Greenwashing dispute risks – International perspectives

With companies increasingly making environmental claims and a rise in ESG regulation, we outline the risks of greenwashing allegations in three key markets

Fuelled by the global spread of ESG and climate-related disclosure obligations and coupled with pressures from increasingly ESG-driven stakeholders, businesses are saying more than ever about their environmental and social performance. These statements might be product-specific, relate to investment strategy or corporate governance. Such statements might be seen as good marketing, positive for a company’s reputation and may well reflect a laudable transparency or ambition. But what are the potential legal consequences if these statements are attacked as inaccurate, unsubstantiated, misleading or false (ie, “greenwashing”)? In this article, we explore the increasing risks for a business in making environmental or social claims, focusing on the UK, Australia and the US.

The UK

The regulatory regime

As set out in our previous post, there are a number of regimes that require UK businesses to report in relation to social and/or environmental matters. Many of these derive from the EU’s European Green Deal, such as the Corporate Sustainability Reporting Directive, the Sustainable Finance Disclosure Regulation or the anticipated Corporate Sustainability Due Diligence Directive. Many of the EU regimes apply (or may apply) to entities accessing the single market and so apply directly to UK based companies. Others include references to “value chains” that will likely impact UK-based companies indirectly as the expectations of their EU business partners align with these new regimes.

There are also UK-specific reporting regimes, such as the UK Modern Slavery Act, the Task Force on Climate-related Financial Disclosures (the widely adopted voluntary standard that is now mandatory for all UK listed entities), the Task Force on Nature-related Disclosures and the International Sustainability Standards Board’s standards.

Other regulatory steps are being taken to ensure that what companies say accurately reflects what they do. In particular:

  • The EU Taxonomy Regulation establishes benchmarks for determining whether an economic activity is “sustainable”.
  • The EU Commission published a proposal for a Directive on Green Claims in March 2023.
  • The UK Competition and Markets Authority (CMA) has adopted a Green Claims Code that seeks to help businesses comply with the existing consumer protection regimes in the UK when making environmental claims. The CMA is working with the International Consumer Protection and Enforcement Network, with a view to aligning standards globally.

Investigations and litigation

There are five emerging categories of potential actions we would highlight:

  • Complaints to the EU Commission and/or CMA: In June 2023, a group of European national consumer protection organisations, supported by ClientEarth, filed a complaint with the EU Commission in relation to what they describe as misleading climate-related claims by 17 European airlines. The complainants are calling for a Europe-wide investigation. In January 2023, the CMA opened an investigation into three “fast fashion” brands to scrutinise their green claims, noting particular concerns about the way the firms’ products are marketed to customers as “eco-friendly”.
  • Complaints to the UK Advertising Standards Agency (ASA): Complaints can be made to the ASA that green claims in adverts are misleading. If the claim is upheld, the company will be ordered to remove the advert. Recent complaints have been made to, and upheld by, the ASA in relation to green marketing claims made by Ryanair (that it was the “lowest emissions airline” with “low CO₂ emissions”) and Repsol (where an advert relating to “renewable hydrogen” omitted material information.
  • Shareholder claims under the Financial Services and Markets Act: Section 90 and Section 90A of the Financial Services and Markets Act 2000 provide potential routes to redress for shareholders in a listed company that makes false or misleading claims about their response to climate change. While shareholder actions under FSMA are not new, ESG-related claims are a more recent area of focus for potential claimants. We explain these potential claims in more detail here and consider the issue of reliance under Section 90A here.
  • Shareholder derivative actions: Derivative actions under Section 261(1) of the Companies Act 2006 allow minority shareholders to bring a claim on a company’s behalf and for its benefit, typically with a view to challenging the conduct or decisions of the company’s directors. The highest profile example of such an action in relation to ESG issues was the unsuccessful action brought by the environmental charity ClientEarth against the directors of Shell, which we discuss in more detail here.
  • Consumer class actions: While we are yet to see a big rise in greenwashing class actions in the UK, claimant firms may seek to allege that misrepresentations by a business have induced consumers to make purchases that would not otherwise have been made, causing loss. These claims could be brought in the UK High Court on an “opt-in” basis (potentially following the example of the group litigation currently being pursued against vehicle manufacturers in relation to allegations concerning NOx emissions from certain diesel engines). Alternatively, claimants might seek to bring consumer claims based on alleged abuses of competition law in the Competition Appeal Tribunal, so as to take advantage of the “opt-out” regime (ie, where each member of the class is automatically enrolled as a claimant unless they take active steps to opt out). Notably, claimant firms have already sought to bring environmental claims via that route, in particular, against water companies.

Australia

The regulatory regime

Greenwashing in Australia is largely dealt with under existing legislative provisions in relation to false, misleading, deceptive or dishonest conduct, and in relation to corporate disclosure obligations and representations without reasonable grounds. Some of those provisions may be relied upon by private persons and entities, and many are also enforced by national regulators, including the Australian Securities and Investments Commission (ASIC), the Australian Competition and Consumer Commission (ACCC) and Ad Standards.

