Long before environmental, social, and governance ("ESG") entered the corporate world's vernacular, these principles were very much present in various aspects of project development and in the policies and procedures of owners and investors. ESG in project finance has always been key to understanding risk, due to the long-term nature of the investment. Now, the increased prominence of ESG presents a new dimension of investment, credit, and even reputational risk for a range of projects, from infrastructure to energy assets.
A report released by S&P Global Ratings in 2020 confirmed that lenders and investors financing projects face similar, and in some cases more pronounced, ESG risks as compared to traditional companies.1 With ESG at the forefront, companies bear responsibility not only to their shareholders, but also to the public and the planet. A focus simply on the "bottom line" of short-term profitability and shareholder returns is not tenable. Since projects are long-term investments in the infrastructure, industry, or public services of a community, investors must consider the long-term stability of a project and its effects on a broad set of stakeholders, including employees and local communities. Projects depend on buy-in from the local community and adaptability in light of pressing climate risks and changing regulatory environments. ESG risks are particularly pronounced for projects related to fossil fuels and coal power, where new and anticipated regulations could constrain operations and impact viability, ultimately undermining their long-term investment rationale.
Public policies increasingly favour investments in energy and infrastructure projects that further environmental and social justice goals by mitigating the impacts of climate change, de-carbonising the energy and transportation sectors, and improving both clean drinking water supplies and digital broadband connectivity in historically underserved or low-income communities.2
At the same time, investors and shareholders are demanding greater ESG transparency and accountability by means of ESG risk assessment, measurement, and reporting to better understand and address the impact of their investments. This is evidenced by the recent shakeup at Exxon, where an activist hedge fund proposed an alternative slate of Exxon directors and, with the aid of proxy advisors, institutional investors, and fund managers focused on ESG concerns, gathered enough votes to seat two directors who they expected to affect corporate policy to better mitigate and manage the climate change impacts facing the energy sector.3
Project companies increasingly leverage interest in ESG to maximise opportunities to obtain financing or to obtain favourable financing terms. ESG is a key consideration and top of mind for investors, according to a study conducted by Harvard Business Review of 70 senior executives at 43 global institutional investing firms, including the three largest asset managers – BlackRock, Vanguard, and State Street.4 In fact, ESG investing has been seeing record growth in 2021, and the head of BlackRock's iShares has predicted that ESG-driven investing will grow to $1 trillion by 2030.5 To meet this investor interest, there has been a proliferation of green and sustainability bonds and other ESG financial instruments. Project companies and investors of these instruments should use tailored ESG reporting frameworks that take into consideration the risks and opportunities specific to their project.
2. ESG Considerations and Risks for Investors, Lenders, and Project
The three factors of ESG – environmental, social, and governance – describe considerations that go beyond traditional financial criteria and relate to sustainable growth, environmental and social impacts, and the governance arrangements of the project company. There are other terms used to express similar ideas to ESG, including the "triple bottom line" (also known as the "three Ps", which are profit, people, and planet), "corporate social responsibility", and "socially responsible investment". In project finance, although the term ESG is not always used, it is highly present in various aspects of project development and in the policies and procedures of owners and sponsors. For example, since 2003, many financial institutions (including banks) have implemented a risk management framework known as the Equator Principles for determining, assessing, and managing environmental and social risk in project finance.6 As of November 2021, more than 125 financial institutions have adopted the Equator Principles. The purpose of the Equator Principles is to promote sustainable environmental and social performance, which can lead to improved financial, environmental, and social outcomes for projects. The Equator Principles are primarily intended to provide a minimum standard for due diligence to support responsible decision-making based on the careful assessment of risk, and can trigger a need to conduct certain actions to provide a remedy for or offset any environmental or social issues identified. The Equator Principles apply across industry sectors, including renewable energy, and have helped spur the development of responsible environmental and social management practices in the financial sector and banking industry.
Characteristics of Project Financings that Enhance ESG Risks
Project financings have particular characteristics that provide protections to creditors – such as all-assets pledges, structures, and covenants to reduce volatility in project cash flows and waterfalls prioritising debt servicing over equity distributions – that allow project companies to have higher leverage ratios than traditional companies while maintaining similar credit quality. Nevertheless, project finance lenders and investors are exposed to similar or enhanced ESG risks. Projects that involve infrastructure and construction work can have effects on the environment and require interactions with local stakeholders. Costs associated with compliance with environmental regulations and coordinating with local communities can be high throughout the life of a project and may impact projected cash flows in the operations phase of a project. To the extent that project risks are allocated to third parties, reducing commercial and technical risks, a credit analysis should identify the extent to which those third parties may be exposed to ESG risks that could affect costs, revenues, or supply chains.
