July 2, 2022

Volume XII, Number 183

Advertisement
Advertisement

July 01, 2022

Subscribe to Latest Legal News and Analysis

June 30, 2022

Subscribe to Latest Legal News and Analysis

June 29, 2022

Subscribe to Latest Legal News and Analysis

ESG: Practical Points For Where Market Practice and Legal Trends Collide

If 2021 was the year in which regulators and investors enthusiastically embraced environmental, social and governance (“ESG”) considerations, by creating new legal and regulatory frameworks, then 2022 will be the year for asset managers to identify and confront the practical challenges of integrating legal requirements and stakeholder expectations into investment policy and performance.

In particular, managers with an ESG focus need to prepare for challenges that arise when their investment mandate intersects with other market or legal trends.  In the United States, with concerns mounting regarding potential “greenwashing,” it is only a matter of time before the SEC brings an enforcement case against one or more asset managers managing ESG-focused products.  The SEC’s focus is on whether representations to investors are accurate, and, specifically, whether the manager’s practices match their sustainability representations.  Managers should anticipate the SEC will expect firms’ compliance and legal arms to play more meaningful roles in confirming that such disclosures are accurate.  The Financial Conduct Authority (“FCA”) in the UK is developing its own ESG legislative framework, which will be generally aligned with the EU’s recent Sustainable Finance Disclosure Regulation, and Taxonomy Regulation (the “EU ESG Rules”).  These legislative frameworks give regulators authority to analyze disclosures for potential greenwashing and use applicable enforcement tools where necessary.  Once the FCA finalizes its framework, it is expected to review marketing and promotional materials by fund managers, and identified weaknesses may give rise to further review and potentially enforcement actions in extreme scenarios.

In market terms, funds are being held accountable for ensuring that their ESG classifications are integrated into their investment making decisions.  As an example, Morningstar recently removed the ESG classification for over 1,200 funds in its rankings, accounting for over $1 trillion in assets, citing managers’ failure to integrate ESG factors in a determinative way for their investment selections.

As another example, the increased interest in cryptocurrencies and related investments raises a question of the environmental impact of certain cryptocurrencies and is a fitting example of where asset managers need to clearly delineate exactly which investments are suitably “green”.  High energy consumption is a designed feature of Bitcoin and other “proof of work” cryptocurrencies, where miners use computing power to solve equations verifying the relevant blockchain.  Combined with the public ledger, this mechanism creates trust in the currency, by preventing a small group from taking control.  The majority of mining takes place (following China’s recent ban) in the US and Kazakhstan—with both remaining heavily dependent on fossil fuels for energy needs.  As specialized hardware rapidly becomes obsolete, crypto-mining also generates electronic waste.  Miners can of course seek to use renewable energy, or rely on newer cryptocurrencies using a less energy-intensive “proof of stake” model, where verifiers pledge a certain amount of their own cryptocurrency.  Some proponents also tout mining as a means of allowing a store of value for electricity that would otherwise be wasted, such as renewable energy during off peak demand.

Given increasing activism around crypto as a “dirty” currency, funds seeking to burnish their ESG credentials are therefore advised to tread cautiously as it seems that not all crypto is equal(ly green).

In legal trends, shareholders, investors, governments, and other advocates are increasingly focusing on environmental wrongs and, in search of perceived deep pockets and favorable legal regimes, on parent companies.  Claimants in such actions rely on company-wide ESG policies, sustainability assessments and reports to argue that parent companies have assumed responsibility and so a duty of care for the policies of, and implementation by, their subsidiaries.  Such positions have been endorsed as arguable by the UK Supreme Court.  Class action and other investor lawsuits are also possible in the U.S., focused on materially inaccurate representations regarding sustainable investment choices or environmentally-friendly policies.  Plaintiffs have had some success pursuing these theories against mining and energy companies.

In addition, claimants are increasingly asserting claims based on ‘supply chain’ misconduct.  For example, in a current English Court claim, it has been held arguable that international tobacco companies could be liable for human rights violations by their third party suppliers.

