This article is free, but to access more of our content, you can sign up for a no strings attached 28-day free trial here.
Part 1 of a two-part special series on the rise of ESG within international law firms
Environmental, Social and Governance (ESG) Law is “hot” according to Legal Cheek, the legal news website.
Seven hundred would-be lawyers clearly thought so when they tuned into a recent Linklaters ESG recruitment webinar. Alan Jope, Chief Executive Officer of Unilever, recently described ESG as a “talent magnet”.
ESG is also now accepted as central to legal, corporate and financial risk assessment. A principal reason is that there has been an explosion of related regulation at national, supranational and international levels. Growth is estimated at over 100 per cent between 2015 and 2018, according to Datamaran.
Companies and financial institutions cannot now ignore the importance of the impact of ESG on profitability and so require legal advice in assessing ESG risks, and law firms have stepped up to the plate.
Until 2018 though, very few could be said to have had integrated ESG legal practices.
Since then, there has been a tectonic shift. A 2020 desktop survey of law firms and ESG carried out by The Blended Capital Group (TBCG), and to be launched at the UNCTAD World Investment Forum in December, identifies over 50 firms worldwide that now offer integrated ESG advice. These law firms include Magic Circle firms, International, US, UK, European, Australian, and boutique law firms.
The object of this series of articles on ESG, law firms and the newly launched TBCG ESG and law project is to examine the reasons why law firms have begun to develop their integrated ESG capabilities.
The rise of ESG in law firms
It is now 15 years since the publication of the Business in the Community Report on The Top 50 UK Law Firms and Corporate Responsibility and the Freshfields Report for the United Nations on the integration of ESG considerations into financial investment decision-making. The Freshfields Report, which challenged the then market orthodoxy that consideration of ESG by pension funds and other financial institutions and intermediaries in investment decisions was unlawful or a breach of fiduciary duties, is widely acknowledged as a game changer. In 2014, the UK Law Commission’s report on the Fiduciary Duties of Investment Intermediaries agreed with its main conclusion that it was not a breach of fiduciary duties for pension funds to have regard to ESG considerations in investment decision-making, and in some cases the discharge of fiduciary duties required ESG considerations to be taken into account. The Law Commission Report effectively ended a rearguard action by some financial institutions against the findings of the Freshfields Report.
What is an integrated ESG legal practice?
Law firms which hold themselves out as providing integrated advice on ESG risk assessment generally define ESG issues as comprising nine interrelated areas:
Around these issues, lawyers from different legal disciplines cluster. Typically they are drawn from environmental, corporate governance, litigation, capital markets, finance and pensions groups.
Drivers for change
Despite the Coronavirus pandemic, 2020 has been the biggest year by far for ESG in investment. But why, in the midst of a pandemic, should investors and asset managers be divesting billions in unfriendly ESG companies and investing billions in companies that are ESG compliant? This is a conundrum that deserves to be unravelled.
As is the difficult question as to why law firms around the globe are investing heavily in bespoke advice on ESG matters, leading to an apparent worldwide surge in ESG amongst law firms. For that there are very different motives and explanations. Amongst the more important are the acceptance by Chief Executive Officers of leading US companies and financial institutions and elsewhere of a New Paradigm for the role of the corporation; the tsunami of regulation that threatens to overwhelm General Counsel (GC); the consequential need of corporations and GC for high-level expert advice on a rapidly changing ESG legal landscape, and the response of law firms to meet their needs and prevent their clients falling into ESG bear-traps.
Two current examples of divestment in unfriendly ESG stocks by major investors are instructive. First, the $1tn Norwegian Government Pension Fund Global (the Oil Fund) began divestment of its shareholdings in fossil fuel and mining stocks in 2019 and is now seeking to reinvest in more ESG-friendly companies. Second, after 5 years of sustained protests and demonstrations by students and academics, Cambridge University’s £3.5bn Endowment Fund finally committed on 1 October 2020 to divest all direct and indirect investments in fossil fuels by 2030.
On the ‘investment’ side, EPFR, the financial data company reported: “ESG-focused equity funds have taken in nearly $70bn of assets just over the past year [2019 – 2020] while traditional equity funds have suffered almost $200bn of outflows over the same period.”
According to Morningstar, the financial research company, ESG funds attracted $71.1bn in investments globally between April and June 2020, which increased total assets in ESG funds to over $1tn.