ESG issues are important for debt and equity investors in project companies. Failure to properly address these issues can adversely impact the development and performance of projects vulnerable to ESG risks and weaken a project company's credit position and profitability. ESG factors can also create financing and refinancing challenges for projects, since their asset life is uncertain, particularly considering new environmental regulatory pressures.
For example, S&P and Moody's both cited ESG factors as key drivers in rating the debt of the operator of a coal plant in West Virginia, noting that as investors increasingly shy away from coal projects, it has become difficult to attract additional capital or arrange an extension or refinancing of existing debt facilities. In 2022, Moody's continued to highlight the operator's overall weak credit position in light of risks associated with decarbonisation and the energy transition, anticipating federal regulatory policy that could adversely impact the coal sector in general and the coal plan in particular, and increasing investor concerns relating to ESG factors, all of which had a highly negative impact on the operator's rating.
Negative social and governance events led S&P to downgrade debt issued by an owner and operator of a highway project under construction in Lima, Peru to speculative grade due to the resulting erosion in the risk profile of the project. From a social perspective, protesters destroyed a new toll plaza facility over concerns of toll charges and their impact on wealth inequality and affordability. Subsequently, the municipality of Lima suspended toll payments at the facility, which resulted in a loss of revenue. From a governance perspective, one of the company's sponsors had been involved in a probe for paying bribes in Latin America to win concessions. The project's relationship to this sponsor carried reputational risks, which in turn affected its ability to secure additional financing.
Environmental, Social, and Governance Considerations in Project Finance
ESG considerations are relevant to all types of large, long-term infrastructure projects, from highways and bridges to energy projects (including renewable energy projects), rail lines, and water or water treatment facilities. Additionally, all three ESG factors can be interrelated and sometimes inversely related given the complicated impact that actions in one factor may have on the other factors. If a coal power plant is shut down for environmental reasons, for example, there can be cascading impacts on social issues if the shutdown results in layoffs and unemployment for local communities.
Environmental considerations have always played a central role in project development, including those related to the siting of projects and proper disposal of materials after a project is decommissioned. The "E" can also overlap with the "S" in the areas of local community relations, environmental justice, preservation of archaeological and cultural resources, and Indigenous rights.
- Project siting impacts may be temporary or permanent in nature. For example, the siting of temporary construction access roads may disturb wetlands or other sensitive habitats. Other impacts may be more permanent, such as harm to protected species. Projects and associated infrastructure (such as transmission lines for energy projects) can require a large amount of acreage, which is often agricultural or previously undeveloped land. Project development can require tree clearing, regrading of the land, and dredging/filling of wetlands. Temporary or permanent access roads or staging areas need to be placed, and ground disturbance such as excavation and filling for foundations must occur. These activities may disturb the habitat of a variety of wildlife depending on location, such as fish and other aquatic species for hydroelectric dam projects, and in some instances, projects may result in intentional or incidental animal death. Also falling under the umbrella of environmental are impacts to safe airspace travel; some types of projects can cause sight hazards or disrupt flight patterns for aircraft, especially if located in proximity to an airport, and have the potential to disrupt national air defence networks. In many jurisdictions, a project will be required to comply with a statute, such as the National Environmental Policy Act in the United States, that can trigger the need for a comprehensive review before issuance of certain permits or other governmental action. These laws can require that a project company thoroughly review the environmental impacts of the proposed project and mitigate those impacts to the extent possible. Project companies should be mindful to comply with all other environmental laws, including those that regulate sensitive resources such as wetlands and protected species.
- Community relations, cultural resources, and Indigenous rights are critical aspects of determining how and where a project should be sited. ESG reflects an increasing social awareness of the impacts a project may have on the surrounding community. For example, if a project is located in proximity to important cultural or Indigenous resources, sovereignty concerns should be assessed and mitigated, with Indigenous community involvement throughout the process. The Equator Principles specifically require that all projects affecting Indigenous Peoples will be subject to an informed consultation and participation process and must comply with the rights and protections for Indigenous Peoples contained in relevant national law, including laws implementing host country obligations under international law.7 Appropriate mitigation can include performing studies and surveys of the area and preparing mitigation and preservation plans.
- The concept of environmental justice more broadly strives for the fair treatment of all people when considering the siting of projects. There are legitimate concerns regarding project siting near vulnerable communities and the associated risks of pollution and disturbances resulting from noise, runoff, excavation, and other features of project operation and development. This is compounded when a community already has several similar projects within its borders. Projects are almost always subject to an approval process that requires an opportunity for public comment, which can raise these concerns and result in a better project with fewer community impacts.
