• Friday, March 01, 2024
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What ESG means for law firms

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In today’s business scene, investors utilise several non-financial metrics to assess the economic sustainability of companies when making investment decisions. This new strategy considers the Environmental, Social and Governance (ESG) performance of a company in addition to traditional parameters such as earnings and dividends.

Increasing evidence suggests that ESG factors, when integrated into investment analysis and portfolio construction, may offer investors potential long-term performance advantages. Each of the three elements of ESG comprises a number of criteria that may be considered, either by socially responsible investors or by companies aiming to adopt a more ESG-friendly operational stance.

The Environmental aspect of ESG considers how a company performs as a steward of the physical environment. These criteria include a company’s use of renewable energy sources, its waste management initiatives, and how it handles potential problems of air or water pollution arising from its operations, deforestation issues, and its attitude and actions around climate change issues.

The Social criteria examine how a company manages its relationships with employees, suppliers, customers and communities where it operates. For example, investors may look at whether a company provides a safe and healthy working environment for its employees, or if it donates time, money or resources to give back to the communities where it operates. Also, workplace policies regarding diversity, inclusion and prevention of sexual harassment are also frequently considered.

Governance has to do with the roles, and processes through which a company and its board are run, including but not limited to board composition, executive compensation, and corporate disclosure.

Governance determines who sits on the board, how these directors gather information and make decisions, and how they communicate with stakeholders and each other. There are many factors that make up the assessment of how a company is governed; some are related to the company culture and its decision-making processes but others are tilted towards social factors, such as gender representation on the board of directors.

Table 1. The spectrum of social and financial investing

Given the aspects of financial and social returns that influence the use of ESG metrics, a key observation of recent surveys by private sector participants is that interests in the use of ESG range widely across social and financial considerations: institutional investors clearly focus on the benefits of ESG investing for financial returns and risk management, while with the end-investors, the focus more on the alignment of portfolios with societal values.

Table 2. Drivers of ESG investing

Desire for Other

Source: Merrill Lynch Wealth Management

Reshaping the perspective for law firms
Corporate Social Responsibility (CSR) initiatives in law firms have traditionally been founded on the delivery of pro bono legal advice and contributing to other charitable causes. While driven by a desire to give back to the society, they were further reaffirmed by the positive implications that are associated with such actions and behaviours, including profile raising and contributing to firm culture. However, just as ESG goes beyond philanthropy and has entered the investment space, so also, has ESG entered the business of law firms.

Read also: How to recession-proof your law firm

ESG is an area where lawyers can add value, and indeed, clients are increasingly likely to require such services given the momentum around ESG, investor demand, and the changing regulatory landscape.

For example, transactional lawyers, more frequently, are advising on the structuring and documentation of green bonds, green loans, sustainability-linked loans and bonds, green funds, impact funds, responsible investment funds, and so on. It’s not just new products that are on the market but also new forms of regulation impacting the finance industry.

As ESG is not just revenue drivers, law firms are also under pressure to enhance their own performance when it comes to environmental and social standards. Furthermore, law firms are not immune from scrutiny when it comes to their roles in negative ESG outcomes, including climate change.

Although law firms might be part of the services industry, with a lighter environmental footprint than other industries, a law firm’s impact on the environment goes beyond its energy and paper usage. It extends to the clients it works with, the example it sets to its employees and the impact of its work within communities and industries.

Litigation risk associated with ESG
The growth in stakeholder awareness of climate issues has been accompanied by a significant global increase in climate litigation. One of the most significant international actions against major emitters came in New York City’s 2018 suit under state nuisance law against BP Plc, Chevron Corp, ConocoPhillips, Exxon Mobil Corp and Royal Dutch Shell Plc for damages caused by the companies’ production and sale of fossil fuels.

The suit was ultimately rejected (and the rejection upheld), with US District Court Judge John F. Keenan ruling that problems associated with climate change should be tackled by Congress and the executive branch. Despite the failure in this instance, increasing acceptance by other courts of scientific evidence may eventually see similar proceedings lead to success.

