Directors' Outlook 2023: ESG

'ESG' has been something of a buzzword for some time now, acting as an umbrella term for a broad range of issues. There are numerous reasons that businesses are putting ESG at the heart of decision-making policy - the need to comply with legislative and regulatory changes, to improve reputation and brand positioning, to attract investors, and indeed employees, to name a few.

The relative importance of each of these factors will vary from business to business and this was reflected in the results of a survey we recently conducted in partnership with TRI Strategy which asked businesses how they are approaching ESG. The reality for all businesses is that the pressure to examine ESG practice and policy with a view to achieving 'better business' is becoming more acute.

What we are expecting to see in 2023

Corporate governance

The need for compliance with statutory regimes is a key driver for change. In 2023, the Economic Crime and Corporate Transparency Bill, the second part of a legislative package designed to prevent the abuse of corporate structures and tackle economic crime, will be front and centre for directors. The Bill introduces reform of identity verification requirements for new and existing company directors. Existing directors will have a period within which to comply and failure to do so could result in criminal proceedings, a civil penalty and/or disqualification. The Bill also creates a new offence for an individual to act as a director unless the relevant company has notified Companies House of the appointment and confirmed that the director's identity has been verified.

Greenwashing and corporate sustainability

Impressive sustainability credentials have proved to be successful marketing tools, with sustainability becoming increasingly important to consumers and investors. The trend has though led to accusations of so-called 'greenwashing'. On 25 October 2022 the FCA launched the CP22/20 consultation on Sustainability Disclosure Requirements and investment labels with the aim to tackle greenwashing in the financial services sector – regulated firms making exaggerated, misleading or unsubstantiated sustainability claims about their products.

Significant new disclosure requirements are proposed where sustainable investment labels are used. Accessible consumer facing disclosures will be required to enable consumers to understand sustainability-related product features, as well as more detailed disclosures targeted at a wider audience such as institutional investors, and a general 'anti greenwashing' rule. There will be no obligation to use the labels, but where they are not used, naming and marketing restrictions will apply, limiting how products can be described with respect to sustainability factors. The final rules will be published at the end of June 2023 with the greenwashing rule having immediate effect and the disclosure requirements being phased in from 30 June 2024.

Separately, the Corporate Sustainability Reporting Directive ("CSRD") was approved by the EU Council at the end of November 2022 with the intention to ensure that companies report reliable and comparable sustainability information that investors and other stakeholders need. The CSRD will need to be transposed into national laws of EU member states and the reporting obligations will be phased in from the beginning of 2024. The rules also apply to large EU undertakings but also non-EU companies with substantial activity in the EU market (€150m in annual turnover in the EU) and at least one subsidiary or branch in the EU, as well as companies where it or any or its subsidiaries have debt or equity securities listed on an EU regulated market.

Shareholder action and the Better Business Act

2022 saw activist shareholders, Client Earth, take steps towards a derivative action against Shell's Board of Directors on the basis that the Board has failed to adopt and implement a climate strategy that aligns with the Paris Agreement goal to keep global temperature rises to below 1.5°C by 2050. Client Earth argue the Board is in breach of duties under sections 172 (to promote the success of the company for the benefit of its members as a whole) and 174 (to exercise reasonable care, skill and diligence) of the UK Companies Act.

S172, in particular, compels directors to have regard to factors including the impact of the company's operations on the community and environment. While the provisions are ripe for use by activist shareholders against directors failing on ESG, the "Better Business Act" campaign seeks to go further, proposing legislative change to s172 which would require directors to seek to align the interests of wider society and the environment alongside the interests of shareholders.

Our survey indicated that there is awareness of the risk for directors in this area, with a 60% majority of participants confirming that they understood the relationship between ESG policy and duties under s172. Even without the Better Business Act amendments, if directors want to effectively manage ESG risk, they will need to have the expectations of a range of stakeholders as well as simply compliance and governance in mind. A failure to do so, that causes financial loss to the company, will expose directors to the risk of derivative action and we expect see further instances of such claims.

Steps you can take to manage the risks

• Ensure that you have a clear understanding of your statutory obligations as a director and be aware of incoming legislative and regulatory changes.
• Make ESG central to decision making in your business. Enshrine ESG considerations in your policies and practices. 
• Identify key stakeholders for your business and their expectations when it comes to ESG. This will help inform ESG policies as well as informing strategy in key areas, including marketing and recruitment.
• Think about what success will look like for your business when it comes to ESG and decide upon benchmarks against which to measure progress.

The final word

Despite predictions for the economy in 2023, with recession looming, we found that ESG remains a priority for company directors, and rightly so. Impressive ESG credentials have previously been seen as way to set your business apart, a marketing strategy, but increasingly decision makers need to recognise that engaging meaningfully with ESG is about risk management. We see time and again, and very recently in the collapse of FTX, that poor governance is often at the root of, and exposed at the time of, business failure. Conversely, establishing effective ESG policy and practice is becoming an essential measure of business performance; successful businesses will be built upon good decision making and good governance.