- Proper disposal of materials at the end of the project life cycle is an oft-overlooked project consideration. Decommissioned project components must be disposed of in ways that preserve the health and safety of the physical environment and of individuals and communities. The Equator Principles can trigger the need for a decommissioning plan, even if not required by a host country's laws.
The social aspects of project finance encompass labour and human rights, supply chain considerations and the ethical procurement of materials, and diversity, equity, and inclusion ("DEI").
- Labour and human rights considerations include improving working conditions, addressing work stoppage risks, preventing modern slavery, and preventing the acquisition of materials from industries or jurisdictions identified as being vulnerable to labour exploitation and forced labour in violation of international standards. Child labour, slavery, and general compliance with employment and fair wage regulations are a few examples of risks that should be mitigated or avoided, including by contractual means.
- Supply chain considerations arise during the procurement of materials for a project. Project companies should conduct supply chain due diligence to understand the business and employment practices of their vendors and suppliers and ensure that materials are not sourced from environmentally fragile locations or using illegal or unethical employment practices. Enhanced supply chain due diligence should be implemented when procuring materials from countries where human rights and forced labour issues are prevalent, or from suppliers that source inputs from such countries. A resource for identifying goods produced by child or forced labour is the U.S. Department of Labor's ("DOL") List of Goods Produced by Child Labor or Forced Labor.8
- DEI measures should involve the representation and participation of a diverse workforce across all levels of a project up to leadership. DEI considerations have not traditionally been a focus in project financing, but diversity can strengthen a project company's reputation and bring in different perspectives and ideas. When diversity is coupled with equity and inclusion, it has been shown to drive innovation and produce better outcomes through increased productivity and profitability. Project companies can demonstrate this commitment through onboarding and developing diverse talent internally. Project companies are also able to mandate certain diversity standards and guidelines when they hire outside vendors, such as construction companies, engineers, and attorneys.
"Governance" is a term that has an increasingly broad reach, encompassing not only traditional notions of corporate governance, but also the structures in place to manage significant areas of risk for the project company, such as transaction requirements imposed by lenders and sponsors, cybersecurity and data privacy, anti-corruption, and trade compliance.
- Corporate governance relates to the composition and procedures of supervisory bodies. Additional considerations include proper separation of a project company with the sponsor or holding company. An important feature of corporate governance is regulatory compliance and the maintenance of compliance policies, procedures, and controls designed to promote compliance with relevant laws and regulations and mitigate risks associated with the jurisdiction, sector, and operations of the project.
- Transaction requirements can include information disclosures and reporting requirements. Investors may build these requirements into project financing documentation to improve transparency and strengthen the integrity of a project. Such requirements may include documentation that will allow financial institution investors to verify the identity of project company borrowers and their beneficial owners, pursuant to their obligations under anti-money laundering laws. Transaction governance can also include internal processes to manage the proceeds of green or sustainability financing and track the allocation of funds.
- Cybersecurity and data privacy issues, if not addressed, can pose significant operational and financial risks, and can halt an entire project. Project companies should review their corporate security and business continuity plans and invest in strengthening their data and cyber protection and resiliency systems. They can look to guidance issued by the White House,9 the U.S. Federal Trade Commission,10 and the U.S. Securities and Exchange Commission ("SEC")11 to understand what is considered reasonable cybersecurity practice. Proposed rules issued by the SEC on February 9, 2022 include requirements for the reporting of material cybersecurity incidents, cybersecurity and the maintenance of procedures to minimise user-related risks, all intended to prevent unauthorised information and systems access and to address cybersecurity incident response and recovery.12
- Ethics and anti-corruption strategies should promote accountability, transparency, and integrity, both internally and externally with customers, suppliers, and third-party agents. Project companies, particularly project companies with meaningful non-U.S. dealings and interactions with foreign governments, including through suppliers or distributors, should be mindful of their obligations under the U.S. Foreign Corrupt Practices Act and other anti-corruption laws and should develop policies and procedures to promote ethical behaviour and prevent bribes and other corrupt payments.