Calastone, the funds platform, found that, in the UK alone, investments in ESG equity funds between April and July 2020 exceeded the total investment in these funds for the five previous years. Investment in ESG funds is only part of the bigger picture as ESG risk-assessment tools are added to the toolbox of fund managers generally. As Wigglesworth noted, ESG funds are a very small part of the stock exchange market but “the broader trend is towards all asset managers becoming more focused on these issues, whether their funds are explicitly ESG-oriented or not.”
The legal spotlight
The Coronavirus Pandemic has caused all these matters to be thrown into sharp relief. It is far from straightforward, however.
Two post-Coronavirus cases, Boohoo, the UK-based on-line clothing retailer, and Rio Tinto, the global mining giant, show ambivalence from investors towards some companies that cross ESG red lines.
The investigation into work practices at BooHoo found that “from (at the very latest) December 2019, senior Boohoo Directors knew for a fact that there were very serious issues about the treatment of factory workers in Leicester and whilst it put a programme intended to remedy this, it did not move quickly enough.” There is nothing new about Leicester’s “dark factories”, with a 2017 inquiry by the Human Rights Joint Select Committee chaired by Harriet Harman stating that there was “compelling evidence” that “labour rights abuses are endemic in the Leicester garment industry”. Whether those directors and Boohoo were complicit in the exploitation of those factory workers will be a matter for the courts. However, no senior members of the Boohoo board have been sacked and the value of shares in Boohoo moved upwards after the publication of the Levitt Report, netting a number of board members a substantial fortune.
The destruction of ancient aboriginal sites by Rio Tinto, by way of contrast, led to the company’s CEO falling on his sword.
Either way, such cases have led to a radical tone shift from the top.
One of the most important catalysts for change has been the re-focusing and re-alignment by CEOs on the role of the corporation in the 21st Century. A movement that can best be described as from exclusive shareholder value to inclusive stakeholder value. This behavior shift was not influenced by enlightenment or altruism alone. These are hard-nosed business heads caught in a perfect storm. The switch of financial investment away from ESG unfriendly or non-compliant companies towards ESG compliant businesses has serious financial impacts. The response of companies to the challenge of climate change and decarbonisation is illustrated by the rebadging of fossil fuel companies and energy generators as renewable or green companies promoting wind and solar power and reducing their carbon footprint. BP’s Chief Executive, Bernard Looney, for example, recently joined the ranks of CEO true-believers in ESG, declaring in February 2020 that it was BPs “new ambition to become a net zero company by 2050 or sooner, and to help the world to get to net zero.”
It would be unfair not to acknowledge that there was also a moral imperative for a number of leading CEOs. Larry Fink, CEO of BlackRock, in January 2018 and 2019 wrote letters to the CEOs of the companies in which it held substantial investments urging them to have regard to the wider interests of stakeholders, defined by Fink as employees, customers and communities as well as shareholders. Moreover, companies, Fink advised them, were not to be vehicles for obtaining short-term profits alone but should “serve a social purpose.” Other major financial investors, economists and lawyers anticipated or followed Fink’s lead. In February 2019, for example, Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz, the US law firm, and
the acknowledged midwife of the corporate “poison pill”, put forward The New Paradigm which was to be promoted as a “roadmap for an implicit corporate governance and stewardship partnership”.
In August 2019, the US Business Roundtable (comprising 181 US CEO, including Jamie Dimon, Chairman and CEO of J.P. Morgan Chase & Co.) released the brake of the dead hand of Milton Friedman on American corporations by re-defining its purpose. Corporations, the US Business Roundtable agreed, no longer were to be the handmaiden of the desire of their shareholders for maximum short-term financial gratification but stewards of the long-term well-being of its stakeholders (which the Roundtable defined as shareholders, employees, suppliers, customers and communities). At about the same time, Private Equity firms woke up to the threat of ESG to their profitability, and now accept the need to re-write the rules of due diligence to go beyond the narrow conventional limits of financial data as “dealmakers are increasingly taking ESG issues into consideration.”
In tomorrow’s part II, we’ll look at how corporate General Counsel are now responding to the ESG regulation tsunami and how litigation is going viral
Carla Parsons, Paul Watchman and Vanessa Wood are the ESG Advisory Group at The Blended Capital Group
 Trysha Daskam and Fizza Khan, “Best Practices in ESG Due Diligence for Private Equity Firms’, www.law.com 25 October 2019.