As the world gradually moves away from the Covid pandemic, investor demand for ESG-compliant financial products has continued to grow.
This thirst for greener assets has in turn led to a steady flow of investment products claiming to meet strict environmental, social and governance (ESG) criteria and, perhaps, at times aggrandizing their climate-change authentication.
However, the standardization and exact definition of what qualifies as a green or responsible investment remains fragmented. To counter this more regulators are working to catch up by rolling out guidelines for institutions to clarify and verify disclosures and credentials.
Some financial regulators are going further. For example, the Australian Securities and Investments Commission is investigating an Australian Stock Exchange-listed company for overstating its environmentally-friendly and progressive credentials, commonly referred to as greenwashing.
The Asset spoke to Mark Uhrynuk, the Hong Kong-based partner of global law firm Mayer Brown, about the state of Asia’s fragmented and divergent ESG standards and regulations.
Uhrynuk is a founding member of his firm’s ESG steering committee and a recognized thought leader on ESG issues. He also co-leads the firm’s family office initiative in the region.
TA: Is there a vulnerability that the creation and sophistication of ESG products might outrun Asian regulators attempts to keep pace with them?
MU: ESG criteria have created both opportunities and risks for businesses, which is why regulators, investors and other stakeholders are requiring ESG principles to be integrated into governance and risk management frameworks.
While a degree of vulnerability exists in any rapidly developing financial product market, ESG investing is certainly attracting its fair share of this vulnerability. This is due, in part, to the relatively recent and rapid evolution of ESG as a driver of investor, consumer and other stakeholder behaviour, but it also flows from the broad range of factors encompassed by the global and shifting ESG paradigm.
This vulnerability has to be assessed by policy makers and regulators in the context of a number of continuing and notable challenges, including those around the lack of globally accepted definitions or taxonomies, inconsistent and fragmented standards, data quality and comparability issues, and a general lack of expertise.
This lack of comparable ESG metrics, standards and ratings also makes it difficult for companies and investors to identify and manage material ESG risks.
While progress is being made towards greater transparency, more consistent metrics and increased comparability of rating methodologies – and regulators around the world are addressing these challenges in a variety of ways – coordinated global leadership and policy direction likely will be required to help ensure integrity and resilience in the market for ESG products.
TA: With the rapid expansion of ESG/sustainability-related financial products, in a sense are you learning as you go when it comes to ESG-related litigation?
MU: Clearly, ESG-related risk assessment will continue to evolve with the market and its regulatory oversight. The market for ESG or sustainability-related products is particularly challenging in this respect.
The relatively recent and rapid evolution of ESG as a driver of investor, consumer and other stakeholder behaviour is a driver here, but so is the broad range of factors that are encompassed by the global and shifting ESG paradigm.
For example, as the connection between a board’s action or inaction and exposure to climate-related risk becomes more evident and verifiable, companies and their directors face an increased risk of litigation, regulatory enforcement action and reputational harm.
This heightened ESG risk environment is intensified by the current lack of accepted definitions or taxonomies, the challenges with data quality and comparability, the inconsistent and fragmented regulatory requirements and standards, and a general lack of expertise within businesses. In this respect, all market participants, including companies, financial institutions, asset managers, regulators, consultants and legal advisers are to an extent “learning as they go”.
At the moment in Asia, where the ESG ecosystem is in an earlier stage of development, ESG litigation risk may be less defined or acute, but it exists and will evolve. Apart from litigation, there is the risk of regulatory enforcement action and reputational harm for companies, financial institutions and asset managers dealing with ESG or sustainability products in the Asia market.
Any assessment of ESG-related litigation, investigation and reputational risk in Asia, however, will be complicated by the range of economic transitions underway in the region and the prevalence and rapid emergence of social issues, with the added overlay of geopolitical tensions.
The fragmented and divergent standards and regulations in Asia and globally have contributed to greenwashing risks and allegations. There is currently a lack of reliable and comparable ESG data in the market, which creates an added challenge in designing ESG products.
As investors and other stakeholders call for more transparent and harmonized data, regulators have begun introducing more prescriptive or mandatory reporting requirements for certain businesses. These new reporting standards, which currently focus on climate-related risks, will intensify ESG-related litigation, investigations and the potential for reputational harm.
This will drive a growing imperative on businesses to continually monitor the regulatory requirements globally to ensure alignment with policies and practices. At the same time, there is an increasing focus on accountability at board and senior management levels, combined with a shortage of relevant expertise, which can enhance the overall risk environment for market participants.
As a result, businesses are under pressure to build out capacity (knowledge, experience and resources) and governance structures to ensure appropriate oversight of climate-related issues and risks as well as other material ESG topics, such as human rights violations within a supply chain.
