South African financial sector faces litigation risks if ESG matters are ignored 

Environmental Social and Governance (ESG) related legal and regulatory developments are maturing from soft law recommendations to hard law obligations worldwide.

Sarah Mckenzie – a partner and litigation specialist at Webber Wentzel – has warned participants in the South African financial sector to ensure that disclosures on ESG matters are accurate, well-founded and backed up with data to avoid greenwashing litigation.

There is increasing pressure on companies and institutional investors to tackle ESG issues, as investors are looking to invest in companies that can demonstrate ESG alignment.

Role players are proactively engaging with institutional investors and asset managers on integrating ESG factors into their decision-making and are facing increasing scrutiny of their investment activities.

This has spurred regulators to develop disclosure standards to meet investors’ growing ESG information needs.

International ESG developments

Over the past two years, there has been a significant move toward developing strategies and regulations relating to ESG matters and company guidance.

Some notable developments include:

• November 2021: the UK’s Financial Sector Conduct Authority (FCA) published its ESG Strategy, stating that market participants and consumers must be able to trust green and other ESG-labelled financial instruments and products.
• 8 February 2022: listed Chinese companies and bond issuers must disclose environmental information under new rules set by China’s Ministry of Ecology and Environment. Similar developments have occurred in other jurisdictions, such as Singapore, Malaysia and Canada.
• 23 February 2022: The European Commission adopted its Corporate Sustainability Due Diligence Directive. This outlined obligations for large companies, such as (i) they have to carry out due diligence to identify any adverse environmental impacts and (ii) produce climate plans. The Directive will allow EU regulators to impose sanctions on companies for failing to comply and civil liability for violations of certain due diligence obligations which have adverse environmental impacts.
• May 2022: the US Securities and Exchange Commission (SEC) proposed amendments seeking to enhance and standardise disclosures of ESG factors considered by funds and advisers to expand regulation on the naming of funds with an ESG focus.
• 29 June 2022: the UK’s FCA published its Feedback Statment FS22/4, which outlined its strategy for bringing ESG-labelled debt instruments and ESG data and rating providers under its regulatory remit and what that would entail.

These jurisdictions have also promoted additional measures, such as greenwashing penalty guidelines and mandatory ESG disclosures for banks and other participants in their respective financial sectors.

ESG developments in South Africa

In South Africa, there is currently no enforced duty to provide disclosures on ESG matters, although the South African regulatory regime may develop obligatory requirements following changes in the international market.

There are, however, guiding principles on disclosures required by companies:

• The King Code 4 deals with corporate governance and sets out 17 principles that an organisation should apply to substantiate a claim that it is practising good governance. These principles are reflected in four outcomes: ethical culture, good performance; effective control; and legitimacy. Many asset owners and investment managers subscribe to the King Code and consider it in their governance. The King Code emphasises sustainable development as “a primary ethical and economic imperative”. The JSE requires listed companies to report annually, on an “apply and explain” basis, the extent to which they have complied with the King Code.
• JSE-listed companies have general continuing disclosure obligations under the JSE Listings Requirements, which apply to financially-material ESG issues.
• 14 June 2022: the JSE released its Sustainability and Climate Disclosure Guidance note, which aims to promote transparency and good governance and guide listed companies on best practices in environmental, social and governance (ESG) disclosure.
• Prudential Standard GOI 3 prompted by the Prudential Authority: This lists requirements that all insurance companies must follow regarding their investment policies, such as taking into account any factor that may materially affect the sustainable long-term performance of assets, including ESG factors.
• A revised draft Code for Responsible Investing in South Africa (CRISA) 2.0 set out various principles and practice recommendations with a clear emphasis on ESG and broader sustainable development issues.

The risk of greenwashing litigation

One of the principal ESG-related litigation risks faced by the financial sector is when financial institutions and companies make inaccurate or misleading ESG reporting and disclosures on climate change, or “Greenwashing”.

Greenwashing is defined as unsubstantiated or misleading claims about an entity’s environmental performance or selective disclosure or non-disclosure about the environmental or social impacts of a company’s business practices.

In other jurisdictions, there has been an increase in litigation in these categories recently, and sometimes the regulators themselves have taken action.

Some interesting cases outlined by Mckenzie are:

• Ramirez v. ExxonMobil: A derivative suit was filed in the US by ExxonMobil’s shareholders against its directors for a breach of fiduciary duty – the obligation a party has to act in another party’s best interest – and failure to disclose the impacts of climate change on the company’s business reserves and assets.
• Abrahams v. Commonwealth Bank of Australia: The Commonwealth Bank of Australia shareholders filed a complaint in 2017 against the bank for investing in coal mines.
• SEC v BNY Mellon: The SEC charged BNY Mellon, an investment adviser, for making misleading statements about the ESG investment considerations of its managed mutual funds. This resulted in the SEC issuing a cease-and-desist order and a penalty of $1.5 million (R25.9 million) against BNY Mellon.
• German law enforcement officials raided the offices of Deutsche Bank on suspicion that the company had made misleading statements in its 2020 annual report by claiming that more than half the group’s $900 billion (R15.5 trillion) assets were invested using environmental, social and governance criteria.

According to Mckenzie, there has been no direct or explicit greenwashing litigation in South Africa or ESG-related enforcement action by South African regulators.

Still, South African legal and regulatory laws create the platform and cater for the possibility of greenwashing claims and litigation.

For example, The Financial Markets Act of 2012 makes it an offence to publish misleading or deceptive company reports, statements, promises or forecasts.

The risk outlined in this act will rise as companies more regularly report to shareholders and stakeholders on their ESG conduct as ESG concerns become more important in investors’ choices.

How to avoid ESG-related litigation

Mckenzie believes that the South African market should treat developments in the international market and crackdowns by global regulators as a warning.

Any ESG-related statements issued by companies and participants in the financial industry are substantiated and true.

Officers, directors and fund managers should focus on ensuring the accuracy of ESG-related disclosures and develop policies and procedures to evaluate ESG-related issues.

Mckenzie, therefore, recommended the following risk-mitigation measures that South African companies and Financial institutions can follow:

• Ensuring that governance and oversight committees focused on ESG-related topics work closely with directors and officers so that management and operational personnel remain well-informed about how these topics impact corporate decision-making.
• Make every attempt not to over-claim the company’s climate actions towards net-zero (or other) commitments.
• Review ESG disclosures with marketing, scientific and legal teams to avoid publishing potentially misleading information. That would reduce the climate litigation risk from potential climate-washing claims.

While the courts are deciding the contours of private ESG litigation, market participants should be mindful that ESG remains an enforcement and rulemaking priority for the regulators.

Like all claims based on misrepresentation, the truth is the best defence. If a company can support concrete statements with concrete sustainability efforts and firm data, it is more likely to be able to neutralise and defend potential greenwashing claims.