Even in a pandemic, maintaining a focus on ESG compliance is critical

The COVID-19 pandemic has justifiably absorbed management and board attention, but environmental and other activist groups have not shifted their focus during the lockdown.

Despite the coronavirus, climate change and environment organisations remain attentive, so corporations cannot allow their environmental, social and governance (ESG) agenda to stagnate.  

Managing business survival during the pandemic, and ensuring compliance with ESG policies, are not mutually exclusive goals.  

Significant risk lies in corporations taking an eye off the ’compliance clock’ while distracted with COVID-19 responses and impacts.

Evidence of activism mounts

In March 2020, the Rainforest Alliance Network (RAN) released its ‘Banking on Climate Change’ report into the financing of the fossil fuel industry by 35 private-sector banks. It found that since the Paris Agreement in 2016, banks, including JPMorgan Chase, Barclays and Bank of China, had funded US$2.7 trillion worth of fossil fuel projects. RAN has now called for an immediate end to the financing of fossil fuel expansion and real commitment toward the phasing out of fossil fuel financing.

Even in the midst of the COVID-19 pandemic, reports like these are not going unheard, with large investment groups urging companies to maintain their attention on reducing carbon emissions, as shareholders strive to see their investments protected against the anticipated risks of climate change.

According to Stockhead, the incidence of shareholder activism in Australia doubled in 2019 and despite the pandemic, the appetite of environmental activists does not appear to have been dulled in 2020. Already this year, several resolutions have been brought by shareholder advocacy groups like Institutional Shareholder Services (ISS), Australasian Centre for Corporate Responsibility (ACCR) and Market Forces calling upon Australian corporations to set Paris Agreement-aligned emissions reductions targets, particularly in the area of scope 3 emissions.

While few climate-related resolutions have found favour with the majority of investors, support is growing and the status quo is shifting. This response is being hastened by the Australian Securities and Investment Commission (ASIC), after it announced in December 2019 that it would begin targeting ASX-listed companies which fail to adequately report on their exposure to climate-related financial risks.

The growing trend of investor-backed climate motions is unlikely to dissipate, as investment groups like ISS and the ACCR continue to drive investor action on climate change.  

Litigation is also in the toolkit

AGM’s are not the only fora for action. The ACCR has pursued legal action in the past. In 2016, ACCR unsuccessfully sought a declaration from the Federal Court that a proposed resolution regarding greenhouse gas emissions could be validly moved.

The ongoing litigation between Mark McVeigh and Retail Employees Superannuation Trust (REST) is likely to influence future climate-related legal challenges. If successful, superannuation fund trustees would be legally obligated to consider the climate risks of their investment activities.

For the first time in Australia’s legal history, a coal mine is being challenged on human rights grounds. On 13 May 2020, the Environmental Defenders Office (EDO), acting on behalf of Youth Verdict, lodged an objection to the proposed Galilee Coal Project in Queensland’s Land Court against Clive Palmer’s company Waratah Coal.

Among other things, the EDO alleges that the proposed mine violates the right to life, recognised under the newly created Queensland Human Rights Act 2019 because of its adverse contribution to climate change. If successful, the Youth Verdict case could pave the way for similar challenges, particularly in States and Territories with similar legislation, like Victoria.

Increasing litigation over climate change is another sign that corporations should not take their focus off the environment. The recent introduction of the Liability for Climate Change Damage (Make the Polluters Pay) Bill 2020 (Cth) (Bill) has the potential to further magnify the legal challenges confronted by Australian companies.

While its prospects of successful passage through Parliament are not high, the Bill seeks to make any fossil fuel company potentially liable for climate change damage if it has emitted more than one million tonnes of emissions in any 12 month period since 1 September 1990.

In NSW, the EDO, acting on behalf of Bushfire Survivors for Climate Action, launched a Class 4, civil enforcement, proceeding, in the NSW Land and Environment Court against the NSW Environment Protection Authority (EPA).

The EDO alleges that bushfires have become more frequent and intense as a result of climate change. They say the EPA has a legal obligation under the Protection of the Environment Operations Act 1997 (NSW) to take action in relation to climate-related issues, including by controlling greenhouse gases. As a consequence, the EDO is seeking orders to compel the EPA to develop a policy with respect to greenhouse gas emissions.

It’s happening elsewhere too

Australia is not the only place where the heat is rising on corporations. In February 2020, it was announced that Poland’s last planned coal plant would no longer proceed, after ClientEarth, one of the world’s leading environmental law charities, successfully litigated two cases against the plant’s co-sponsor, Enea.  

ClientEarth is now pursuing Europe’s largest coal plant, Bełchatów power station, demanding that the plant eliminates all carbon emissions by 2035.

The US leader in shareholder advocacy, As You Sow, has reported that despite attempts by the US Securities Exchange Commission (SEC) to stifle climate-related resolutions, climate change continues to be the dominant environmental topic in 2020.