Directors and senior management are expected to have a solid competence; and, while experts are important, the increasing importance of the role and influence of all directors and senior management is key.
TA: Is there sufficient professional legal expertise of ESG-related topics in Asia and are firms building pipelines to manage the projected demand?
MU: There is a general shortage of ESG expertise within the broader ESG ecosystem, and this applies to the legal community as well. Over the past couple of years many law firms have begun forming dedicated ESG practice or product groups to take advantage of the growing market demand and evolving impact of ESG factors on a range of clients and their legal needs.
In line with the evolution of ESG regulation more generally, this development began in Europe, but we now see a number of US-based and international firms announcing the formation of ESG practices. There are a handful of firms [like Mayer Brown] that have adopted a global approach (including across Asia) to organizing and managing their client-facing ESG practice to better align with the global challenges facing many businesses in this area. This anticipated demand is also directly driven by client needs and expectations as some businesses have begun to consider the formation of ESG panels.
In the early days of ESG adoption, much of the activity is around internal and external education and training. Knowledge and capacity constraints at companies, financial institutions and asset managers have created opportunities for law firms in this area. Today, as investors and other stakeholders get more actively engaged on ESG concerns and regulators begin to introduce more prescriptive and mandatory reporting requirements, there is a real and immediate need from a range of clients across different industries for advice and support to continually track applicable regulatory requirements and to align their policies and practices to mitigate risk.
The growing focus on accountability at board and senior management level combined with a shortage of relevant expertise also creates an opportunity for law firms. This is also driving change (and opportunity) within the legal function of companies and financial institutions.
As companies, financial institutions and asset managers seek to navigate the demands of new reporting regimes and related risks, there is an important role for both internal and external legal counsel who understand the evolving ESG ecosystem, appreciate the related challenges and opportunities and can help guide clients to understand and manage legal risk in this rapidly evolving landscape.
This can involve helping craft responsive governance policies, procedures and frameworks, designing and developing appropriate products, supporting reporting and disclosure obligations, assisting with ESG-related due diligence and supply-chain matters, and generally supporting the design and development of a systematic approach to embrace opportunities while mitigating the inherent risks.
Just as there is no such thing as ESG law, there is no one category of ESG lawyer. An ESG law practice requires a multidisciplinary approach and the support of corporate, finance, regulatory, technology and litigation specialists, among others.
Given the importance of the rapidly evolving regulatory regimes and the inherent litigation risk, firms will be enhancing their ESG capabilities in these areas. With the current focus on climate–related risk, lawyers with a background in environmental matters are in demand. Finally, as we are seeing regulatory developments and related requirements and risks impacting businesses globally, multi-jurisdictional capabilities will be required to effectively support clients with international business operations.
TA: A number of jurisdictions in Asia have issued guidelines and codes of conduct on ESG financial products. Should they now go further and agree on a market standard to alleviate the risk of greenwashing?
MU: This is the direction of travel. Certainly, the fragmented and divergent standards and regulations in the region and globally have contributed to greenwashing risks and allegations. There is currently a lack of reliable and comparable ESG data in the market, which creates an added challenge in designing ESG products.
As investors and other stakeholders call for more transparent and harmonized data, regulators have begun introducing more prescriptive or mandatory reporting requirements for certain businesses. But to alleviate the risk of greenwashing, greater transparency, more harmonized and consistent standards, and better quality data are required to support these regulatory efforts.
TA: Although ESG is a coverall phrase, do the E, the S and the G components increasingly require their own deep expertise?
MU: As ESG evolves and the stakeholder expectations continue to intensify and become more exacting, the various components of ESG will attract more focused and specific attention. Even within the E factor, as attention shifts to other environmental concerns, such as biodiversity, water scarcity and food security, we will see the need for deeper, more refined expertise, particularly where the issues are backed by science, and there is a real need to identify, understand and analyze the data underpinning the issues and related risks.
Today the S factors are less well defined and understood, and are inherently more qualitative and harder to quantify, which makes regulation and data more challenging. As attention continues to shift to the social and welfare issues inherent in a business (including from within its supply chain and through consumer and community interaction), there will be a growing demand for expertise (and technology) to help identify and effectively manage these risks.
Clearly, there are significant social related-risks in Asia. Despite this, we still see less attention being paid to social risk in Asia than in other parts of the world (e.g., Europe).
The region’s political, cultural and economic diversity creates significant differences in approach by governments, regulators and companies as to how to address these risks. That being said, we are seeing positive initiatives from regulators in the region, particularly with respect to diversity.