In August 2022, ASIC identified greenwashing as an enforcement priority for 2023. In November 2023, it then confirmed its focus on greenwashing will remain a priority in 2024 and indicated that focus would widen to give attention to “net zero” statements and targets and the use of such terms as “carbon neutral”, “clean” and “green”.

In its March 2023 “internet sweep” of environmental claims, the ACCC noted concerns that a significant portion of statements made by businesses may be false, misleading or have no reasonable basis, including “vague” terms including “green”, “eco-friendly”, “sustainable”, “recycled”, “carbon neutral” and “zero emissions”. In July 2023, the ACCC released draft guidance on environmental and sustainability claims.

Ad Standards, Australia’s advertising regulator, independently administers industry codes such as the Environmental Claims Code. The Code requires environmental claims to be presented truthfully and factually, not to be misleading or deceptive, and must be substantiated and verifiable. Ad Standards’ Community Panel handles complaints concerning breaches of the Code.

Litigation

In relation to private actions:

  • in August 2021, a shareholder environmental activist organisation filed proceedings against an oil and gas producer alleging that its market disclosures amounted to misleading or deceptive conduct in relation to: its 2030 and 2040 emissions reduction targets; its use of the word “clean” to describe its business and the production of natural gas; and it describing the use of hydrogen as “zero emissions” or “clean”; and
  • in August 2023, Australian Parents for Climate Action (AP4CA) filed proceedings against EnergyAustralia, challenging claims made on its website that its “Go Neutral” electricity and gas products are “carbon neutral”; emissions created by “Go Neutral” products are “cancelled out” or “negated”; and that by opting into its “Go Neutral” products, consumers “have a positive impact on the environment”.

In relation to regulator actions:

  • in February 2023, ASIC commenced its first greenwashing proceedings against Mercer Superannuation (Australia) Ltd (Mercer), alleging that Mercer engaged in greenwashing in relation to its ”Sustainable Plus” investment options because those options relevantly included investments in companies involved in the extraction or sale of fossil fuels, despite marketing statements made by Mercer to the contrary;
  • in January 2023, Ad Standards’ Community Panel upheld a complaint in relation to a flyer produced by ATCO which included the words, “Natural gas not only saves you money on hot water, cooking and heating, it’s also better for the environment” and under the subheading “Benefits” included a dot point with the words “Produce 70% less greenhouse gas”. The Panel held that this claim was misleading as there are other energy sources which produce less greenhouse gas than natural gas;
  • in July 2023, ASIC commenced proceedings against Vanguard Investments Australia Ltd (Vanguard) alleging that Vanguard had engaged in misleading and deceptive conduct because it represented that all securities in its “Ethically Conscious” fund were screened according to ESG criteria to exclude issuers with significant business activities in a range of industries, including fossil fuels, when it is alleged that Vanguard largely did not undertake that screening;
  • in August 2023, ASIC commenced proceedings against Active Super, alleging greenwashing in relation to claims that it eliminated investments from its superannuation fund that posed too great a risk to the environment and community (including tobacco, oil and gambling-related investments) in circumstances where the fund was allegedly exposed to securities in gambling, tobacco, oil and coal mining; and;
  • in March 2023, the ACCC announced it had researched 247 business and/or brands across Australia and had found that some of those businesses were: using vague or unclear environmental claims; not providing sufficient evidence for their claims; setting environmental goals without clear plans for how these will be achieved; and using third-party certifications and symbols in a confusing way.

The US

The regulatory regime

We have previously considered the SEC’s activities in this area here and here. This post, therefore, focuses on the consumer angle.

US regulatory action with respect to greenwashing claims remains fairly passive.  For the first time in more than a decade, the US Federal Trade Commission (FTC), which enforces federal antitrust and consumer protection laws, plans to release updated Green Guides for environmental marketing communications. The Green Guides, first issued in 1992 and last updated in 2012, are intended to help marketers avoid making unfair or deceptive environmental marketing claims in violation of Section 5 of the FTC Act. The revised Green Guides are expected to address current gaps in guidance with respect to claims that form the basis for modern greenwashing actions, such as claims that products are “sustainable” or “carbon neutral,” claims of achieving (or being on target to achieve) “net zero” carbon emissions, and claimed or implied endorsements from third-party organisations with strong ESG credentials. The revised guidance is expected to include examples of problematic statements and marketing, as well as the type and degree of substantiation required to defend against claims that given marketing statements are false or misleading.

Litigation

Even as the FTC works to better define the contours of false or misleading environmental claims, private class action litigation, rather than agency action, remains the principal means of regulating greenwashing in the US. For decades, plaintiffs’ firms have brought consumer fraud class actions premised on allegedly false or misleading claims that products are, for example, “healthy” or “all natural”.  Applying that same template, consumer fraud class actions have now begun to target statements that products are carbon neutral, fully recyclable, or made of recycled content, and other green or sustainable marketing claims.