- Trade compliance considerations related to sanctions and import/export controls may restrict a project's ability to engage certain customers, suppliers, distributors, or other counterparties, or to import certain raw or finished materials. For example, in recent years, the U.S. Department of the Treasury's Office of Foreign Assets Control ("OFAC") has imposed blocking sanctions on a number of Chinese individuals and entities in connection with forced labour and human rights abuses in the Xinjiang province of China.13 Also, Congress passed the Uyghur Forced Labor Prevention Act in December 2021, creating a rebuttable presumption that goods manufactured, wholly or in part, in the Xinjiang province are produced through forced labour, therefore barring their release by U.S. Customs and Border Protection from U.S. ports of entry.14 Solar project companies, which rely on silica as a raw material in the production of solar panels, should be aware of these restrictions and implement appropriate diligence and screening procedures. Additionally, in response to Russia's invasion of Ukraine, the United States has imposed a number of sanctions measures targeting certain Russia individuals and entities and dealings involving certain sectors. The United States has also prohibited U.S. persons from engaging in any new investment activity in Russia, directly or indirectly. Investors will have to be mindful of these restrictions in relation to projects in Russia or involving Russian counterparties.15
3. Financial Instruments for ESG Investment in Projects
There are a number of financial instruments available to project companies engaged in ESG activities. These include green, social, and sustainability bonds, whose proceeds are linked to ESG activities, as well as sustainability-linked bonds, whose financial terms are linked to ESG metrics.
Green Bonds, Social Bonds, and Sustainability Bonds
Green, social, and sustainability bond financing are activity-based bonds that link the proceeds of the financing or refinancing provided to project companies to ESG activities, such that project companies must use the proceeds in a manner that meets the criteria of a "green" or "social" activity, or a mix of the two for sustainability bonds.
The eligibility of projects to qualify for this type of financing can be based on a multitude of frameworks, including the International Capital Market Association's ("ICMA") Green Bond Principles,16 Social Bond Principles,17 and Sustainability Bond Guidelines.18 The four core components for alignment with these principles are related to the following: (i) use of proceeds; (ii) process for project evaluation and selection; (iii) management of proceeds; and (iv) reporting.
Use of Proceeds and Project Selection
Green bonds are instruments where the proceeds are used solely to finance projects with environmental benefits. They can include projects in renewable energy, energy efficiency, land and water management, biodiversity conservation, clean transportation, pollution prevention and control, and climate change adaptation. The proceeds for social bonds, meanwhile, finance projects that address a social issue by mitigating social harms or attempting to achieve positive social outcomes. Such projects can seek to improve a community's access to, or the affordability of, essential services, housing, infrastructure, employment, and food, and may be aimed at socioeconomic advancement and empowerment. Sustainability bonds are bond instruments whose proceeds are used to finance a particular goal (such as decarbonisation) or a combination of "green" and "social" projects.
Proceeds Management and Reporting
Project companies issuing these types of bonds should implement an internal process to manage the proceeds and for reporting on uses of proceeds. Issuers should report on the use of bond proceeds by describing the projects and their impact, at least on an annual basis. It is recommended that issuers use both qualitative and quantitative performance indicators. For projects where the actual impact cannot be calculated until projects are completed and operational, which may not be at bond issuance, issuers can report on the estimated impact of their projects. This is common for social projects like the construction of affordable housing or healthcare facilities. Green bonds are generally certified at issuance by an independent third party. Of late, credit ratings agencies are introducing ratings methodologies for debt that is intended to be sustainable or to meet the green or social goals of the issuer.
For green bonds, the Harmonised Framework for Impact Reporting,19 developed by multilateral development banks and international financial institutions, lays out principles and recommendations for impact reporting. Harmonised frameworks have been released for energy efficiency and renewable energy projects, sustainable water and wastewater management projects, sustainable waste management and resource-efficiency projects, clean transportation projects, green building projects, biodiversity projects, and climate change adaptation projects. The frameworks offer sector-specific recommendations for reporting, including core principles, metrics, and indicators for reporting. For example, the suggested core indicators for renewable projects include: (i) annual greenhouse gas emissions reduced or avoided; (ii) annual renewable energy generation; and (iii) capacity of renewable energy plants constructed or rehabilitated. The frameworks do not dictate a single commonly used standard for the calculation of indicators, and issuers may follow their own methodologies. Issuers are encouraged to use this guidance to develop their own reporting that is adapted to their own circumstances and their own approaches to the management of proceeds.
For social bonds, a working group has been established to develop a harmonised framework. The outcome of the working group is a document that sets out principles for reporting.20 In addition to reporting on the use of bond proceeds and on the expected impacts, issuers are encouraged to identify the target populations for which the project is expected to result in positive socioeconomic outcomes, and why the selected target population is considered underserved or vulnerable. For projects addressing broad social issues that impact the general population, like health issues and water supply, issuers are still encouraged to identify any particular segments of the population that are expected to especially benefit from the project.
In addition, multilateral organisations have established internal standards for their financing of "green" projects. For example, green bond financing by the International Finance Corporation ("IFC"), a member of the World Bank Group, may include investments in the following types of projects: (i) investments that result in a reduced use of energy per unit of product or service generated; (ii) investments that enable the productive use of energy from renewable resources such as wind, hydro, solar, and geothermal production; (iii) investments to improve industrial processes, services, and products that enhance the conversion efficiency of manufacturing inputs, like energy, water, and raw materials, to saleable outputs; (iv) investments in manufacturing of components used in energy efficiency, renewable energy, or cleaner production; and (v) investments in sustainable forestry.
