With heightened public interest and concern for environmental issues, climate litigation against financial services firms has gained momentum and is almost certainly set to increase. Banking & financial disputes Associate, Lucy Waddicor, discusses some of the  the steps that can be taken to offset those risks.

Heightened public interest and concern for environmental issues creates opportunities for businesses, including financial services firms, looking to align themselves with that sentiment. Environmental, social and governance (ESG) investing has grown exponentially recently, and a range of funds and financial products are being marketed with a focus on their environmental impact.

Climate change is particularly noteworthy in the spectrum of ESG concerns as it also poses foreseeable financial risks for businesses, rather than merely reputational risks, which need to be considered and dealt with appropriately. Climate risk should therefore be on the agenda even for firms otherwise unconcerned by the ESG trend.

Climate litigation against financial services firms is at a nascent stage, although it is gathering momentum across all sectors worldwide, and financial institutions are already facing lawsuits in jurisdictions such as Australia. Activist shareholders, investors and nongovernmental organisations (NGOs) have made clear their desire to redirect capital toward climate-friendly initiatives, and litigation is a tool that could be used to do so. As a result, climate litigation against financial services firms will almost certainly increase, although evidentiary burdens and legal costs are likely to be significant hurdles for potential claimants, in the absence of funding.

This article discusses some of the areas where climate litigation could affect financial services firms, and the steps that can be taken to offset those risks.

Disclosures

Obligations on companies to report climate-related financial risks are increasing. Most recently, in December 2020 the Financial Conduct Authority (FCA) made it mandatory for UK premium listed commercial companies to disclose climate risk in accordance
with the framework set out by the Task Force on Climate-Related Financial Disclosures (TCFD). The framework focuses on climate disclosures in four areas: governance, strategy, risk management and metrics and targets. The requirement to report in accordance
with the TCFD is expected to be rolled out more widely in due course.

All UK companies are also under a general duty to disclose material climate-related financial risks. Directors do have some discretion about which risks they consider “material” and therefore worthy of disclosure, but institutional investors are increasingly
demanding decision-useful disclosures on climate risk.

As regulatory and investor pressure for sophisticated climate disclosures increases, so does the scope for disputes about non/insufficient disclosures. The result could be regulatory breaches and sanctions, and claims from investors and shareholders.

Claimants might simply seek to compel businesses to change their disclosure practices and disclose climate risks on a more comprehensive basis. This was the aim of the individual claimant in the Australian case McVeigh v Retail Employees Superannuation
Trust (REST), who brought a claim against his superannuation fund for failure to disclose climate risk. The case settled at the end of 2020 when REST made the disclosures sought.

Alternatively, claimants could seek compensation or the return of invested funds where they claim that they received inadequate or misleading disclosures (see Misrepresentations below).

While falling short of litigation, firms should also expect their accounts and reports to be examined by non-investor interested parties including NGOs such as ClientEarth. Such parties have previously made complaints to the Financial Reporting Council and the FCA
about inadequate reporting of climate risk by some listed companies. The number and strength of these complaints is expected to increase following the new FCA rules on TCFD-compliant reporting.

To offset these risks, firms should consider reporting in accordance with the TCFD on a voluntary basis, even if they are not mandated to do so. The TCFD is emerging as the framework of choice for regulators and investors alike.

Misrepresentations

Statements made about environmental credentials are likely to be scrutinised by investors and activists, as are any environmental commitments. Such statements need to be justified, or firms risk claims for misrepresentation.

One aspect of misrepresentation claims is whether the alleged misrepresentation can have been reasonably relied on. Companie smight say that statements about their climate aims are aspirational and forward-looking and cannot reasonably be relied on. Given the
trend toward ESG investing and the incorporation of climate-related statements into investment decisions both at an institutional and individual level, however, even statements of this type could potentially form the basis of a misrepresentation claim. Companies will be expected to have at least intended to live up to their stated aspirations.

If a claimant is successful in a misrepresentation claim, one possible remedy is recission — that is, an investment could be completely unwound. There is therefore substantial risk with such cases, even where an investment has objectively performed well.

For publicly listed companies, there is an additional route for action by dissatisfied investors. Untrue or misleading statements and omissions can give rise to claims by shareholders under the Financial Services and Markets Act 2000 (FSMA). Where such statements are made in a company’s prospectus or listing particulars, claims can be brought by investors who have suffered loss as a result, against “any person responsible” for the prospectus/listing particulars. Importantly, this could include the company’s directors, and any advisers who have accepted responsibility for, or authorised the contents of, the prospectus. Issuers can also be liable for untrue and
misleading statements made in other publications.

There has been a general trend toward group shareholder litigation in recent years, with high-profile cases such as the RBS Rights Issue Litigation. The prevalence of third-party litigation funding (some of which is being devoted specifically to ESG issues) might make
such a claim in the climate context possible, if the right factual matrix arises and the claim for damages is sufficiently large.

To help avoid claims of this type, statements made (by both private and public businesses) about environmental credentials should be specific, justifiable and regularly reviewed. Attempts might legitimately be made to capitalise on the trend toward ESG investing, but
care should be taken not to overstate the virtues of any product/investment.

Negligence/breach of duty

Claims can also arise against advisers who fail to consider, or advise appropriately on, climate-related financial risks. Such risks can cause significant changes to company balance sheets; for example, BP wrote down assets by £14 billion in 2020, citing the impact of net-zero commitments worldwide. Financial services firms need to be alert to these risks when providing advice and valuation services.

Similarly, firms advising on investment strategy and making investment decisions will need to ensure climate risk is factored in, where relevant. The McVeigh v REST case against the Australian superannuation fund alleged breach of fiduciary duty in respect of the fund’s approach to climate risk. Claims for breach of duty are more likely to arise where specific climate-related objectives have been sought by the investor or advertised by a fund manager.

One aspect of claims for negligence and breach of duty is the level of knowledge and awareness expected of a “reasonable” director/professional. It remains to be seen whether the worldwide recognition of the financial and economic risks of climate change will
influence this standard. For instance, climate action failure has been identified by the World Economic Forum as one of the top three global risks by likelihood and by impact since 2019.

Lastly, in the UK, directors are already required to have regard to “the impact of the company’s operations on the community and the environment” (s 172 of the Companies Act 2006). They are also required to exercise reasonable care, skill and diligence. Arguments that directors have acted in breach of these duties might arise where foreseeable climate risks prove decisions to have been illfounded. In some circumstances, company shareholders can even obtain permission to bring a claim on behalf of a company, against its directors, for breaches of duty. This could well be an avenue more shareholders explore for climate-related litigation in the future.

Firms might wish to consider whether they have sufficient understanding of climate-related financial risks or whether this could be improved. Firms should also aim for consistency between their public statements/climate commitments and the decisions they make on behalf of investors/shareholders.

Originally published by ThomsonReuters © ThomsonReuters