Recent examples include Dorris v. Danone Waters of America, challenging Danone’s labelling Evian-brand bottled water as “carbon neutral”; Lizama v. H&M Hennes & Mauritz, challenging H&M’s use of “conscious choice” branding to market clothing made with 50% or more “sustainable materials”; and Ellis v. Nike USA Inc, similarly challenging Nike’s “Sustainability” product line. In these and other greenwashing class actions, plaintiffs allege (i) the marketer’s claim is false or misleading and (ii) the misleading statement inflated the purchase price of the product by a certain amount, as reflected in sales data and analyses by economic experts.

Like other US class actions, greenwashing class actions generally are brought by plaintiffs’ firms as “opt-out” class actions (as above, where each member of the class is automatically enrolled as a plaintiff in the action and must take steps if they wish to opt out of the class, which few people do), as consumers do not have the financial incentive to pursue these claims on an individual basis. If successful, plaintiffs’ firms can recoup a large contingent fee percentage (eg, 30% to 40%) of the class recovery, with damages calculated based upon the number of products sold with false or misleading claims multiplied by the amount by which the challenged statement inflated the purchase price.

Greenwashing class actions have seen mixed success in US courts. Some consumer fraud class actions have survived motions to dismiss because questions of fact remained as to whether the challenged statements were false or misleading and/or improperly substantiated. In other cases, courts have dismissed greenwashing claims because the challenged statements were held not to be false or misleading on their face (eg, in the Lizama case, the court granted H&M’s motion to dismiss because the only reasonable reading of H&M’s “conscious choice” marketing was that the products at issue used more sustainable materials than H&M’s other clothing, which was not in question).

Nonetheless, greenwashing class actions (and similar claims brought under state consumer protection laws by governments) are expected to continue in the US given the growing importance consumers place on ESG considerations and, as a consequence, marketers’ increased efforts to promote their brands and products based on those considerations.

To follow the rest of this series on climate change disputes, please subscribe to our ESG blog here or click here to view on our website.

Key contacts

Rachel Lidgate
Rachel Lidgate
Partner, London
+44 20 7466 2418
David Bennett
David Bennett
Partner, London
+44 20 7466 6435
Oliver Elgie
Oliver Elgie
Senior Associate, London
+44 20 7466 6446
Benjamin Rubinstein
Benjamin Rubinstein
Partner, New York
+1 917 542 7818
Chris Emch
Chris Emch
Associate, New York
+1 917 542 7838
Mark Smyth
Mark Smyth
Partner, Sydney
+61 2 9225 5440

Court of Appeal rejects second major attempt at a climate-related derivative action

In July 2023, the Court of Appeal upheld the first instance decision in McGaughey & Anor v Universities Superannuation Scheme Limited [2023] EWCA Civ 873 (“McGaughey“), dismissing the application by members of a pension scheme to bring a derivative action against the directors of the scheme’s trustee company.

McGaughey and ClientEarth v Shell, taken together, confirm that the courts of England and Wales remain wary of challenging reasonably made decisions of company directors. In McGaughey, the Court of Appeal also made clear that derivative actions are not appropriate when direct challenges are available. For more on ClientEarth v Shell, see our blog post here.

So, while derivative actions may continue to be brought as a disruptive tactic by activist shareholders, there is likewise continued judicial reluctance to second-guess corporate decision-making. The Courts are aware that climate risks are just one of the many risks which executives consider when deciding on strategy. In the absence of evidence of egregious disregard for climate risks, the courts seem unwilling to find that directors have the balance wrong.

Factual background to McGaughey

Two academics (the “Applicants“), members of the Universities Superannuation Scheme (the “Scheme“), one of the largest private occupational pension schemes in the UK, appealed the High Court’s rejection of their attempt to bring a derivative action against the directors of the Scheme’s trustee company.

The directors had approved resolutions amending Scheme benefits by making changes to salary threshold, accrual rate and inflationary increases and increased member contributions. They had also obtained an actuarial valuation as at 31 March 2020, when they were not required to do so until a year later. The Applicants challenged these decisions.

The Applicants also argued that the directors had breached their duties under the Companies Act 2006 by continuing to invest in fossil fuels despite the Scheme’s ambition to be carbon neutral by 2050. They argued the directors had not adequately considered the attendant financial risks. These breaches were therefore said to cause current and future loss to Scheme members, in the form of lost assets, increased deficit and other knock-on future losses.

As the trustee company of the Scheme is a company limited by guarantee, it has no shareholders. The statutory derivative action under the Companies Act 2006 was therefore not available and the Applicants consequently framed their claim at common law.

A common law derivative action must satisfy four requirements:

  1. sufficient interest or standing to pursue the claim on behalf of the company;
  2. a prima facie case that the claim falls within an exception to the rule in Foss v Harbottle;
  3. a prima facie case on the merits; and
  4. that it is appropriate in all the circumstances to permit the derivative claim(s).

