ESG Market Alert – November 2022

In this month’s ESG Market Alert, we cover:

• The expanding scope of EU rules on ESG disclosures;
• FRC Lab launches project on materiality in corporate reporting;
• FCA opens consultation into SDR and investment labels to tackle greenwashing; and
• Market Practice Development: the growing importance of ESG to EMEA M&A.

The expanding scope of EU rules on ESG disclosures

From 2024 to 2026, certain EU and non-EU companies (if the group generates significant income in the EU and has an EU-based subsidiary or branch that meets certain criteria) will be required to disclose further non-financial information under the new Corporate Sustainability Reporting Directive 2021/0104(COD) (“CSRD”). The CSRD builds on and expands the scope of the existing Non-Financial Reporting Directive (“NFRD”) both in terms of the companies to which it applies and the contents of required disclosures.

The CSRD will apply to:

• all large undertakings and those listed on regulated markets;
• small and medium-sized enterprises (“SMEs”) listed on regulated markets except for certain micro-undertakings; and
• non-EU companies which have turnover of €150 million in the EU and at least one subsidiary or branch in the EU.

The extended scope of the CSRD will now require non-EU parent companies to, among other things, disclose sustainability targets, adopt sustainability reporting standards and disclose their business model and strategy towards risks and opportunities related to sustainability matters.

Alongside the CSRD, the EU have also proposed the complementary Corporate Sustainability Due Diligence Directive COM(2022) 71 (“CSDDD”) which, if adopted as proposed, would have far-reaching due diligence and governance requirements relating to ESG matters. It will require EU companies with significant operations in the EU to integrate due diligence into their policies in order to identify, monitor and prevent circumstances which might negatively impact human rights and the environment. Within the proposed EU regime, the CSDDD contemplates a specific administrative sanction that would be imposed by each EU Member State's regulator in the event of a breach with potential penalties including heavy financial sanctions based on the company's turnover.

FRC Lab launches project on materiality in corporate reporting

The Financial Reporting Council ("FRC") Lab has announced it will launch a project aimed at understanding how companies use, develop and assess the concept of 'materiality'. In its call for participants, the FRC Lab noted 'materiality' can be an important tool to assist companies when determining what information should be included in corporate reporting and the requisite depth of information to be provided. However, it acknowledged that currently determinations as to what is 'material' are highly subjective. As such, whilst a useful tool, 'materiality' concepts can prove challenging for companies; particularly when dealing with non-financial information, in the case of ESG reporting.

The FRC Lab invites companies, investors and other interested parties to participate in this project. The proposed list of topics to be covered, among other things, includes:

• what factors companies consider when determining what to report;
• when and how regularly companies consider 'materiality';
• how 'materiality' is used in assessments by companies to determine what information ought to be included or excluded in corporate reporting;
• how companies think about 'materiality' with respect to non-financial information, as compared to financial information; and
• what investors want to understand regarding 'materiality'.

Outputs are expected to be published during 2023. Participants will be kept updated on the progress of the project and given an opportunity to comment on draft findings.

FCA opens consultation into SDR and investment labels to tackle greenwashing

On 25 October 2022, the Financial Conduct Authority (the “FCA”) published their Sustainability Disclosure Requirements (“SDR”) and investment labels consultation paper. The consultation, which is open until 25 January 2023, invites responses from an array of stakeholders (FCA regulated firms, industry groups, consumers, regulators, industry experts, academics, and advocacy groups) on the proposed rules which will apply to all FCA-regulated firms. The answers will shape the FCA’s final rules and guidance which are planned to be published by the end of the first half of 2023.

The proposed rules are aimed at clamping down on greenwashing and improving consumer trust in the market for sustainable investment products. They include developing sustainable investment labels, imposing disclosure requirements, and restrictions on the use of sustainability-related terms – such as ‘ESG’, ‘green’, or ‘sustainable’ – in product naming and marketing. Arising out of the FCA’s concern that firms are making exaggerated or misleading sustainability-related claims about their investment products, the proposed measures focus on asset managers and their UK-based fund products and portfolio management services. The FCA have attempted to set up this regime following other similar regimes (as in the EU and the US), but has noted that their approach differs as it is more consumer-focused.

Market Practice Development: the growing importance of ESG to EMEA M&A

The need for a shift to more sustainable and less carbon-intensive economic models has been globally recognised. This is demonstrated by the injection of over US$500 billion into Europe-domiciled ESG-integrated open-end funds and ETFs in 2021. In particular, the European Commission (“EC”) intends to make Europe the first carbon neutral continent by 2050. The proposed regulatory framework by the EC will encourage businesses and investors to make decisions based on ESG considerations such as climate change, greenhouse gas emissions, human rights and labour standards. This will inevitably impact the mergers and acquisitions sector where acquirers must now assess target companies for latent risks and facilitate their sustainability and social responsibility agendas.

