Washington, D.C. (March 26, 2021) - On March 10, 2021, a new set of sustainability disclosure requirements went into effect in the European Union, in the form of its Sustainable Finance Disclosure Regulation (SFDR or EU Regulation). While the measure is complicated, essentially it imposes new obligations on investment funds, requiring disclosures of environmental, social, and governance (ESG) risk factors in materials that are provided to investors and made available on asset companies' websites and in their periodic reports. The twin objectives of the new EU Regulation are to increase transparency of ESG risk information and enhance comparability of these disclosures for end use investors.

The SFDR is moving toward adoption of standardized metrics, to eliminate the current situation in which numerous voluntary ESG disclosure taxonomies are in use, making apples-to-apples comparisons among different investments effectively impossible (see our March 8 Bloomberg Law Insights article on developments underway on converging standardization analytics). The EU Regulation is focused first on climate-related risk disclosures – the set of disclosures required to be made as of March 10 – but by the end of this year it will encompass broader ESG factors such as “social and employee matters,” “respect for human rights,” and “anti-corruption and anti-bribery matters.”

Although the EU Regulation applies only to EU fund managers and U.S. asset companies that sell investment products in the EU, its implications are likely to be much more far-reaching, as many have suggested the EU approach provides a good model for U.S. adoption. For these reasons, U.S. corporation and investment sectors have good reason to watch these developments closely and consider opportunities for engagement.

Implications for companies in the U.S.

  • As noted above, the SFDR currently applies to fund managers and investments in the EU, but for numerous reasons it may serve as a harbinger of things to come in broader contexts. The U.S. Securities and Exchange Commission (SEC) has called attention to the problem of too many different ESG disclosure standards and is seeking comment on how to harmonize these metrics, potentially with a view toward designating one standardized system in new reporting requirements for U.S. public companies (see our previous alert from March 19). The EU Regulation could seem like a natural for multinationals unenthusiastic about having to comply with differing disclosure requirements and interested in quickly adopting a best practices approach. Shareholder groups and activists want a common set of analytics so they can rate various companies' performance on one yardstick. Additionally, pressures from customers, supply chains, and competitors may drive companies to adopt the first out of the gate model that is widely accepted.
     
  • While companies may want to leap onto the ESG bandwagon and advertise their embrace of the EU Regulation to avoid marketing blowback or shareholder suits, hasty disclosures or the dissemination of inaccurate information can result in a boomerang of potential legal risk, including in the U.S. This month a coalition of three “green” groups filed a complaint with the Federal Trade Commission (FTC) alleging that a leading oil company is misleading the public about the company's efforts to reduce greenhouse gas emissions. The FTC is not shy about wading into cross-border issues that fall within its jurisdiction and could conceivably review and investigate the accuracy of a company's ESG-related advertisements/ disclosures, including those touting compliance or concordance with the new SFDR.
     
  • In appropriate circumstances, the False Claims Act could also apply to false or misleading statements of this type, which could draw the attention of other government regulators, including the U.S. Department of Justice. And even where the facts fall short of crossing the line into potential violations of law, brand and reputational risks represent concerns that cannot be underestimated.
     
  • While the SEC has not yet adopted mandatory ESG disclosure or reporting requirements, current regulations require disclosure of material risks that could affect an investor's informed investment decisions. Shareholder suits are proliferating in the climate change and ESG space and represent a significant area of business risk for publicly traded companies.
     
  • Finally, given that cross-border and intra-border cooperation and coordination among government authorities are expected to continue into the foreseeable future, non-compliance with the SFDR could result in scrutiny of other areas of a company's business. Investigations can and often do uncover further wrongdoing, which allows additional regulatory agencies to exercise their jurisdictional authority on violations that may not have been within the scope of the initial investigation. Recent high-profile international prosecutions of falsification of data from emission control devices and financial irregularities on energy and other projects provide examples.

What can companies do?

Understanding the emerging international standards can be key to developing effective business strategies for quantifying climate benefits and ensuring that the best methodologies are included in any U.S. framework. Companies should pay close attention to ongoing U.S. efforts to create mandatory climate-related and ESG disclosure requirements, including the establishment of a globally standardized system of reporting metrics, and seek opportunities for engagement through public comments and meetings with key policymakers. This is especially important for fossil fuel sectors and for businesses – such as agriculture, construction, and manufacturing – that rely on products in their supply chain produced with fossil fuels, which are a common focus of climate-change activist groups.

Companies should consider conducting internal audits of policies and updating them consistent with the emerging trend in climate- and ESG-related disclosures, with an eye toward the anticipated increased risk of shareholder and third-party lawsuits and the other areas of concern noted above.

Originally Published by Lewis Brisbois, March 2021

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