In addition to meeting green bond eligibility criteria, any project financed through green bond proceeds must also meet the IFC's investment process, which includes rigorous due diligence, including disclosure and consultation requirements and integrity due diligence using the IFC's Environmental and Social Performance Standards21 and Environmental, Health and Safety Guidelines.22 Projects must also comply with IFC's Anti-Corruption Guidelines, with potential penalties for entities engaging in fraud and corruption being sanctions and debarment from financing from the IFC and other international financial institutions and multilateral development banks.23
Sustainability-linked bonds are performance-based bond instruments, for which proceeds can flow to general corporate activities, unlike with green, social, and sustainability bonds. Instead, the interest rate, payment, or other financing terms are linked to ESG factors and may be adjusted if certain sustainability performance targets are met. Sustainability performance targets are tracked by key performance indicators, which should be measurable and reportable, such as emissions reductions.
The Sustainability-Linked Bond Principles,24 also developed by the ICMA, can be used to determine eligibility for sustainability-linked bonds. These principles have five core components related to: (i) selection of key performance indicators; (ii) calibration of sustainability performance targets; (iii) bond characteristics; (iv) reporting; and (v) verification.
Accordingly, project companies issuing sustainability-linked
bonds should implement internal processes and procedures to ensure
proper monitoring, disclosure, and verification of key performance
indicators. Projects should report on key performance indicators
regularly, and in any case for any date or period that may be
relevant for assessing the status of sustainability performance
targets that are established as trigger events leading to a
potential adjustment of the bond's financial or structural
4. Frameworks for Accurately Assessing Whether a Project Meets ESG Standards
As noted above, there is significant investor appetite for understanding and measuring the ESG benefits and risks of a project. There is a plethora of frameworks that project companies can use or take inspiration from to identify relevant and material indicators for reporting on ESG metrics. They include international agreements and standards adopted by countries, such as the UN Sustainable Development Goals ("SDGs"), which establish 17 political goals related to peace, climate action, affordable and clean energy, clean water and sanitation, infrastructure, ending poverty, and reducing inequality, among others. The SDGs are defined by 169 targets that are tracked by 232 indicators.25 The Paris Agreement was formed by 197 countries with a goal of reducing the increase in global average temperatures to 1.5 degrees Celsius and has been reinforced by subsequent international agreements, most recently at COP-27 in Sharm El-Sheikh, Egypt in November 2022.26
The UN Principles for Responsible Investing ("PRI") is an initiative of the United Nations with large institutional investors that lays out six principles for responsible investments relating to the incorporation of ESG issues into investment analyses, decision-making processes, ownership policies and practices, and disclosures from the entities in which they invest.27 PRI, in collaboration with the UN Global Compact and UN Environment Programme, has also issued practical guidance on the integration of ESG into investment analyses and decisions. The UN Guiding Principles on Business and Human Rights, voluntary principles adopted by the UN Human Rights Council, set forth the responsibility of companies to respect human rights and provide a remedy when adverse impacts occur.28
Project companies can also look to guidance or tools such as those developed by the Global Reporting Initiative ("GRI"),29 Sustainability Accounting Standards Board ("SASB"),30 and Task Force on Climate-Related Financial Disclosures ("TCFD").31 Both the GRI and SASB have published sets of universal standards that provide guidance on disclosures across companies, as well as sector-specific standards that account for the sustainability context of a particular sector. The SASB has developed a set of 77 sector-specific sustainability accounting standards, which identify financially material sustainability topics and their associated metrics for a typical company in that sector. Recently, in August 2022, the Value Reporting Foundation, which houses the SASB, completed its consolidation with the Climate Disclosure Standards Board to form the International Sustainability Standards Board ("ISSB").32 The ISSB aims to combine existing disclosure frameworks and develop an integrated, comprehensive baseline that would make it easier for companies to distil and report information to investors.33 The Financial Stability Board established the TCFD to develop recommendations for more effective climate-related disclosures that could inform investment, credit, and insurance underwriting decisions, and enable investors to better understand climate-related risks to a company and its counterparties, including its suppliers. Project companies can also rely on benchmarks and data houses such as S&P Dow Jones Indices that supply datasets providing industry-specific and financially material ESG opportunities and risks.34
Each project company should consider the most appropriate
framework that is tailored to its activities. Ultimately, though,
the metrics that a project company adopts will inevitably reflect
what its investors are demanding.