The test for standing

The appeal in McGaughey failed at the first hurdle. The Court highlighted two key aspects to the Applicants’ lack of standing:

  1. Under the ‘Reflective Loss’ principle, the Applicants had to show they had suffered a loss. Also, importantly, they had to show this loss related to (or at least correlated with) the Scheme’s loss. The Applicants were unable to make out either of these. In particular, they could not prove any substantive loss suffered by the company on account of the directors’ actions (including in relation to fossil fuels claims).
  2. Further, because changes made by the directors to the Scheme benefits were not uniformly detrimental (ie the changes affected different classes of Scheme members differently), the Applicants were not able to bring the claim on behalf of all the members of the Scheme. Contrast this to the position of shareholders in a company, who all enjoy the same benefits.

Directors’ duties and other obligations

McGaughey makes clear that directors’ duties must be considered separately from their other obligations.

The rule in Foss v Harbottle is that, generally, the Company is the correct party to bring an action against its directors. There are, however, a number of exceptions to this rule, including where a fraud has been committed and the minority (ie shareholders) are prevented from remedying the fraud because the company is controlled by the wrongdoers (ie the directors).

The Applicants claimed that the directors knew or believed that the changes to Scheme benefits involved indirect discrimination and were nonetheless prepared to tolerate it for their own ends.

However, the Court of Appeal found this attempted to elide the directors’ statutory duties, owed to the company, with the objects of the trust. Mere allegations of directors acting in bad faith or having conflicts of interest are insufficient to fall under an exception. Claimants must specifically identify the fraud on minority stakeholders and the wrongfully obtained benefits of that fraud. The Applicants’ vague allegations were given short shrift, with Lady Justice Asplin commenting that “it was entirely inappropriate that the[se] allegations [of fraud] should have been made.”

Direct claims rather than derivative actions

Both the High Court and Court of Appeal showed a preference for direct claims over derivative claims. The derivative action mechanism is “not intended to enable would be claimants to avoid other procedural hurdles“.

The Court of Appeal noted that because of this, even if the Applicants had a prima facie case, the derivative action would not have been allowed to continue. In particular, the Court of Appeal noted it was “surprised” that the claim had been brought in this form, noting there was “no reason, save perhaps a desire to avoid the difficulties in relation to costs and representation,” for bringing it as a derivative action. Instead, the Applicants should have brought a claim which challenged the Scheme’s investment policy directly, here most simply in breach of trust.

The importance of internal governance to climate claims

While clearly a success for the Scheme’s directors, McGaughey also shows the importance of shareholder resolutions in corporate governance.

Leech J, deciding at first instance in McGaughey, considered a survey of members in finding that the directors had complied with their obligations to diversify and manage the Scheme’s assets.

Similarly, in deciding not to grant ClientEarth leave to pursue its derivative action, the High Court explicitly had regard to a shareholders’ vote of approval for Shell’s Energy Transition Strategy at previous Annual General Meetings.

Both the McGaughey and ClientEarth decisions highlight the courts’ consideration of these resolutions, signalling that proactive shareholder involvement can shape corporate climate strategy and that companies should consider their internal controls when assessing litigation risk.

Key contacts

Rachel Pinto
Rachel Pinto
Partner, London
+44 20 7466 2638
Rupert Swallow
Rupert Swallow
Associate, London
+44 20 7466 2157
Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612
Rebecca Perlman
Rebecca Perlman
Partner, London
+44 20 7466 2075
Natalie Shippen
Natalie Shippen
Professional Support Lawyer, London
+44 20 7466 7623

UK government launches call for evidence on scope 3 emissions reporting

UK government seeks views on the costs, benefits and practicalities of Scope 3 emissions reporting to inform whether it endorses the International Sustainability Standard Board’s sustainability disclosure standards. 

The Department for Energy Security and Net Zero (“DESNZ“) has launched a call for evidence on Scope 3 greenhouse gas emissions (“GHG“) reporting. Scope 3 emissions are the indirect emissions (not included in Scope 2) that occur in the reporting company’s value chain. Disclosure of most Scope 3 emissions remains voluntary under current reporting requirements. However, the International Sustainability Standards Board’s (“ISSB“) first two standards – IFRS S1 (general requirements for disclosure of sustainability-related financial information) and IFRS S2 (climate-related disclosures) – require entities to report their Scope 1 (direct emissions from owned or controlled sources), Scope 2 (indirect emissions from the generation of purchased energy) as well as Scope 3 emissions. The government’s call for evidence therefore seeks views on the costs, benefits and practicalities of Scope 3 emissions reporting to inform its decision as to whether it endorses the ISSB’s sustainability standards.

The government acknowledges the complexities associated with identifying and quantifying Scope 3 emissions but, at the same time, recognises the significance of measuring these emissions to prioritise and support decarbonisation efforts. As such, the call for evidence is more likely an exercise of how the government will endorse the ISSB standards rather than whether it will do so. This is especially so given the government’s announcement in August 2023 that it will establish the UK Sustainability Disclosure Standards based on the ISSB standards, which is expected by July 2024. Stakeholders have until 14 December 2023 to respond.