While a typical private equity structure will be further removed from the operational business than most parent companies, plaintiffs are getting more aggressive in attacking affiliates and an aggressive plaintiff may argue that a manager’s commitments to ESG somehow is a basis to assert liability against the manager’s affiliates (including their funds).

Notwithstanding that claimants may seek to use a manager’s ESG policies as a route to a claim, the solution is not to avoid having such policies, but rather to have effective and appropriate ones, and to ensure compliance. Managers that lack adequate procedures and policies also risk SEC enforcement action for failure to adequately implement and maintain their procedures under the Compliance Rule of the Advisers Act (Rule 206(4)-7)—even in the absence of material misrepresentations to clients.  While it may not be necessary for all firms to implement a specific “ESG Policy,” this is a must for managers that are highly focused on sustainability. Given other global developments such as the EU ESG Rules, investors have increased expectations for some form of ESG or responsible investment policy as part of their diligence process, which is another reason why firms should consider implementing such policies.

With the above legal and market trends in mind, fund managers must ensure that their ESG focus is more than a “badge” for marketing.  At the same time, they must continually scrutinize their portfolios to ensure compliance with increasingly rigorous standards and expectations.  Achieving strong returns within a strict investment mandate requires discipline and continual vigilance.

Dorothy Murray, Joshua M. Newville, Todd J. Ohlms, Seetha Ramachandran, Jonathan M. Weiss, Julia Alonzo, Julia M. Ansanelli, James Anderson, William D. Dalsen, Adam L. Deming, Reut N. Samuels and Hena M. Vora  also contributed to this article.

© 2022 Proskauer Rose LLP. National Law Review, Volume XII, Number 55
Advertisement
Advertisement
Advertisement
Advertisement
Advertisement
Advertisement

About this Author

Partner

Steven Baker is a partner in the Litigation department and a member of the International Arbitration group. He has over 25 years of experience advising clients on complex, often multi-jurisdictional disputes in a wide range of industries, including asset management, technology, life sciences, financial services and defence sectors. He also has extensive experience advising upon and managing disputes for clients involving major technology or telecommunications projects and their financing, technology licensing and misappropriation of trade secrets.

...
+44.20.7280.2238
Margaret A Dale, Commercial Litigation, Proskauer Rose Law Firm
Partner

Margaret Dale is a Partner in the Litigation Department, resident in the New York office. Her practice focuses on commercial litigation, including class action defense, as well as intellectual property, privacy and data security, corporate governance litigation, securities litigation, and regulatory and internal investigations. She also represents and counsels clients in art law matters. 

212.969.3315
Michael R. Hackett, Litigation Attorney, Proskauer Law Firm
Associate

Michael R. Hackett is an associate in the Litigation Department and a member of the Asset Management Litigation practice. His practice focuses on disputes and regulation involving private funds, including private equity, venture capital, hedge, real estate and private credit funds, as well as other limited partnerships, where he regularly advises funds, fund sponsors, investment advisers and institutional and individual investors.

Mike’s experience representing private fund clients runs the gamut, from control contests within advisers, to...

617-526-9723
William Komaroff Litigation White Collar Attorney Proskauer Law Firm New York
Partner

Bill Komaroff is a partner in the Litigation Department and White Collar Practice Group. He has a nationwide federal practice focused on corporate defense and investigations, counseling and defending institutional and individual clients in connection with a broad array of complex government investigations, prosecutions and civil disputes.

Bill also has served as a member of the Criminal Justice Act Panel for the District Court for the Southern District of New York.

From 2003 to 2007, Bill served as an Assistant U.S....

212-969-3975
Kirsten Lapham FInancial Services Attorney Proskauer Rose Law Firm, United Kingdom
Partner

Kirsten Lapham is a partner specialising in financial services regulation. She advises a broad range of both institutional and individual clients on a variety of financial services regulatory and compliance issues. Her practice has a specific emphasis on the regulatory issues arising under the AIFMD, and MiFID II for a range of EU and indirectly impacted firms outside of the EU.

Experience in this area includes advising multiple clients on the EU marketing and registration regimes and overlaying local regulatory considerations, such as the U.K. retail distribution...

+44.20.7280.2031
Advertisement
Advertisement
Advertisement