This article was originally published by Latham & Watkins LLP.
As expected, 2021 saw continued emphasis being placed on environmental, social and governance (ESG) issues on a global scale, both at government level and within the private sector. Given the increasing interest throughout society on ESG issues and their importance, we expect this growth trend to continue throughout 2022.
The wide range of ESG topics that are gaining traction worldwide can make it challenging to keep up with and focus on the most salient ESG issues, particularly as new political commitments and legislative proposals continue to be announced across the world’s leading economies and financial centres. This third instalment of Latham’s annual 10 Things to Look Out For blog post highlights the ESG-related developments and trends that we expect to remain in the headlines in 2022.
SEC – When and what to expect
2021 saw the US Securities and Exchange Commission (SEC) place a considerable focus on ESG, and in particular climate change, issues in a way not previously seen. By the end of March, the SEC had already hired its first Senior Policy Adviser for Climate and ESG, created a Climate and ESG Task Force as part of the Division of Enforcement (the Task Force), directed the Division of Corporate Finance to enhance its focus on climate change disclosures and sought input on any such climate change disclosures in the form of a public consultation.
These actions were followed in June 2021 by the inclusion on the SEC’s Spring 2021 regulatory agenda of proposed rule amendments for enhanced climate disclosure obligations on companies, backed by public remarks from SEC Chair Gary Gensler requesting that such a mandatory climate risk disclosure rule be mandated “by the end of ”.
However, to date, the SEC has not revealed any such mandatory climate risk disclosure rule, and it appears as though the timeframe has slipped to early 2022. This may in large part be due to the heavy scrutiny that any such rule will be placed under – the public consultation saw multiple responses indicating that any rule will be challenged in court for being outside the SEC’s remit, and the progress of the proposed rule and any such litigation will be closely monitored throughout 2022.
In addition to the announcement of the proposed climate risk disclosure rule, 2022 will likely see the Task Force continue it work in relation to ESG enforcement actions. In September 2021 a sample comment letter was produced on the SEC website requesting information on various ESG issues, demonstrating the type of queries that issuers could receive in relation to ESG matters, and it was further reported by the Wall Street Journal that the SEC has sent tailored comment letters to “dozens” of companies relating to their climate change disclosures. This increasing appetite of the SEC to intervene in relation to climate disclosures is likely to continue to grow in 2022 given the continuing uptick in investor demand for ESG information, and any developing trends in these interactions will be closely monitored.
China – Uyghur Forced Labor Act
23 December 2021 saw the signing into law by President Biden of the Uyghur Forced Labor Prevention Act (UFLPA). The UFLPA represents a significant expansion of historic US restrictions on items imported from, or with links to, the Xinjiang Uyghur Autonomous Region (XUAR) (which were previously limited to bans on specific categories of items and items produced by specific suppliers), in relation to purported human rights abuses against Uyghurs and other ethnic minorities in the XUAR.
The UFLPA imposes a rebuttable presumption against imports from, or linked to, the XUAR, effectively prohibiting their import into the US unless it can be clearly demonstrated by the importer that the item was produced free from forced labor or human rights abuses. The UFLPA requires the Forced Labor Enforcement Task Force (an existing entity established in 2020) to develop a strategy (the Strategy) to prevent the import of goods produced using forced labor in China. This Strategy will include guidance for importers on measures they may adopt to ensure that their Chinese-origin products are created free from forced labor, and also requires the Forced Labor Enforcement Task Force to produce a number of lists of entities and products that are linked to forced labor in China.
This Strategy, including the guidance and lists of products and entities, is required under the UFLPA to be released by mid-2022, and will hopefully provide further clarity to importers of Chinese goods and those who use such goods in their supply chains as to how the UFLPA will directly impact their business, particularly in sectors such as silica and cotton where the XUAR plays a key role in global supply. For more information on the UFLPA, please see our blog post detailing the requirements of the Act.
Supply chains – Tracking new legal proposals
The implementation of the provisions of the UFLPA is far from the only legislative development focused on ESG issues in companies’ supply chains that we expect to see in 2022. The European Commission is expected to propose formal draft legislation during early 2022 on a mandatory supply chain due diligence law, which will be based on the recommendations of the European Parliament who adopted the text of a draft directive in March 2021.