It is in the interests of the shareholders to improve a company’s ESG profile as may be vital in delivering long-term economic value. A company’s ESG profile is central to its overall brand and reputation as the media and public are increasingly holding them accountable for failing to act. This can have a long-lasting impact on revenues as clients and customers may seek alternatives. For an M&A transaction, according to a report by SS&C Intralinks, this would likely raise a higher number of red flags in the due diligence process ranging from a mismanagement of waste or limited resources, or discriminatory practices in the workforce. ESG due diligence is fast becoming market standard even if the considerations might differ slightly from country to country. ESG is not solely about protecting the businesses against downside financial risk. On the contrary, growing emphasis on sustainability and social responsibility places businesses in a better position to gain market share and grow their value as it increases their popularity amongst investors.

Most, if not all, M&A transactions need to also consider the relevant anti-trust laws since authorities have stepped up their reviews of potentially anti-competitive deals and transactions which may pose a threat to national security. Companies are therefore finding it difficult to proceed with ESG transactions as they cannot achieve their sustainability goals in isolation and often have to collaborate with their suppliers and competitors to achieve such ambitious targets. This in turn has an adverse impact where companies would abandon ESG transactions that may be seen as incompatible with anti-trust concerns. Nonetheless, companies with strong governance, healthy working cultures, and commitment to sustainability and social responsibility are highly sought after in the market. In fact, corporate acquirers and other investors are seeking to improve their own ESG credentials by acquiring such companies, and financial sponsors can achieve a higher exit value from companies with gold-standard ESG credentials when they sell them on. ESG therefore acts as a business opportunity for certain companies as ESG expectations become more stringent.

ESG Counsel™ 

The Hogan Lovells ESG team is here to help, including on all the issues raised in this snapshot. Hogan Lovells is one of the leading ESG firms in the world, delivering uniquely tailored cross-practice and -geographic holistic advice as ESG Counsel to clients globally. Our holistic and solutions-driven approach to managing ESG issues draws on the full scope of our global practice and sector capabilities (including our leading global corporate, environmental, governmental relations and regulatory, employment, and dispute resolution teams) to drive sustainable value and maximize positive impact for clients. Please contact us to discuss next steps or for our latest ESG-related materials, including our ESG Academy.

Upcoming ESG events 

• ESG Game Changers reception

Join us for an evening reception in London on Wednesday, 23 November 2022 to mix with the most progressive and insightful minds from business, the investment community, and government to discuss the role of business in driving positive social change. Find out more and register here.

• Webinar: Keeping markets updated

When and what information does a listed company need to disclose? What new considerations apply? When and how could things go wrong? Join us on Thursday, 17 November 2022 for the latest webinar in our corporate governance ESG webinar series, to hear about your disclosure obligations illustrated through a series of relevant case studies and recent enforcement actions. Register here.

How we can help 

Our knowledge of ESG matters, coupled with our sector-focused expertise and experience can help businesses navigate this complex area. In particular, we can help by:

• bringing clarity to the complex and fast developing legal and regulatory background driving ESG considerations and helping your business shape its response to those requirements, opportunities and risks;
• engaging effectively with policy-makers and regulators that will shape the environment in which your business operates;
• undertaking a sustainability and business integrity ‘healthcheck’ to identify and establish corporate purpose and clear ESG initiatives/targets;
• evaluating supply chains and procurement processes to ensure that they appropriately deal with ESG considerations;
• ensuring that governance structures are “fit for purpose” and drive appropriate behaviours within your organisation;
• evaluating best practice with regards to talent management, diversity and inclusion, employee engagement, corporate purpose, culture, reward and remuneration and tax practices; and
• in cases of crisis, assisting in responding to and dealing with that crisis.

Our recent ESG public markets experience

• Advising SABMiller plc on governance transitions and reforms.
• Advising a number of companies and stakeholders on ESG-related activist and stakeholder engagement.
• Advising ITV on ongoing corporate governance matters.
• Advising Shaftesbury on numerous corporate governance matters.
• Advising an international ride-sharing company on its governance arrangements in the UK in the context of an ongoing license appeal.
• Advising Brookfield on the environmental aspects of its acquisition of Greenergy, including its interest that owns Thames Oilport and Thames Enterprise Park.

Authored by Nicola Evans, Patrick Sarch, Gaspare Chirillo, Katie Barton, Rory Hazelton, Aayush Kainya, Kaushik Karunakaran, Susan Lee and Madalena Marques.