Going Long & Short with ESG: A Case Study on an International Cruise Lines Stock
July 29th, 2020 | Jessica Clark Barrow
As investors have called for more transparent and harmonized sustainability data in recent years, regulators in major markets are introducing a rising number of mandatory reporting requirements for certain types of entities. Combined with existing legislation, these rules have intensified ESG-related litigation risk for reporting entities.
A growing number of lawsuits on the basis of ESG statements in securities filings, including bond offering documents, have been filed against corporations and governments. A stakeholder’s right to pursue civil remedies varies depending on jurisdiction, but the scope of information that can form the basis of a lawsuit is expanding with greater inclusion of ESG. In the credit market, this includes sustainable finance frameworks, sustainable bond documentation, and any other sustainability information contained in material related to the solicitation of investment. A potential liability occurs when sustainability disclosures are false, misleading, or cannot be substantiated, causing financial harm to an investor.
The US provides the most scope for investors to sue based on information in securities documentation, including ESG statements in securities filings. The size of the US’s financial market means that non-US entities can be subject to litigation in the US, including those that do not have a physical presence in the country. In addition, legal developments in several countries have increased the amount of litigation taking place in other markets. Australia is the second-largest jurisdiction for corporate class actions after the US, with 20% of global cases related to shareholder claims, according to data from Allens law firm.
Climate-focused lawsuits are the most common type of ESG-related litigation. Most fall into one of three categories:
- Suing a government over climate change policies; seeking damages or a change in law;
- Suing a corporation for contributing to climate change; seeking damages or a change in its operations, practices, or strategy; and
- Suing an entity over misleading climate claims in securities documentation; seeking damages or a change in its operations, practices, strategy, or law.
About 1,800 climate change lawsuits have been filed to date, and most cases have a government as defendant – about 75% of all cases in Australia and the UK, and 88% of US cases in 2020 and 2021, according to the Grantham Institute and the Sabin Center for Climate Change Law. Most cases are brought by NGOs on behalf of a community, on the basis that a government has failed to mitigate climate change. Lawsuits against governments in Colombia, France, Ireland, Mexico, Nepal, the Netherlands and Spain have been decided in favour of environmental groups and resulted in policy changes on emissions, national climate plans and renewable energy.
Within corporate litigation, climate change is a small but growing subject. Sectors with sizeable emissions impacts, such as oil and gas, utilities and vehicles are most often targets of corporate climate litigation. In 2021, Dutch courts ruled against Royal Dutch Shell plc (AA/Stable) in a landmark class action suit (Milieudefensie et. al. v Royal Dutch Shell plc), requiring the company to reduce its Scope 1, 2, and 3 emissions by 45% by 2030. Shell has filed an appeal. There are several active cases by US state and local governments against oil and gas companies that have yet to be decided or are under appeal.
Among securities lawsuits, judges have not consistently agreed with investors that financial losses due to climate-related issues were intentional or avoidable by the plaintiffs – although cases seeking policy changes rather than compensation, or those with corresponding criminal/regulatory enforcement actions, have been more successful.
In our view, the main consequences of climate lawsuits against governments are regulatory and policy changes that could significantly alter the operating environment for carbon intensive industries. We do not see a direct link between climate lawsuits and credit risk impact for sovereign or public finance issuers themselves at this time. For lawsuits against companies, a ruling leading to a change in business strategy or operations would have a greater effect on medium- to long-term credit profiles than financial settlements or fines.
While there has been a heavy focus on environmental-related litigation, the development of the sustainable finance field is likely to determine which ESG issues feature in lawsuits. Regulations targeting modern slavery, deforestation, labour conditions, and supply chain due diligence will increase the amount of reporting on these subjects. While most ESG-related securities class action lawsuits have a climate or environmental basis, societal trends can influence year-to-year swings in certain areas – for example, six securities class actions in the US related to workplace discrimination, harassment, or abuse in 2018 following the emergence of the #MeToo movement in the previous year.
The growing importance of social factors within corporate sustainability frameworks may create new areas where investors or consumers identify gaps between disclosures and practices. Areas that could see increased ESG-litigation in the coming years include consumer greenwashing, data privacy, labour-related issues, and health and safety.
The main risks to issuers from the rising incidence of ESG-related litigation are not financial but strategic and operational, as many ESG lawsuits seek structural changes in business practice rather than financial restitution.
RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.
Author
Nneka Chike-Obi
Director, ESG Research
Sustainable Fitch