At a national level, 2022 will see Germany continue the process of implementing its Supply Chain Act, which will require German companies with more than 3,000 employees worldwide (or 1,000 employees from 2024) to use their best efforts to prevent violations of human rights in their own business operations and in their supply chains. The law will also require German companies to conduct audits on their direct suppliers and extend risk analyses / risk mitigation measures to indirect suppliers to the extent a company obtains substantial knowledge of a possible human rights or environmental violation.
We expect to see more proposals for similar laws in different jurisdictions continue to be developed over the course of 2022, leading to an increased compliance burden on companies operating worldwide. To help meet this challenge, we also expect in parallel to see the continuing development of technological solutions that companies can utilise to perform diligence on their supply chains, and ensure that they remain in compliance with the developing requirements.
The global transition towards more renewable and sustainable sources of energy is likely to continue at pace in 2022, with renewables projects worldwide continuing to be built and developed. However, the events of late 2021, with issues across Europe and the world in relation to supply shortages of natural gas and resulting elevated energy prices, means that it will be interesting to note how considerations relating to energy security and affordability impact the pace of the transition in 2022.
It has been widely acknowledged that, to ensure a fair, just and timely energy transition, technology will need to continue to improve across a wide variety of areas, from battery storage to advancements in hard to decarbonise industries such as steel and cement. How these innovations and improvements continue throughout 2022, both in terms of the development of new technologies but also the refining of existing technologies to a point where they become economically viable at scale, will be of interest to governments, investors and wider stakeholders worldwide.
It can be expected that the pace of ESG-related litigation will continue to grow amid increasing interest in companies’ ESG performance and higher expectations from stakeholders regarding ESG matters. Such litigation is likely to cover a broad and growing range of ESG factors, including climate change — which has thus far taken centre stage and will likely remain a key theme, particularly in relation to companies in heavy emitting industries.
As noted above, supply chain issues, especially given ongoing legislative developments in the US and EU, are likely to play a growing role in non-climate change related ESG litigation, and greenwashing claims both from regulators and private stakeholders may increase as green marketing and ESG commitments become ever more important to consumers and investors. Climate change litigation may also continue to grow in scope, as public and private entities providing the financing of highly emitting companies and/or infrastructure projects face increased scrutiny in relation to their role in such activities, and whether it aligns with their publicly stated commitments.
In addition, given the notable successes of 2021 in relation to the climate-related proxy battles, we expect to see more such campaigns wages over the course of 2022, with activist investors seeking to impact the ESG-related policies of high emitting companies through shareholder action.
Boards and senior management may wish to continue to develop their ESG strategies and look at mitigation measures and stakeholder engagement strategies to seek to address ESG litigation risk.
COP26, held in Glasgow in November 2021, was met with mixed reviews as to its success in achieving progress towards limiting global temperature increases to acceptable levels, with the resulting Glasgow Climate Pact (the Pact) establishing a number of new commitments by parties (see our blog post on our key takeaways from being on the ground in Glasgow).
Perhaps most significantly for the purposes of 2022, parties to the Pact agreed to submit updated or revised Nationally Determined Contributions (NDCs) ahead of COP27 (which will take place in Egypt in November 2022). NDCs outline the efforts by each party to reduce national emissions and adapt to the impacts of climate change. The timeframe for updated NDCs is shorter than envisioned under the Paris Agreement, and the Pact requested that parties’ targets in their NDCs be strengthened, signalling the increasing efforts in accelerating the pace of the transition.
COP27 itself promises to also raise a number of interesting discussions, most notably on some of the issues where elements of public perception and pressure from NGOs have been of the view that COP26 did not go far enough, including in relation to compensation to be paid to developing countries in relation to loss and damage from climate events, and whether developed countries reach their target of providing $100 billion per year in climate finance to help developing countries finance their transition. Early indications suggest that the topics of green and climate finance, both in relation to the public and private sector, will play a key role in discussions at COP27, and therefore the development of the narrative and discussions surrounding these topics over the course of 2022 will be of considerable interest.
The EU Taxonomy, a classification system which establishes a list of environmentally sustainable activities according to the EU, is set to go live on 1 January 2022. The technical screening criteria (TSC) for two of the six environmental objectives (climate change mitigation and climate change adaptation) are in place, meaning that disclosures from companies and financial institutions can commence.