Background

A variety of legal regimes govern emissions reporting in the UK. The Companies Act 2006 (Strategic Report and Director’s Report) Regulations 2013 put in place requirements for quoted companies to report their annual emissions and an intensity ratio. The Streamlined Energy and Carbon Reporting (“SECR“) framework, introduced in 2019, added further disclosure requirements on quoted companies. It also created new requirements for large unquoted companies and large limited liability partnerships. By and large, the SECR framework focuses on Scope 1 and Scope 2 emissions, with only a limited subset of Scope 3 emissions and energy use requiring disclosures. This means most Scope 3 disclosures are voluntary, notwithstanding that Scope 3 emissions make up roughly 80-95% of total emissions for many organisations.

Rationale for Scope 3 disclosures

Investors and stakeholders are increasingly taking into account the transition readiness of businesses to adapt to a low-carbon economy in light of net-zero commitments made in the UK and elsewhere. Disclosure of Scope 3 emissions is deemed an important indicator of such readiness because there is a clear link between a business’ exposure to GHG emissions and its exposure to risks in a decarbonising society and economy. This rationale led to calls for the ISSB’s sustainability disclosures standards to require disclosure of absolute gross GHG emissions, that is, Scope 1, Scope 2 and Scope 3 emissions, which the ISSB subsequently accepted. The final IFRS S2 requires an entity to disclose information about its climate-related risks and opportunities that is useful to primary users of general-purpose financial reports in making decisions. Such information will include disclosure of absolute gross GHG emissions so long as the information is “material”, that is, it could reasonably be expected to affect the business’ prospects.

Objectives of the call for evidence

As noted, the government’s call for evidence seeks feedback on the costs, benefits and practicalities of Scope 3 emissions reporting. The feedback gathered will help inform the government’s decision as to whether it endorses the ISSB standards for use by UK businesses. The call for evidence also seeks information on how endorsement of the ISSB standards might complement existing reporting requirements under the SECR framework and any future changes to the framework that will be considered in its post-implementation review in 2024.

 

Key contacts

Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612
Rebecca Perlman
Rebecca Perlman
Partner, London
+44 20 7466 2075
Jannis Bille
Jannis Bille
Senior Associate, London
+44 20 7466 6314
Natalie Shippen
Natalie Shippen
Professional Support Lawyer, London
+44 20 7466 7623

UK Transition Plan Taskforce publishes final disclosure framework

On 9 October 2023, the UK’s Transition Plan Taskforce (“TPT“) published its final disclosure framework (“Disclosure Framework“) and supporting documents. The Disclosure Framework is intended to act as a “gold standard” for companies to develop, disclose and deliver their climate transition plans.

The Disclosure Framework seeks to offer practical support to UK companies already disclosing their transition plans on a voluntary basis or those preparing to do so in accordance with international sustainability standards, in particular, the European Sustainability Reporting Standards (“ESRS“) and those of the International Sustainability Standards Board (“ISSB“). Given the proliferation of sustainability standards across the globe, stakeholders are likely to welcome TPT’s alignment with ESRS and ISSB. We understand the ISSB itself may adopt TPT’s Disclosure Framework as part of its own guidance on complying with IFRS S2, ISSB’s standards that deal with climate-related disclosures.

In this blog, we set out a high-level overview of the Disclosure Framework and implementation guidance, including key changes from the TPT’s initial November 2022 consultation, which we previously covered here.

Climate transition plans in the UK

As set out in our more detailed June 2023 briefing, a transition plan sets out an organisation’s strategy to adapt its business model to a low-carbon economy.

More broadly, the UK has adopted a legally binding target under the Climate Change Act 2008 to achieve net-zero emissions by 2050. This commits the UK to reduce its greenhouse gas (“GHG“) emissions by 100% by 2050 compared to 1990 levels. The UK’s sixth carbon budget, adopted in April 2021, further commits the government to reduce emissions by 78% by 2035 compared to 1990 levels.

TPT’s Disclosure Framework is intended to facilitate the decarbonisation of businesses to help achieve these targets.

TPT’s Disclosure Framework

In keeping with the November 2022 consultation, the Disclosure Framework is centred on three principles: ambition, action and accountability. In practice, this means transition plans will be expected to cover:

  • high-level ambitions to mitigate climate change risks and leverage opportunities (“Strategic Ambition“);
  • short-, medium- and long-term actions to achieve these strategic ambitions; and
  • governance and accountability mechanisms supporting delivery of those actions.