5. Mechanisms to Manage and Mitigate ESG Risks
There are a multitude of positive effects on the "triple bottom line" when project companies, sponsors, lenders, and investors take ESG seriously during project development and funding. There can also be risks associated with the failure to properly apply ESG metrics to a project. Investors and lenders may choose to decline to fund projects that do not place emphasis on ESG. There can be impacts to credit quality – positive or negative – caused by reviewing a project against ESG standards. For example, in the energy industry, a renewable energy project may receive a more favourable credit rating, while projects producing or using fossil fuels may receive a worse rating due to uncertainty around future regulatory policy or environmental impacts. Project location may also receive heightened scrutiny, and construction in areas vulnerable to extreme weather events may require higher liquidity reserves and insurance policies. For projects that are less resilient or have higher ESG risks, insurance may become more expensive or less available.
The lack of a unified conceptualisation and parameters for ESG and the variability of ESG factors by sector and by location has led to challenges within ESG reporting. Since projects can involve a wide variety of sectors, harmonisation of metrics and comparability and reliability of reporting is an issue. In the current formal regulatory vacuum, it can be difficult to choose which ESG framework to apply and understand how to properly assess ESG metrics. Other contributing factors are the voluntary nature of the frameworks, difficulties of monitoring and measurement, and the absence of mandatory external auditing and verification.
Further, ESG is not a static concept. ESG considerations and evolving ESG standards are fundamentally a reflection of the present zeitgeist, and the current events that inform policy objectives, the interests of consumers and investors, and technological developments. The field of ESG is just as complicated and nuanced as the world that informs it. As these features evolve and change, so do the factors that make up ESG and the methods of assessing their interconnectedness.
These challenges have made ESG reporting susceptible to "greenwashing", where some companies overreport sustainability, cherry-pick metrics, or otherwise engage in an inaccurate portrayal of ESG practices to look better to investors or to qualify for funding. In a noteworthy example, in April 2022, the SEC charged Vale, a Brazilian mining company and one of the world's largest iron ore producers, with making false and misleading claims about the safety of its dams prior to the January 2019 collapse of its Brumadinho dam, which killed 270 people and caused immeasurable environmental and social harm.35 The SEC alleged that Vale intentionally misled investors through its ESG disclosures in which it made assurances that the company adhered to the "strictest international practices" in evaluating dam safety and that one hundred percent of its dams were certified to be in stable condition. Proposed new ESG disclosure requirements under securities laws and the establishment of more objective, consistent standards for claimed environmental attributes or other ESG metrics may address this complex issue.
Another concerning trend involves companies that engage in "brownwashing", which has taken on different meanings. It could mean investors that are betting against ESG and acquiring fossil fuel assets at discounted prices relative to projected cash flows. The term has also been used to describe companies that sell fossil fuel assets to private equity funds or other buyers so that their balance sheets appear greener to consumers or investors. "Brownwashing" may also refer to companies underreporting their ESG credentials, which may be intentional or may be due to a lack of understanding of ESG issues or inadequate management of ESG monitoring.
While approaches to ESG reporting remain in flux, investor demand for "consistent, comparable, and decision-useful" disclosures related to ESG risks remains strong, as has been highlighted by SEC Chair Gary Gensler.36 Taking heed of these demands, on March 21, 2022 the SEC released its proposed rules on climate risk disclosures, which amend and build upon existing climate change disclosure rules and guidance and seek to enhance and standardise disclosures on climate-related risks that are like to have a material impact on a public company's business and financing performance.37 In crafting the Proposed Rules, the SEC took guidance from existing third-party frameworks, standards, and metrics, principally the TCFD and standards for accounting and reporting on greenhouse gas emissions established by the Greenhouse Gas Protocol. The SEC has missed its self-imposed deadline to finalise the rule by October 2022 due to the large volume of comments received and a technical glitch in its online comment system that required the reopening of the comment period for the rule; the rule is now expected to be finalised sometime in 2023.38 The DOL, on November 22, 2022, published a final rule allowing plan fiduciaries to consider climate change and other ESG factors in their selection of retirement investments.39 In the United Kingdom, the U.K. Financial Conduct Authority recently published a Consultation Paper (CP22/20) with proposed rules aimed at addressing greenwashing that would standardise and qualify specific sustainable investment labels, with an intent to publish a final rule by June 30, 2023.40 In response to investor demand for harmonisation, there have also been efforts to develop a common reporting framework by the World Economic Forum, the Big 4 accounting firms, the GRI and SASB.41
Yet, over the past year, another trend has been emerging in the United States: a counter-reaction to companies' increasing normalisation of ESG reporting. Vocal critics have framed ESG efforts as a type of stakeholder capitalism that injects politics into the decision-making processes of corporations and shifts the focus away from maximisation of shareholder profits and raising questions about the future of the SEC's Proposed Rules.42
With these considerations in mind, project companies should take steps to leverage opportunities and mitigate risks by understanding the ESG considerations of a project from the very beginning of the development and procurement process. Site selection and initial design and engineering should reflect ESG goals and risks, for example by intentionally choosing to site a project in a location that would not adversely affect vulnerable communities or environmentally sensitive areas and that would be more resilient to extreme weather events. Investors and lenders who embrace ESG goals should create a contractual framework to hold project companies accountable and encourage the incorporation of ESG into project development. Increased transparency, verification, and reporting will be important to maintain a robust market for green, social, and sustainability bonds and other financial instruments and to bolster the integrity of market standards for project financings in the future.
