In the wake of COP26 and the recent government paper on ‘Greening Finance’, Karen Hutchinson and Francesca Berry look at how heightened investor emphasis on environmental issues may have the undesired consequence of encouraging the practice of ‘greenwashing’ and how this, in turn, could result in shareholder claims.

The UK government has set ambitious environmental and climate change targets and is committed to achieving a net-zero economy by 2050. A key factor in reaching these targets is ensuring investment is directed towards companies with appropriate environmental credentials. To achieve this, there has been an increased impetus on putting in place a regulatory and legislative framework to support greater clarity around the disclosures organisations are required to make in relation to their environmental risks and opportunities.

In addition, as public awareness of the impact of environmental and social issues continues to increase, they are becoming ever more important factors in informing and directing investor decision making. Savvy investors are increasingly moving their funds into sustainable projects, renewable energy and green technology. And institutional investors are adopting their own “green” policies, which will shape and influence how their capital is allocated. There is unquestionably pressure on companies to respond to these investor demands. This requires them to make firm commitments around environmental and social responsibility and offer investors greater transparency and accuracy in reporting their risks and objectives.

Many companies actively promote their green credentials, understanding that this gives them a competitive advantage and makes them attractive to long-term investors. The motivations are twofold:

• Qualitative advantages: being seen to be environmentally and socially responsible is great PR. Investors are no longer solely interested in the bottom line.
• Quantitative advantages: investors trying to assess which companies will survive and prosper in a rapidly changing global energy economy will carefully consider environmental targets and metrics. Given the speed at which environmental issues are coming to the fore, being ahead of the curve will increasingly impact market pricing.

Increased rules/regulations around environmental disclosures

In addition to the incentives for companies to make voluntary disclosures around their “green” credentials, there is a myriad of evolving rules requiring organisations to disclose what they are doing to promote environmental and sustainability objectives. Different rules apply to different types of organisations, with some having more teeth than others, but the increase in pressure to report is hard to ignore. For example:

• UK corporates are subject to obligations to disclose material information in their financial filings (for example, in accordance with rules in the FCA Handbook, EU legislation, the UK Corporate Governance Code 2018 or the UK Companies Act 2006). Specifically, since 2013, companies have been required to include a strategic report in their annual report containing certain non-financial information. In 2016, further reporting requirements were added for large public interest entities requiring them to disclose information on their environmental impact, social matters, employees, human rights, and anti-bribery and corruption. And since 2019, all large UK companies have been required to disclose their greenhouse gas emissions.
• The Task Force on Climate-related Financial Disclosure (“TCFD”) was set up in 2015 to develop an internationally recognised set of climate-related financial disclosure recommendations designed to help companies provide better information to support informed capital allocation.
• In November 2020, a joint UK government and FCA taskforce published a ‘roadmap’ setting out a path towards mandatory TCFD-aligned disclosure obligations across the UK economy by 2025. Under this roadmap, mandatory disclosure rules are now in place for companies with a UK premium listing, and steps to extend these rules are underway.
• In July 2021, further Sustainability Disclosure Requirements (“SDR”) were announced to build on the TCFD implementation. The intention of SDR is to create an integrated economy-wide framework covering disclosures from corporates, asset managers and owners and investment products. Among other things, SDR will require organisations to provide disclosures on their transition plans to support commitments to reaching net-zero emissions.
• The government is also implementing a UK Green Taxonomy, which sets out a common definition or classification system according to which investors and businesses can reach a shared understanding of which economic activities can be classified as “green”. This is intended to provide clarity and allow investors to compare measures of environmental performance and impact easily.
• Finally, the International Financial Reporting Standards (IFRS) Foundation, the international body that governs the setting of global accounting standards, is establishing an International Sustainability Standards Board to develop baseline global reporting standards for sustainability.

Implications

It is clear from the above that while the rules governing environmental reporting obligations are still evolving, there has been a stark paradigm shift. In future, companies will be unable to avoid making detailed and clear disclosures on their environmental risks and objectives, which can be benchmarked against a uniform set of standards or homogenous classification system.

This shift has led to positive changes in companies’ attitudes and policies and their transparency and accountability. This can be expected to continue as existing proposals develop and become mandatory. However, one potentially negative impact of the changes in recent years is the increased practice of “greenwashing”. Some companies’ response to investor expectations and the increased government and regulatory scrutiny on environmental issues has been to deliberately or recklessly convey a false impression to the market by providing misleading, unsubstantiated or overly optimistic information.

Certain sources suggest this practice is rife:

• Greenwashing was the most prevalent concern raised by respondents to the 2021 Schroders Institutional Investor Study. This study analysed the investment perspectives of 750 global institutional investors, 80% of whom found sustainability challenging, with 59% citing greenwashing as the major challenge to sustainable investing.
• In January 2021, the European Commission published the result of its “screening of websites for greenwashing”. The results suggested that 42% of green online claims were exaggerated, false or deceptive.
• In April 2021, ClientEarth, an environmental charity, launched a resource highlighting how public statements by some of the world’s biggest fossil fuel companies are misleading the public over climate change.