More specifically, the three principles are put into effect through five central disclosure elements:

  1. Foundations, which cover the scope of the transition plan by reference to the company’s objectives and priorities in transitioning to a low-carbon economy (ie, its Strategic Ambition), including the impact on its business model and value chain and key assumptions and external factors affecting the achievement of the Strategic Ambition.
  2. Implementation strategy, which requires companies to disclose the policies implemented and actions taken in pursuit of the Strategic Ambition, including the impact of such policies and actions on financial position, performance and cashflow.
  3. Engagement strategy, which requires companies to disclose their plan of engagement with key stakeholders to achieve their Strategic Ambition and, in particular, their engagement with its value chain, industry, government, public sector, host and affected communities and civil society.
  4. Metrics and targets, which require companies to identify the key metrics and targets by reference to which they monitor and assess their progress in achieving the Strategic Ambition.
  5. Governance, which requires companies to disclose how they are embedding their transition plans within their governance structures to achieve the Strategic Ambition.

These five disclosure elements are further broken down into sub-elements, totalling 19 individual recommended disclosures that companies will be required to report against in their transition plans.

TPT suggests that transition plans are updated at least every three years, with periodic updates in the event of significant changes. In interim years, entities should report on progress against the commitments set out in the current transition plan, as well as on all other content deemed to be material to investors, in line with ISSB-aligned disclosures.

Changes from November 2022 consultation

The Disclosure Framework is generally consistent with the draft published as part of the November 2022 consultation, although a few changes have been made as a result of feedback received.

In particular, two changes are notable:

  1. The foundations element has been expanded to require companies to report on their Strategic Ambition, value chain, key assumptions and external factors affecting its achievement. Previously, this element was limited to disclosure of the company’s objectives, priorities and business model implications of its transition plan.
  2. The implementation strategy element has been curtailed as a result of implementation concerns highlighted in TPT’s July 2023 status update. In practice, this means companies will no longer be required to disclose the results of their sensitivity analysis as part of the disclosures relating to their implementation strategy. This would have previously involved disclosing “key assumptions and dependencies underlying the entity’s business, operational and financial plans and the implications for achievement of the strategic ambitions in its transition plan if its central assumptions are not met.”

Interaction with ISSB, TCFD and ESRS

The wording of the Disclosure Framework has been updated to be more consistent with the ISSB standards. This is in line with TPT’s aim to align the Disclosure Framework closely with the ISSB standards, the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD“) and the ESRS. To aid interoperability with these standards, TPT has published technical mapping documents.

Implementation guidance and next steps

TPT has also published additional guidance for each recommended disclosure. Notably, the implementation guidance, previously set out in one document as part of the November 2022 consultation, has now been split into two parts:

  1. Implementation guidance, which sets out a practical guide for companies in relation to each stage of the transition planning cycle; and
  2. Interpretative guidance, which sets out the importance of element and sub-element of the Disclosure Framework as well as additional disclosure considerations that companies may want to take into account when preparing their disclosures.

Next steps

In addition to the implementation guidance, TPT has published summary guidance for 40 sectors outlining the decarbonisation levers and metrics and targets which may be relevant to each particular sector. This guidance is based on existing market guidance and is open to comment until 24 November 2023.

TPT will also consult on sector deep-dive guidance for seven additional sectors: asset managers, asset owners, banks, food and beverage, electric utilities and power generators, metals and mining, and oil and gas. The draft sector deep-dives are intended to provide supplemental disclosures in relation to each of the relevant sectors, as well as sector-specific guidance and references to third-party materials. They are expected to be published on 13 November 2023 and finalised in February 2024.

In its Primary Market Bulletin 45, the FCA set out plans to consult on guidance that will note its expectations for listed companies’ transition plan disclosures, by reference to the Disclosure Framework. Note that, in the FCA’s view, TPT’s Disclosure Framework will help issuers “report more effectively on the transition plan-related aspects of IFRS S2“, which is expected to form a core component of the UK Sustainability Disclosure Requirements expected to come into force from 2025.

 

Key contacts

Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612
Rebecca Perlman
Rebecca Perlman
Partner, London
+44 20 7466 2075
Tihomir Svilanovic
Tihomir Svilanovic
Associate, London
+44 20 7466 3941
Jannis Bille
Jannis Bille
Senior Associate, London
+44 20 7466 6314
Natalie Shippen
Natalie Shippen
Professional Support Lawyer, London
+44 20 7466 7623

Fit for 55 – EU aims to protect against carbon leakage with a carbon border adjustment mechanism (EU CBAM)

On 14 July 2021, the European Commission (the Commission) published its proposed regulation which would establish a carbon border adjustment mechanism (EU CBAM) (the Regulation), and is intended to come into effect, subject to transitional provisions, from 1 January 2023.

The Regulation would require importers of certain goods to purchase a number of electronic certificates, each certificate corresponding to one tonne of embedded emissions in certain goods (CBAM certificate), in order to cover the total embedded emissions in imported goods. Although the obligation to purchase CBAM certificates and account for embedded emissions rests on importers, it is likely that the EU CBAM will have important impacts on international producers.