Most recently, the judgment in Bushfire Survivors for Climate Action Incorporated v Environment Protection Authority [2021] NSWLEC 92 (Bushfire Survivors), handed down on 26 August 2021, found that the NSW Environment Protection Authority has a duty to take serious action on greenhouse gas emissions and climate change.

ESGs form
part of the external legal constraints to which firms are subject. For this reason, and because ESG makes inherent business sense, it should be taken seriously in firms’ decision-making processes. This elevated litigation risk emphasizes the necessity of being alive to ESG issues.

It is the first time that an Australian Court has ordered a government to take meaningful action on climate change. In this case, the plaintiffs sought and obtained an order of mandamus compelling the NSW Environment Protection Authority (EPA) to “develop environmental quality objectives, guidelines and policies to ensure environment protection from climate change”.

It was argued that the statutory duty under section 9(1) of the Protection of the Environment Administration Act 1991 (POEA Act) evidently requires the EPA to develop policies that protect the environment from the most ‘grave’ threat of all, climate change. The Land and Environment Court agreed that the EPA had such a statutory duty and had failed to fulfil that duty.

In the Nigerian perspective, the ruling to stop Shell from continuing with its seismic exploration survey off the Wild Coast has shown that ESG matters significantly, as it will increasingly form part of the external legal constraints to which firms are subject. For this reason, and because ESG makes inherent business sense, it should be taken seriously in firms’ decision-making processes. This elevated litigation risk emphasises the necessity of being alive to ESG issues.

Role of lawyers and law firms in ESG
The following are some of the roles law firms and lawyers play in ensuring that organisations are ESG compliant.

● Sustainability strategy and integration into decision making – Lawyers, particularly, in-house counsel, are increasingly involved in setting the strategic direction of sustainability and ESG within organisations and ensuring sustainability is embedded into corporate governance and integrated into broader business operations. As more companies set stretching time-bound sustainability commitments and targets, legal teams have been integral in reviewing these commitments before launch and ensuring they stand up to external scrutiny. In a number of cases, the sustainability agenda is driven by the top legal officer.

● Disclosure and transparency – Lawyers also provide pragmatic advice relating to the preparation of ESG disclosure for the purpose of satisfying board oversight responsibilities, institutional investors, proxy advisory services, activist shareholders and employees. In this capacity, lawyers are often engaged to draft disclosure, design ESG strategies, prepare board presentations and establish ESG action plans.

● Financing – Finance lawyers also advise financial services clients in the design of ESG-related financial products, counsel companies across various industries in procuring and complying with these products.

● Horizon Scanning – Lawyers are experts in identifying and dealing with risk, and spotting trends in the evolution of regulations – such as regulations around the green recovery, modern slavery, circularity and extended producer responsibility – that could have a material impact on the business, and pre-empting any changes. Hence, lawyers are able to horizon-scan and understand what ESG opportunities and risks will affect the company.

Conclusion
According to the 2021 ACC Chief Legal Officers, survey conducted by the Association of Corporate Counsel and Exterro, 65.8% of Chief Legal Officers (CLO) believe that a focus on ESG will accelerate, as compared to 52.3% of CLOs who indicated the same in 2020.
Considering ESG impacts in the context of strategic decision-making, such as, evaluation of a new project or product, or expanding operations, will ensure that an organisation is proactive in this space, and may make it less likely that it will be the target of potential action.

Monitoring and engaging with community expectations and public sentiment regarding ESG issues may provide a good way for organisations to manage the legal, commercial and reputational risks. As a result, law firm clients and their in-house counsel are looking more closely at the sustainability of the firms they retain. While this may not be so popular yet, it is gradually becoming the order of the day as these companies are being spurred to re-evaluate their own supply chains and vendors amidst growing awareness and pressure from stakeholders.