Jun 9, 2023

The grass isn’t necessarily greener: how to mitigate ESG risk within the banking and finance sector

With the risk of ESG litigation ramping up, companies in the banking and finance sector are finding themselves needing to navigate this space. Climate change, gender pay gaps, modern day slavery and pollution have been making headlines for some time now. Given the rapid increase in environmental, social and governance (“ESG”) awareness, the boards of many international organisations find themselves walking a tightrope between ESG factors and the discharge of their fiduciary duties.

Why do we care?

Companies owe a fiduciary duty to pursue a long-term increase in financial value (other than in an insolvency situation). As ESG factors directly impact on both the financial bottom line and a company's reputation, to the extent they are not doing so already, companies need to ensure they take ESG factors into account.

Section 172 of the Companies Act requires directors of UK companies to consider the interests of the company’s employees, the need to foster business relationships, the impact of the company’s operation on the community, environment, and its reputation for high standards of business conduct. The directors’ primary duty is to promote company success for shareholders. In addition to this, the Companies Act requires large and medium-sized companies to publish an annual strategic report. The report must include information on ESG-related items, such as the business’s environmental impact, employee disclosures, social, community and human rights issues. It must also include the company’s policies on each of the said items.

Although self-reporting remains the key method by which a company’s ESG credentials are reviewed and assessed, there has been a move away from voluntary reporting toward mandatory reporting. With reporting and disclosure requirements being mandatory, one would expect to see a flow of ‘decision-useful’ information about a company’s sustainability to its stakeholders, including its investors. In keeping with this theme, certain large companies are required by the Companies Act 2006 to report on the effect of climate-related financial risks and opportunities within a new non-financial and sustainability information statement which will form part of their annual report.

What do we do?

With the uptick in green products and services, investors, consumers and NGOs, have resorted to the use of litigation to scrutinise whether businesses are living up to any statements made. In addition to this, the Financial Conduct Authority are preparing to implement new Sustainability Disclosure Requirements to help consumers to navigate the sustainable investment product landscape and address greenwashing of financial products. With the implementation of these new requirements we expect to see an increase in investor-led disputes. That being said, there are three practical steps that companies can take to mitigate the risk of ESG litigation.

Step 1: Audits

Board members must understand their duties in respect of ESG. A failure to assess and manage ESG-related financial risks could expose the company and/or its directors to civil liability actions. Putting in place an effective audit and assurance regime around ESG disclosures can help mitigate this risk.

Step 2: Policies

Organisations need to have an effective governance framework in place around ESG-related risks and issues together with robust policies and procedures.

Step 3: Crisis management plan

If an ESG dispute arises, an organisation’s initial response can impact its potential exposure and reputation. Developing an ESG disputes crisis action management plan puts the company on its best footing.

What next?

The world is changing and so is business. With a drive towards economies becoming more sustainable no time is more important than now to ensure that your business adapts to change and embraces ESG.

To discuss any of the topics raised in this article, speak with Kerri Wilson or a member of our team today.

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