1. Gregg Lemos-Stein, et al., General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, S&P Global Inc. (March 9, 2022), available at(Hyperlink) Diego Weisvein, How ESG Factors Have Begun To Influence Our Project Finance Rating Outcomes, S&P Global Inc. (January 27, 2020), available at(Hyperlink)
2. See, e.g., H.R. 3684 – Infrastructure Investment and Jobs Act, Public Law No. 117-58 (passed into law November 15, 2021), available at(Hyperlink)See also Allan Marks, Biden Signs Infrastructure Law: Here's How It Will Streamline $1 Trillion in Spending, Forbes (November 16, 2021), available at(Hyperlink)
3. Jennifer Hiller and Jessica Resnick-ault, The Two New Exxon Board Members Poised to Shake up Insular Culture, Reuters (May 26, 2021), available at(Hyperlink) On the point of the increasing influence of proxy advisors in the ESG context, see Neil Whoriskey and Allan Marks, Corporate Governance & Proxy Advisors: "Who Watches the Watchers?", Milbank LLP Law, Policy & Markets Podcast (January 29, 2021), available at(Hyperlink)
4. Robert G. Eccles and Svetlana Klimenko, The Investor Revolution, Harvard Business Review (2019), available at(Hyperlink)
5. ESG May Surpass $41 Trillion Assets in 2022, But Not Without Challenges, Finds Bloomberg Intelligence, Bloomberg (Jan. 24, 2022), (Hyperlink)
6. Equator Principles EP4, Equator Principles (2020), available at(Hyperlink). See also Matthew H. Ahrens, Munib Hussain, and Ryan Harman, The New Equator Principles – Climate Change, US Application and What EP4 Means For You, Milbank LLP, available at(Hyperlink)
7. Guidance Note: Evaluating Projects with Affected Indigenous Peoples, Equator Principles (September 2020), available at(Hyperlink)
8. List of Goods Produced by Child Labor or Forced Labor, U.S. Department of Labor, Bureau of International Labor Affairs (2020), available at(Hyperlink)
9. See, e.g., Executive Order No. 14028, 86 Fed. Reg. 26,633 (May 17, 2021).
10. Start with Security: A Guide for Business, U.S. Federal Trade Commission (2015), available at(Hyperlink)
11. Cybersecurity and Resiliency Observations, SEC Office of Compliance Inspections and Examinations (2020), available at(Hyperlink)
12. Cybersecurity Risk Management for Investment Advisers, Registered Investment Companies, and Business Development Companies, SEC (2022), available at(Hyperlink)
13. See, e.g., Treasury Sanctions Chinese Entity and Officials Pursuant to Global Magnitsky Human Rights Executive Order, U.S. Department of the Treasury (July 31, 2020), (Hyperlink)
14. Uyghur Forced Labor Prevention Act (2021), available at(Hyperlink)
15. See generally Ukraine-/Russia-related Sanctions, OFAC, (Hyperlink)
16. Green Bond Principles, ICMA (2021), available at(Hyperlink) In June 2022, the Appendix 1 of the Green Bond Principles was updated to distinguish between secured and unsecured debt structures.
17. Social Bond Principles, ICMA (2021), available at (Hyperlink) Appendix 1 of the Social Bond Principles was similarly updated in June 2022 to provide guidance on securitisation.
