The rise of ESG: considerations for directors18 July 2023
- ESG-related regulation and enforcement activity in Australia has expanded significantly, in line with the rise in prominence of these issues.
- Understanding ESG issues is the first step to developing a strong ESG strategy allowing directors to understand the impact of the company’s operations on the environment and community, and the ESG regulatory trends and risks that may impact the company, including around shareholder activism.
- Where environmental claims or disclosures are false or are not able to be substantiated, companies run the risk of offending under Australian Consumer Law. Directors should be aware of the potential for any false or unsubstantiated claim to also give rise to personal liability risks.
In the fourth episode of the Series, we explained how directors of companies are bound by a number of duties, both under the general law and as codified in the Corporations Act 2001 (Cth) (Corporations Act).
Part of discharging those duties involves directors identifying, considering, and ensuring their company properly manages environmental, social and governance (ESG) issues.
The rise of ESG
ESG refers to a set of frameworks used to assess activities that may impact on or present an opportunity to a company across the three broad categories of “environmental”, “social”, and “governance”. In other words:
- (E) – how does the company treat the environment?
- (S) – how does the company treat employees, consumers and the community?
- (G) – how is the company being run?
ESG issues have become increasingly prominent in recent years, and we have seen a significant expansion in ESG-related regulation and enforcement activity across Australia, particularly in relation to reporting and disclosure.
ESG are important issues for all companies, with the effective management of ESG concerns and opportunities now a key business objective. Apart from the risk of exposing themselves and their companies to financial and reputational risk as well as to regulatory action where ESG issues are not properly considered, directors must also be mindful of stakeholder expectations. Stakeholders will be keeping a close eye on how companies respond to ESG-related concerns and also how the operations of the company potentially contribute to ESG impacts.
A director’s role
Companies and directors need to be across the different ESG issues, requirements and expectations that apply to each company, its activities and the industry in which it operates. Understanding ESG issues is the first step to developing a strong ESG strategy allowing directors to understand the impact of the company’s operations on the environment and community, and the ESG regulatory trends and risks that may impact the company.
Understanding the risks associated with greenwashing
A particular area of ESG risk for directors is “greenwashing”. Greenwashing involves misrepresenting or overstating a company’s environmental credentials or positive environmental impacts.
With companies now facing pressure from investors and consumers to make net zero commitments, establish and implement energy transition strategies, companies may feel pressured to make environmental claims about their products, services, and operations. Similarly, market expectations around ESG reporting are increasing, particularly regarding disclosure of climate change-related risks and impacts. Where those claims or disclosures are false or are not able to be substantiated, companies run the risk of offending under the prohibition on misleading and deceptive conduct under Australian Consumer Law (ACL). Committing an offence under this legislation can carry heavy penalties.
While it is important that companies provide accurate, detailed, and transparent disclosure of the ESG risks relevant to the company and how it is responding to those risks, directors should be aware that these disclosures have the potential to give rise to personal liability risks for their involvement in the company’s misleading and deceptive conduct and false or misleading statements.
Overstating a company’s climate credentials or understating its exposure including unrealistic representations about net zero goals or emission reduction targets are some examples of the kind of matters that may expose companies and directors to action by regulators.
To safeguard against the risk of greenwashing and to avoid regulatory scrutiny, directors should ensure all ESG-related claims, commitments and disclosures to the market are clear, accurate and can be substantiated.
Litigation and shareholder activism
Shareholders want assurances that a company they have invested in reflects their values, and where that is not the case, they may seek to influence corporate decision-making through shareholder activism.
ESG-related litigation and shareholder activism is increasingly common, with shareholders demanding responsible business conduct and that directors recognise the financial and operational risks to the company of not adequately responding to ESG issues. In particular, there has been a significant increase globally in climate-related litigation, mainly due to increasing urgent calls for responses to climate change and growing stakeholder awareness of ESG issues.
It is imperative that companies keep up to date with trends in shareholder activism and trends in corporate governance to reduce the risk of shareholder activism by identifying ESG risks, communicating openly with shareholders and specifically addressing their concerns.
Companies and directors must recognise and understand the increasing attention being given to ESG issues, and the associated regulation and risks arising from this attention, and work to address the following priorities:
- strengthen and improve standards of governance and disclosure
- take steps to avoid the practice of greenwashing
- ensure that standards remain high when it comes to ESG compliance, and
- prepare for the broader evolution of the ESG space and future regulatory enforcement.
 Australian Securities & Investments Commission, ‘ASIC highlights focus areas for 30 June 2022 reporting’ (Media Release 22-124MR, 1 June 2022).
 Australian Securities & Investments Commission, ‘ASIC announces Enforcement Priorities for 2023 (Media Release 22-302MR, 3 November 2022) (‘ASIC Enforcement Priorities for 2023’).
 Joe Longo, ‘ASIC Chair’s AFR ESG Summit speech’ (Speech, AFR environmental, social, and governance (ESG) Summit, 5 June 2023) (‘ASIC Chair’s Summit speech’).
 ACL, s 18.
 ASIC Enforcement Priorities for 2023.
 Australian Securities & Investments Commission, ‘How to avoid greenwashing when offering or promoting sustainability products, Information Sheet 271 (INFO 271, June 2022).
 ASIC Chair’s Summit speech.