On 19 May 2020, shareholders of JP Morgan Chase, America’s largest bank, narrowly lost a vote which saw 49.6% of investors demand that Chase disclose the carbon emissions of all companies to which it makes loans.  While the vote did not succeed, it has sent a strong message to climate investors.

In Norway, the response to climate change has been even more profound. Changes introduced by Norway’s Parliament in June 2019 mean that Norway’s US$1 trillion wealth Fund can no longer invest in companies that mine more than 20 million tonnes of coal per year or generate more than 10 gigawatts of power from coal. The Fund also excluded four Canadian oil companies for producing excessive greenhouse emissions. Further exclusions are expected.

Regulatory risk

Even against this background, with many companies under pressure to merely remain viable, environmental compliance obligations can easily slip down the agenda.

This would seem to even have been encouraged in the USA.  In response to the overwhelming financial impacts of COVID-19, the United States Environmental Protection Agency has suspended its enforcement of environmental regulations. It announced it will not expect or enforce regulatory compliance relating to pollution during the pandemic, nor later pursue companies with penalties, so long as the entity can demonstrate that any non-compliant activity was caused by COVID-19.

Australian businesses do not enjoy the same degree of leniency, although Victoria has delayed commencement of its significant environmental protection legislation, and other regulators have hinted at a more accommodating exercise of discretion when applying prosecution guidelines.

The financial (and reputational) cost of non-compliance remains high. For example, in NSW, a factor in sentencing for breach of the Protection of the Environment Operations Act 1997 is whether the offender’s conduct resulted in financial gain. Negligent behaviour is treated as severely as deliberate offending in some offences, such as the harmful disposal of waste under s 115.  

There is an upside

As demonstrated by the success of companies focused on ESG compliance during the Global Financial Crisis (GFC), increased engagement with these policies may be key to businesses not just surviving but thriving throughout the pandemic and its aftermath.

It is already evident that the COVID-19 lockdown will cause an even more severe economic downturn than that experienced during and after the GFC. Nevertheless, as the most recent rapid global economic downturn, the GFC is a highly relevant yardstick in analysing the relationship between business survival during crises and their management of ESG issues.

A 2016 study by Harvard University found that American companies with good ESG policies achieved ’above average’ financial performance for the 2008-9 financial year. They experienced a 40-45% lower cost of debt than their counterparts.

The study suggested that companies which focused on ESG did not experience the significant declines in share price which their industry peers did during the crisis, being better prepared for sudden industry changes. In 80% of the companies studied, there was a link between sustainability practises and increased share price performance.

Perhaps more importantly, the GFC refocused individual and shareholder attention on corporate ESG responsibilities (see Morningstar research).

This is demonstrated by the significantly increased popularity of ethically managed funds following the GFC, with assets under management in ESG portfolios growing by 25% between 2014 and 2016 to an estimated US$23 trillion by the start of 2016.

ESG compliance may be essential in not only mitigating poor financial performance but in improving it during times of turbulence.

ESG – a line of white pebbles through COVID-19

The market disruption caused by COVID-19 presents an opportunity to implement and expand corporate ESG policies.  

The fragility of supply chains could not have been more starkly demonstrated than over the past few months of pandemic-related disruption. For this reason alone, companies are well advised to use this time to review, identify and mitigate against strategic and operational risks.

The ‘S’ in ESG has also emerged as an important consideration for companies. In March 2020, a group of investors representing more than USD8.2 trillion in assets called upon corporations to provide paid leave, prioritise health and safety and retain jobs.  There is a growing recognition that social issues caused by the pandemic constitute a real investment risk.

From a supply chain perspective, not only human risk factors but also issues such as natural resource depletion, human rights violations and corruption are being increasingly subject to regulator and consumer attention. COVID-19 is an opportunity for corporates to align their assets to organisational values, minimise their headline risks and enhance their reputations. 

Companies which incorporate ESG principles avoid risk by investing in activities with long-term growth prospects which will not be weakened by future market disruptions such as climate change.  

A 2019 report from the Responsible Investment Association Australasia indicated that ’responsible investing’ funds already outperform mainstream funds over most asset classes and time frames. Credit Suisse has forecast that stocks with poor ESG credentials will eventually trade at a discount.  

An analysis undertaken by investment bank, HSBC, has revealed that shares in ESG-aware companies have outperformed non-ESG companies during the COVID-19 pandemic by as much as 7%.

In the economic aftermath of COVID-19, investors will be looking to see how businesses have identified and mitigated future risks, in order to preserve and enhance their value.

Taking a lead

With the public’s increasing preference for carbon-neutral industry, the current market disruption provides an excellent opportunity for businesses to review their compliance practices and ESG policies, to take competitive advantage.  

Perhaps even more significantly, updating these policies and ensuring that there is no loss of focus on the compliance framework is critical in developing companies’ risk tolerance and resilience.

Communities, regulators and shareholders are unlikely to be particularly forgiving of those who allow their compliance focus to slip.