Directors and Officers face mounting pressure on all fronts, from onerous reporting obligations and an ever more stringent regulatory regime, to stakeholders and shareholders. James Whitaker, Partner and Co-Lead of ESG Practice, Mayer Brown International LLP, examines how changes to the Companies Act could make the current climate even tougher.
Not withstanding the early signs, in certain quarters, of something of a backlash against the rapid growth of Environmental, Social and Governance (ESG) investing, the conduct of those responsible for running companies continues to be scrutinised through an ever-keener ‘ESG lens’.
Environmental sustainability, and the activities and impact of companies in that context, continues to be a highly significant focal point for multiple stakeholders, both within and outside organisations. The remarkable evolution of the legislative and regulatory regimes governing climate disclosures in particular over recent years, principally in the European Union, as well as the United Kingdom, provides an increasingly stringent backdrop against which companies and their directors must now operate. The pace of that evolution shows little sign of slowing.
At the EU level, it is widely expected that the forthcoming EU Directive on Corporate Sustainability Due Diligence will impose an obligation on directors of companies within the scope of the Directive to take into account the “human rights, climate and environmental consequences, including in the long term, of their decisions”. Further afield, whilst their fate presently seems somewhat uncertain, the US Securities and Exchange Commission’s recent introduction of proposed climate reporting requirements also indicates the trend towards tougher regulatory frameworks with regard to sustainability.
In the UK, the recent Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 impose new sustainability reporting requirements (non-compliance with which can result in personal exposures for directors). This represents a clear example of how the UK Government’s Net Zero Strategy (which, of course, was very recently challenged in the High Court), with its focus on climate reporting and disclosure obligations, may play out in the legislative domain.
The regulatory enforcement backdrop is also toughening. Recent announcements of commitments and priorities, and activity, by European and UK financial regulators (ESMA and the FCA respectively), the UK competition watchdog (the CMA), and advertising regulators (for example, the UK Advertising Standards Agency), to name a few, provide clear indications that regulators are focused on how companies are operating, what they are doing, what they are saying, and what they are selling, with regard to ESG-related issues.
The news, in March 2022, of ClientEarth’s prospective derivative action against the Board of Directors of Shell based on allegations of breaches of statutory directors’ duties in the context of climate risks, reflects an emerging litigation risk for company directors in this context also.
Whilst an awareness of the changing legislative and regulatory requirements, and the increasing expectations on companies with regard to climate issues, and the decarbonisation of the economy in particular, is plainly important, there is a clear, positive, role for those responsible for leading companies to play. Campaigns such as the Better Business Act Campaign are actively seeking – with the support of a growing number of signatory companies – revisions to the wording (and scope) of the statutory duty for directors to “act in the way [the director] considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”, to impose more stringent requirements than merely having to “have regard” to various factors.
Earlier this year, the Institute of Directors published its policy paper entitled ‘The Green Incentive: how to put net zero at the heart of business planning’, arguing that in order for the UK Government’s target of reaching net zero by 2050, significant work needed to be done to incentivise businesses, and smaller businesses in particular, to take action to decarbonise the economy. The report made a number of specific recommendations which, whilst aimed at the UK Government, are instructive from the perspective of company directors also, in terms of developing (and likely forthcoming) requirements and expectations.
In particular, the IoD report suggested that, in line with the UK’s decarbonisation targets and with the global United Nations’ initiative to encourage small and medium businesses to commit to decarbonisation targets, a clear goal be defined with regard to all businesses achieving net zero in their operations. Secondly, the report called for incentives around net zero performance, including specifically potentially lower corporation tax rates for businesses that achieve net zero within a specified timeframe (or higher rates for other businesses), to be examined.
Relatedly, it recommended that a clear methodology – and clear requirements to report – be established for businesses’ carbon accounting, which could then be used to determine the appropriate corporation tax band for a given company. Finally, the report recommended a governmental assessment of the existing support frameworks for businesses looking to decarbonise.
Taken in the round, then, these developments provide a clear indication not only of the direction of travel, in terms of the more robust legislative and regulatory framework within which companies are operating, but also of the expectations of company directors, and the role they have to play, in terms of steering their companies towards more environmentally sustainable operations. Whilst ultimately there will be little choice other than to comply with increasing regulatory and stakeholder demands in this context, the evolving landscape also provides a potentially valuable opportunity for business leaders to develop best-in-class practices.