The role of a CBAM

As explained in our previous blog post here, a CBAM can be used to protect against the risk of carbon leakage and preserve the competitiveness of domestic operators. Carbon leakage occurs if, due to costs incurred in relation to climate policies, businesses in certain sectors transfer an underlying economic activity and its associated emissions to a different country with less onerous climate policies. This can lead to an increase in emissions globally.

A CBAM may prevent carbon leakage as all goods within its scope, whether produced domestically or internationally, would be subject to carbon costs, thereby discouraging businesses from relocating their operations elsewhere, or importing goods from countries with less ambitious climate policies.

Goods within scope of the EU CBAM

The goods within the scope of the EU CBAM include cement, electricity, fertilisers, iron, steel and aluminium. With the exception of electricity, the production or manufacture of these goods all figure on the ‘Carbon Leakage List‘ under the EU Emissions Trading System (EU ETS), as sectors and subsectors deemed at risk of carbon leakage for the period 2021 to 2030. However, not all sectors and subsectors on the Carbon Leakage List are within scope of the EU CBAM.

The mechanics of the EU CBAM

The EU CBAM applies when the above goods are imported into the Union’s customs territory from a third country. It would not apply to goods originating in countries and territories listed in Annex II of the Regulation, which include Iceland, Liechtenstein, Norway and Switzerland. A process is proposed for other countries to be exempted.

Annual declaration

Before any goods within the scope of the EU CBAM are imported, an importer must apply to the competent authority in the Member State where it is established for authorisation to import those goods into the customs territory of the Union. Each Member State is required to designate a competent authority to administer the EU CBAM.

Once authorised, an importer must submit to the competent authority a declaration by 31 May each year (CBAM declaration) for the calendar year preceding the declaration. A CBAM declaration must include certain information relating to the embedded emissions in imported goods, and the total number of CBAM certificates which will be surrendered.

During the transition period, the EU CBAM shall apply as a reporting obligation: importers must report the information above, as well as the carbon price due in a country of origin for the embedded emissions in imported goods.

CBAM certificates

By 31 May each year, each importer must surrender to the competent authority a number of CBAM certificates that corresponds to the embedded emissions in its CBAM declaration.

Embedded emissions are defined as direct emissions released during the production of the goods, i.e. emissions from the production processes of goods over which the producer has direct control.

The Regulation provides that the amount of embedded emissions will be based on the actual direct emissions of goods. If this cannot be determined, a default value will be used. The Commission shall adopt implementing acts to establish detailed rules regarding the methods for calculating the actual embedded emissions of imported goods. Operators and installations in third countries will have the option of registering in a central database: once the embedded emissions of their goods have been verified, importers may use these embedded emissions figures in their CBAM certificate calculations.

The default value will be set in accordance with the average emission intensity of each exporting country for each of the goods within the scope of the EU CBAM (other than electricity), increased by a mark-up. If reliable data is not available, the default values will be based on the average emission intensity of the 10% worst performing EU installations for that type of goods.

Importers will be able to purchase CBAM certificates from the competent authority in the Member State in which they are registered. CBAM certificates will be sold at the price calculated by the Commission, which shall be the average price of the closing price of EU ETS allowances on the common auction platform for each calendar week. Each CBAM certificate will be valid for two years, which will enable importers to take advantage of fluctuations in the price of EU ETS allowances.

Reduction to reflect carbon price paid in a country of origin

In its CBAM declaration, an importer may claim a reduction in the number of CBAM certificates to be surrendered, in order to take into account a carbon price paid in the country of origin. The Commission is empowered to adopt implementing acts to establish the methodology for calculating the appropriate reduction, the conversion of a carbon price paid and the certification process for these.

The number of CBAM certificates to be surrendered may also be reduced in light of EU ETS allowances which would be freely allocated to EU producers of the same products (see below).

Interaction with the EU ETS

The EU ETS will continue to apply to the goods within its scope produced in the EU, whilst the EU CBAM will create a carbon price for goods (within the scope the Regulation) imported into the EU.

Although there are differences in scope between the EU ETS and the EU CBAM, the Regulation demonstrates that the two carbon pricing systems will not operate in separate vacuums. In addition to the link to the EU ETS allowance price (see above), the Regulation also provides that the number of CBAM certificates to be surrendered will be adjusted, to reflect the extent to which installations producing goods within the scope of the EU CBAM are entitled to free allocation of allowances under the EU ETS. The methodology of this calculation will be adopted by the Commission in an implementing act.

Further, in the event of non-compliance with the Regulation, i.e. if an authorised importer fails to surrender sufficient CBAM certificates by 31 May each year, the authorised importer shall be liable to a penalty identical to the excess emissions penalty under the EU ETS. However, payment of such a penalty would not relieve an authorised importer from the obligation to surrender the outstanding number of CBAM certificates in a particular year.

Impact on the UK

As the UK is now a third country under the Regulation, EU importers would be liable to comply with the EU CBAM when importing certain goods (see above) from the UK. The Regulation empowers the Commission to adopt implementing acts to establish the methodology for calculating the reduction in the number of CBAM certificates to be surrendered in light of carbon prices paid in a third country. The Regulation also includes a transitional period during which such acts may be adopted.

