Federal Court, NSD864/2021, commenced 26 August 2021).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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