The EU Taxonomy is far from in its finished form however, with the TSC for nuclear and natural gas currently not included for political reasons, and the TSC for the other four environmental objectives yet to be formally approved following a call for feedback that closed in September 2021. 2022 will therefore be a notable year for the EU Taxonomy, not only in relation to seeing the impact and requirements of Taxonomy-aligned disclosures in practice, but also with respect to continuing political and legal developments in relation to nuclear and gas power. The EU is also due to report back on a potential extension of the environmental objectives in the Taxonomy, and the possible creation of a Social Taxonomy in 2022.
Outside of the EU, other jurisdictions are continuing to consider the implementation of environmental taxonomies, including the UK, which has indicated that it will consult on the TSC for its climate change mitigation and climate change adaptation objectives in Q1 2022.
Reporting – ISSB/Rating Agencies to regulated?
Investors’ calls for greater availability of corporate information on ESG matters have been growing for several years, but there have often been frustrations with respect to the lack of a unified global ESG standard, leading to challenges with comparability of data.
In 2021, the IFRS Foundation announced the creation of the International Sustainability Standards Board (ISSB), which aims to address these concerns by producing an authoritative set of standards and consolidating two of the leading sustainability standards organisations (CDSB and the Value Reporting Foundation) to form one leading body. The ISSB, chaired by former Danone Chair and CEO Emmanuel Faber, will consult on proposed general disclosure requirements in Q1 2022, and the process of attempting to form a globally recognised standard will continue to develop throughout the year. For more information in relation to the remit of the ISSB, please read our blog post.
Scope 3 emissions – Fit for Purpose?
One particular aspect of ESG reporting that has become, and will likely continue to become, more popular in 2022 is the reporting of companies’ greenhouse gas inventories. This particularly the case in jurisdictions such as the UK, where reporting in line with the recommendations of the Task Force on Climate-related Financial Disclosures will be mandatory for a considerable number of companies.
When reporting emissions, companies tend to split their emissions into three categories, or Scopes, as identified by the leading framework in this area, the Greenhouse Gas Protocol. These Scopes categorise emissions as direct emissions form the company (Scope 1), emissions from the electricity, heating and cooling that the company uses (Scope 2), and all other indirect emissions from the company’s value chain (Scope 3).
As mandatory requirements to report emissions, and in particular Scope 3 emissions, continue to develop in 2022, it will be interesting to note how companies engage with Scope 3 reporting. Aside from the fact that a company in practice often has limited control over its Scope 3 emissions (as the emissions are stemming from the activities of business partners and not the company itself), Scope 3 emissions can be challenging to accurately record given the diverse and widespread nature of the emissions sources. As a result of this, companies that currently report their Scope 3 emissions do so in a wide variety of methods, that lead to results being challenging to compare at best. In addition, Scope 3 emissions can often be double counted as a result of overlapping supply chains, including in some cases where the same emissions can be reported twice by the same company, and others where a company may have to report Scope 3 emissions at a higher level than the amount of greenhouse gas actually emitted into the atmosphere (e.g. if carbon capture technology has been utilised).
These inconsistencies in the frameworks underlying Scope 3 reporting have not caused significant issues to date, given that Scope 3 reporting has been voluntary and only undertaken by a limited subset of companies. However, as climate reporting becomes increasingly popular with investors, and in many cases mandatory, in 2022, increased scrutiny on the methodology behind Scope 3 reporting may lead to questions being asked about required revisions to the framework or the role of Scope 3 emissions in mandatory reporting.
2022 will likely see a continued focus on diversity, equity and inclusion (DEI) matters throughout the public and private sector. In a World Business Research study conducted in late 2021, it was found that 79% of organisations across a variety of industries were planning to allocate more budget and resources to DEI in 2022 than in 2021, demonstrating the increasingly important role DEI is having across businesses.
Key to DEI initiatives in 2022 will be the approach taken by companies in relation to remote and/or flexible working, with companies facing the possible challenge of ensuring that employees who choose to embrace remote working more fully are not disadvantaged by their lack of time spent in the office. We also expect to see further focus placed on diverse employee retention and development.