However, until the reduction methodology is established, EU importers of UK-produced goods may experience a degree of uncertainty, with goods subject to the UK ETS upon production in the UK, and also to the EU CBAM upon import to the EU.

Comment

Ahead of the publication of the Regulation, a number of commentators raised concerns that an EU CBAM could be anti-competitive and protectionist in nature. The Commission stresses that it has taken such concerns into consideration in the design of the EU CBAM, as the final version of the Regulation contains a number of features which it claims addresses such concerns:

  • The price of CBAM certificates is linked to the EU ETS price. As the goods within the scope of the EU CBAM (when imported from third countries) are within the scope of the EU ETS when produced in the EU, all such goods in the EU will be subject to a carbon price, set at a similar level. This would in theory prevent carbon leakage (see above), as importers would not be able to obtain cheaper goods by importing from a country with less onerous climate policies.
  • The Regulation also provides for a reduction in the number of CBAM certificates to be surrendered in the event that domestic EU producers of such goods would be entitled to free allowances. This feature aims to ensure that EU producers and EU importers compete on a ‘level playing field’: if an EU producer would have been entitled to freely allocated allowances for producing the imported goods, the importer will be required to surrender fewer CBAM certificates (thereby reducing the carbon price paid by the importer). Because of the different bases of calculation of free allowances and CBAM certificates, it may be complicated to implement this mechanism in a way that is non-discriminatory in all cases.

In spite of the Commission’s assertions that the effects of the EU CBAM will be EU-focussed, concerns have been raised that it will have a significant impact on producers in third countries. The price of imported goods within the scope of the EU CBAM is likely to increase, which may reduce the price competitiveness of these products within the EU single market. Alternatively, if such a price increase were not passed on to consumers, the value of the imported goods may decrease, as EU importers may try to off-set the new carbon cost of these products against their initial purchase price.

Although the primary aim of the EU CBAM is to prevent the risk of carbon leakage, the Commission has suggested that it may encourage the use of more greenhouse gas emissions-efficient technologies by producers from third countries. It remains to be seen whether this will be the case, and whether the EU CBAM will trigger other countries to adopt more ambitious domestic climate policies.

We will continue to monitor developments in this area, and encourage you to subscribe to be kept informed of latest developments. Please contact the authors or your usual Herbert Smith Freehills contacts for more information.

More on the Fit for 55 suite of proposals

For more, see also our Decarbonisation Hub where you can also access our full series of posts – Fit for 55: A greener transition for Europe.

Contacts

Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612

Jannis Bille
Jannis Bille
Associate, London
+44 20 7466 6314

Lode Van Den Hende
Lode Van Den Hende
Partner, Brussels
+32 477 883 709

Eric White
Eric White
Consultant, Brussels
+32 2 518 1826

 

Listing Regime – FCA consultation on enhanced climate-related financial disclosures

The Financial Conduct Authority (FCA) has published a consultation on enhancing climate-related disclosures by standard listed companies (CP21/18).  This consultation follows the FCA’s policy statement (PS20/17) on climate related disclosures by premium listed companies, published in December 2020, which introduced Listing Rule 9.8.6(8), requiring premium listed companies to report climate-related information in line with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations and recommended disclosures (the TCFD Recommendations) on a comply and explain basis.

For accounting periods beginning on or after 1 January 2022, the FCA proposes to expand the existing rules under LR 9.8.6(8) to issuers of standard listed equity shares (as included in LR14), excluding standard listed investment entities and shell companies. Therefore, under the new proposal, standard listed companies would be required to include a statement in their annual financial report which sets out whether the report contains disclosures consistent with the TCFD June 2017 recommendations, and to explain why, if it does not.

The new rule for standard listed companies – and associated guidance – would be located in LR 14 is intended to directly mirror the structure and wording of the rule and associated guidance in LR 9.8.6R(8) and LR 9.8.6BG to LR 98.6EG for premium listed commercial companies. For more information on LR 9.8.6(8) and related obligations see our briefing for premium listed companies.

The FCA is also seeking feedback on the rationale for (and potential approach to) extending the application of these requirements to issuers of standard listed debt (and debt-like)

Securities (as included in LR 17), standard listed issuers of global depositary receipts (GDRs) (as included in LR18) and standard listed issuers of shares other than equity shares.

In addition, to inform their ongoing policy work, the FCA is looking to generate discussion and engage stakeholders on the topic of ESG integration in UK capital markets. Specifically, aiming to cover (a) Issues related to green, social or sustainability labelled debt instruments, and (b) ESG data and rating providers. In relation to point (a), the FCA is particularly interested in the implications on (i) the Prospectus and ‘use of proceeds’ bond frameworks, and (ii) the role of verifiers and second party opinion providers.

The consultation is scheduled to close on 10 September 2021.

Contacts

Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612
Jannis Bille
Jannis Bille
Associate, London
+44 20 7466 6314