18. Sustainability Bond Guidelines, ICMA (2021), available at(Hyperlink)
19. Harmonised Framework for Impact Reporting, ICMA (2021), available at(Hyperlink)
20. Working Towards a Harmonized Framework for Impact Reporting for Social Bonds, ICMA (2019), available at(Hyperlink)
21. Performance Standards on Environmental and Social Sustainability, IFC, (January 1, 2012), available at(Hyperlink)
22. Environmental, Health, and Safety Guidelines, IFC, (April 30, 2007), available at(Hyperlink)
24. Sustainability Linked Bond Principles, ICMA (2020), available at(Hyperlink)
25. Transforming our World: the 2030 Agenda for Sustainable Development, A/RES/70/1, UN General Assembly (adopted October 21, 2015), available at(Hyperlink)see also Sustainable Development Goals, United Nations, available at(Hyperlink)
26. Paris Agreement, United Nations (adopted December 12, 2015, entered into force November 4, 2016), available at(Hyperlink)
27. Principles for Responsible Investment, United Nations, available at(Hyperlink).
28. Report of the Special Representative of the Secretary-General on the Issue of Human Rights and Transnational Corporations and Other Business Enterprises: Guiding Principles on Business and Human Rights, A/HRC/17/31, Human Rights Council (March 21, 2011), available at(Hyperlink)see also Guiding Principles on Business and Human Rights, United Nations (2011), available at(Hyperlink)
29. GRI Standards, GRI (2021), available at(Hyperlink)
30. SASB Standards, SASB, available at(Hyperlink)
31. See various reports and guidance documents including Guidance on Metrics, Targets and Transition Plans (2021) and Recommendations of the Task Force on Climate-Related Financial Disclosures (2017), TCFD, available at (Hyperlink)
32. IFRS Foundation completes consolidation with Value Reporting Foundation, IFRS (August 1, 2022), (Hyperlink)
33. See SASB Investor Advisory Group (IAG) Welcomes Formation of the International Sustainability Standards Board (ISSB), Value Reporting Foundation (November 18, 2021), (Hyperlink)
34. Investment Theme: ESG, S&P Dow Jones Indices, available at(Hyperlink)
35. SEC Charges Brazilian Mining Company with Misleading Investors about Safety Prior to Deadly Dam Collapse, SEC (April 28, 2022), (Hyperlink)
36. Chair Gary Gensler, Prepared Remarks Before the Principles for Responsible Investment "Climate and Global Financial Markets" Webinar, U.S. Securities and Exchange Commission (July 28, 2021), available at(Hyperlink)
37. The Enhancement and Standardization of Climate-Related Disclosures for Investors, 87 Fed. Register 21334 (April 11, 2022), SEC, (Hyperlink) Matt H. Ahrens, Pinky P. Mehta, and Allison E. Sloto, An Overview of the SEC's Proposed Climate-Related Risk Disclosure Rules, The New York Environmental Lawyer, New York State Bar Association, Vol. 42, No. 2 at 33 (2022), (Hyperlink) Matt H. Ahrens, Pinky P. Mehta, Allison E. Sloto, Brett Nadritch, Teresa Chen, and Sean Strasburg, The SEC Proposes Enhanced Climate Disclosure Rules, Milbank General Counsel Blog (April 4, 2022), (Hyperlink)
38. SEC Climate Rules Pushed Back Amid Bureaucratic, Legal Woes, Bloomberg Law (Oct. 19, 2022), (Hyperlink)
39. Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, DOL, (Hyperlink)
40. William Charles and Vasiliki Katsarou, Milbank Insights, Combatting 'Greenwashing': New Proposals from the UK Financial Conduct Authority ("FCA") (Nov. 8, 2022), (Hyperlink) Sustainability Disclosure Requirements (SDR) and investment labels Consultation Paper CP22/20, Financial Conduct Authority (Oct. 2022), (Hyperlink)
41. Toward Common Metrics and Consistent Reporting of Sustainable Value Creation, World Economic Forum (2020), available at(Hyperlink)
42. Andrew Ross Sorkin, Bernhard Warner, Vivian Giang, Sarah Kessler, Stephen Gandel, Michael J. de la Merced, Lauren Hersch, and Ephrat Livni, An Anti-E.S.G. Activist Takes on Apple and Disney, The New York Times (Sept. 20, 2022), (Hyperlink) Andrew Petillon, The Republican War on "Woke Capitalism" Is Really Just a War on Capitalism, Slate (June 23, 2022), (Hyperlink)
The authors would like to thank Iliana Ongun and Neil Whoriskey, partners in the Global Corporate Group at Milbank LLP, for their valuable contributions to this chapter. Iliana advises public and private companies across various industries on mergers and acquisitions, joint ventures, private equity transactions, recapitalisations, and spin-offs. She also focuses on advising clients on ESG matters, shareholder activism, takeover defence strategies and other corporate governance matters. Neil's practice focuses primarily on mergers, acquisitions, and corporate governance matters and he has authored numerous articles on these topics. He also has experience in advising on ESG matters, with respect to governance.
This article was first published in ICLG - Environmental, Social, & Governance Law.
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