Responsible Future

ESG in the courtroom

Gregory Kunz, Head of Equity and Fixed Income Research

ESG in the courtroom

Litigation around environmental, social and governance (ESG) issues is on the rise, with both civil and criminal cases being heard by courts around the world. Such litigation poses not only financial risk but also reputational risk to the corporations involved. This trend therefore adds an additional layer of investment risk to companies with weak ESG metrics.

There is a positive indirect outcome of heightened litigation around ESG issues. Corporations have been spurred into action, with a fast-growing number of them now taking concrete steps toward improving their ESG attributes. 

Interestingly, the covid pandemic has further accelerated this trend. The crisis forced all institutions, including corporations, financial markets and governments, to find a sort of common ground in confronting the crisis and ultimately adapt to a post-pandemic world. The way companies do business has changed dramatically in an extremely short period of time and in so doing, presented the perfect opportunity to rethink corporate objectives. At the same time, the pandemic itself brought to light the urgency in addressing the complex relationships between human activities and climate change, inequalities, biodiversity degradation, etc. The cost of inaction has increased significantly. For the laggards, the clock is ticking and they could face an expensive wake-up call. Accounting for all stakeholders will likely prove the only way to create corporate value over the long term. 

Plaintiffs E, S and G 

Court cases around serious governance (the ‘G’) breaches are well established and often highly visible, often leading to bankruptcy, prison sentences and new laws and regulations. These may involve criminal money laundering cases brought against financial institutions, widespread fraud and other major scandals. 

"Accounting for all stakeholders will likely prove the only way to create corporate value over the long term."

More novel are court cases around environmental and social issues, the ‘E’ and the ‘S’. Historically and relative to corporate governance, these topics may have tended to be associated more with investor preference than investment risk. However, there is increasing public and government scrutiny around these issues and demands for greater transparency and corporate responsibility, including over supply chains. Companies without robust environmental and social policies and oversight are vulnerable to both financial and reputational repercussions. 

In defence of climate 

Today, the focus on how infrastructure projects align with the Paris Agreement goals is intensifying. At the same time, corporate behaviour around addressing climate change is shifting toward greater responsibility. Between 1990 and 2019, there were 1,328 cases of climate-change litigation around the world, in at least 28 countries initiated by governments, with a rising number brought against greenhouse gas (GHG) emitting companies [1] . In short, addressing climate change can no longer be postponed until tomorrow.

Despite the high costs associated with the required investments, corporations are finetuning their contributions toward a healthier environment. One of the world’s leading food companies recently announced investment plans on the order of several billion US dollars to halve its GHG emissions by 2030 and reach net-zero GHG emissions by 2050. What is particularly impressive about this is that 95% of these planned emissions cuts are classified as Scope 3. Whereas Scope 1 accounts for a company’s direct emissions from its business activities and Scope 2 its indirect emissions (electricity usage, etc.), Scope 3 includes all other indirect emissions coming from a company’s value chain (transportation of supplies and distribution of goods, employee commuting, business travel, etc.).

At the end of the day, this type of corporate investment is no different than other types in that it should ultimately boost competitiveness and add value. Here again, failing to act now could end up costing the company more in the long run. 

This example is not a one-off occurrence but rather indicative of a growing global trend toward addressing social issues and scrutinising corporate supply chains (though perfect monitoring is undoubtedly a complex process). Hopefully real change will result, with more countries taking tougher positions around these issues. There are encouraging examples of this already. In March of this year, the German government approved a supply-chain law that imposes unprecedented obligations on German corporations to control practices of their suppliers as well as their own [2] . It is the first country to impose such a law to date. In the US, the California Transparency in Supply Chain Act requires large retailers and manufacturers to inform customers on their efforts to eradicate slavery and human trafficking from their supply chains [3] . And these are just a couple of the examples. 

Damage control 

While it is debatable whether a company can control, and therefore be held accountable for, its entire supply chain, any labour-related scandal could inflict reputational damage on a company. This was recently the case for an online fashion retailer. There are also positive examples of companies taking proactive steps. The world’s largest cocoa manufacturer is supporting local farmers in becoming real entrepreneurs, a move that will ultimately make their own business more sustainable over the long term, as these local communities are lifted out of poverty. More generally, appropriately addressing workers’ rights, child labour prevention and income inequality has become an urgent priority and covid has accelerated that shift. 

"Companies without robust environmental and social policies and oversight are vulnerable to both financial and reputational repercussions."

Applying holistically built, longterm strategies incentivises managements to take investment decisions that result in more robust supply chains. This in turn produces better outcomes for all involved stakeholders. 

While there is no shortage of challenges remaining and the ‘wake-up call’ cost could look high for some companies, there appears to be no alternative. As we emerge from the grip of the pandemic, the way corporations manage their activities has evolved dramatically and there is an imperative for ESG parameters to be accounted for in their growth equations. What’s more, as the next generation takes the reins, there is growing optimism that the pace of such positive change will accelerate as heightened awareness around these issues drives citizens around the world to urge corporations to be vectors of positive change.

[1] Source: Setzer J and Byrnes R. Global trends in climate change litigation: 2019 snapshot. 2019. 

[2] Source: Rathke and Lonergan. Globalsupplychainlawblog. 2021. 

[3] Source: State of California Department of Justice. Office of the Attorney General.

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