Litigation risk

The number of environmental or climate cases being filed against corporations and public authorities is on the rise. Traditionally, claimants in these actions have been motivated by the desire to ensure companies are held to account for claims about their products or to shape future environmental policy decisions rather than financial gain. However, the increased potential for financial market or shareholder claims seeking compensation based on misstatements is real and has been seen already in other jurisdictions:

• In 2016, a securities fraud class action was brought against Exxon Mobil Corporation in the US, alleging that Exxon artificially inflated its share price by failing to disclose the proper costs of carbon emissions in its project calculations.
• In 2018, investors in Volkswagen brought an action in the German courts seeking billions of euros in compensation due to the drop in the company’s share price following its diesel emission scandal. The plaintiffs allege that Volkswagen failed to inform investors about its actions, the investigations into the same and the associated risk of financial impact. They claim that had these disclosures been made, it would have impacted their investment decisions.
• In 2021, multiple class actions were filed in the US against Oatly Group AB. The complainants allege that false statements were made public regarding the company’s greenhouse gas emissions and energy consumption, which artificially inflated the price of the company’s shares.

Future claims in the UK

It is easy to see how the imposition of more stringent disclosure obligations on organisations could expose financial market participants to an increased risk of litigation. The more information organisations are expected to report, the more likely investors are to use and rely on it. It will feed into and become an increasingly important factor in their investment decision-making process. If that information is incorrect or misleading, any consequential loss suffered could be recoverable.

Alongside the primary common law and equitable claims that investors might bring against an issuer (including claims for misrepresentation, breach of contract, mistake and claims in equity), this greater scrutiny may result in an increased risk of litigation under Sections 90 and 90A of the Financial Services and Markets Act 2000 (“FSMA”). These provisions allow shareholders, or those with an interest in shares in listed companies, to seek financial redress for any losses suffered as a consequence of:

• any untrue or misleading statements within or omissions from prospectuses or listing particulars (Section 90 FSMA); or
• reliance on any untrue or misleading statement in, or omission from, other information published by the issuer or dishonest delay in publishing information relating to its securities (Section 90A FSMA).

To date, claims brought under s90 and s90A have largely focused on readily quantifiable statements such as misleading financial reporting on an organisation’s asset position or profits. Furthermore, proving reliance is typically viewed as a difficult obstacle in s90A claims.

Against this backdrop, one can envisage the challenges an investor might face in demonstrating that it has relied on misleading environmental statements in deciding whether to invest. Historically, companies might have sought to pass off such statements as too subjective or vague to warrant reliance or claim that they merely evidence opinion or aspirations rather than firm commitments. However, such arguments are likely to become harder to sustain as the rules governing environmental disclosures continue to develop.

For example, one can see that it might be difficult to make a credible claim that broad, aspirational statements such as “we are committed to sustainability” or “achieving net-zero carbon emissions is our top priority” seriously influenced an investment decision. However, the position will be different where a company makes more specific disclosures, setting out clear environmental transition plans, strategies or metrics. For example, statements that set out firm commitments, such as the following, are more likely to influence an investment decision:

• “To reduce carbon emissions by 50% by 2022,”
• “To ensure 80% of total energy used in our plants is from renewable sources”, or
• “To make 100% of our products with sustainable material by 2030.”

Assessing losses

Assuming reliance can be established, another difficulty will be showing that the inaccurate or false statement caused a loss. Again, the more qualitative nature of environmental reporting may present additional hurdles, but it is certainly possible to conceive of circumstances that would give rise to causational losses.

The FCA, in particular, has recognised the crucial role of accurate TCFD aligned disclosures in informing asset pricing. It recognises that the value of a company’s assets or future profits (and therefore share price) can be susceptible to changes in policy responses to environmental issues. It follows that any inaccurate statements around these issues could falsely impact share prices. Any circumstances in which a share price drop can be linked to misleading market disclosures could conceivably give rise to securities class actions. Examples might include:

• Insufficient or inaccurate information on environmental risks where it subsequently becomes clear a company was aware of those risks.
• Where corrective statements are required regarding an organisation’s environmental failings, inability to meet previously set targets or breaches of its own internal environmental policies.
• As noted above, many institutional investors and sovereign wealth funds have their own “green” investment objectives and/or specifically market themselves as environmentally focused. If circumstances arise that force these large investors to divest of significant holdings following environmental failings, this could further exacerbate any stock drops.
• In the same way that climate-related reporting will increase brand value, the mischaracterisation of an organisation’s climate profile could lead to reputational damage and a corresponding loss of share price. Therefore, the financial impact will not necessarily be limited to the immediate consequences of the untrue statement but the longer-term impact of any loss of market confidence.
• Quantitative misinformation, for example:

–  Failure to properly account for or price the environmental costs associated with any new projects, such as carbon pricing, plastic taxes or other environmental duties, levies or taxes.

– The mischaracterisation of or failure to properly price or account for the risk of “stranded assets” (ie, assets, resources or equipment that have become obsolete or suffered an unanticipated or premature write-down or devaluation due to environmental issues, oil and coal reserves being an obvious example).

– Inaccurate environmental risk-weighting of assets can impact on capital ratios or give rise to capital adequacy concerns.

Conclusion

Organisations’ obligations to report on environmental issues are rapidly changing, and it remains to be seen how they will adapt and respond. However, given the increased importance of these issues and the pace of change, there is significant potential for this to be a focal point for future shareholder action.

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