Marathon or sprint? The race to decarbonize includes many early hurdles and mazes

Authors: MLT Aikins ESG practice group

The speed of change in environmental, social and corporate governance (ESG) risk management, reporting and marketing continues at varying paces. The road ahead involves complex regulations, more stringent rules and an ever-expanding encyclopedia of risks and challenges posed by climate litigation.

Different speeds in regulation uncover front runners and new risks

While the International Sustainability Standards Board (ISSB) unveiled standards IFRS S1 and S2 in July 2023, Canada may take another year to regulate ESG and climate-related risk reporting. In contrast, the United States is progressing at a noticeably quicker pace. The U.S. Securities and Exchange Commission (SEC) plans to issue its Climate Related Disclosure rule in October, and in California, Senate Bill (SB) 253, the Climate Corporate Data Accountability Act recently passed and the Climate-Related Financial Risk Act (SB 261) is expected to follow soon. Some experts suggest that these sub-national regulations could have a more significant impact on climate reporting than the SEC rule.

There’s speculation that the Canadian Securities Administrators (CSA) may be waiting for the final SEC rules to avoid creating incompatible sets of regulations for Canadian issuers with U.S. listings. Another factor may be the consultation process that the CSA and Canadian Sustainability Standards Board (CSSB) will undertake before adopting ISSB standards and issuing rules, such as National Instrument 51-107 – Disclosure of Climate-related Matters.

Across the Atlantic, the European Union has adopted regulations that will soon affect Canadian companies and likely shape North American ESG and climate-related rules. Under requirements from the European Financial Reporting Advisory Group (EFRAG), nearly 10,000 companies headquartered outside the EU will be subject to the EU’s Corporate Sustainability Reporting Directive (CSRD) starting in 2024. The EU Parliament is also tightening rules to combat greenwashing, particularly banning claims like “carbon neutral” that rely on emissions offsets. It’s unclear whether updates to the U.S. Federal Trade Commission (FTC) Green Guides will be as stringent. It seems Apple’s recent advertising campaign about its net-zero commitment may not fly under the radar of future climate-related regulations.

California, Montana and Texas take the lead in climate lawsuits

After the U.S. Supreme Court’s landmark ruling this year, the State of California filed a climate lawsuit against Exxon Mobil, Shell, BP, ConocoPhillips, Chevron and the American Petroleum Institute. The claim alleges they misled the public about fossil fuel impacts on climate change, and thereby “caused a delayed societal response.” The State is seeking damages, penalties and financing of climate mitigation and adaptation efforts, which is a pertinent concern after Allstate and State Farm began terminating home insurance in response to wildfire damage. Despite the outcomes of the case against Shell’s Directors in the U.K., this lawsuit in California may have implications for directors and officers of major energy companies. Per the State’s filing, accountability and direct responsibility for climate change policy lies with the Board of Directors and executive management.

In Montana, the first constitutional climate lawsuit to go to trial ended with a precedent setting ruling. The State must now consider potential climate impacts when approving energy projects after the judge determined that youth “have a fundamental constitutional right to a clean and healthful environment, which includes climate as part of the environmental life-support system.”

This human rights approach to climate litigation is a clear trend across global jurisdictions and this ruling is influencing numerous other cases across North America. Here in Canada, similar human rights approaches to climate litigation may be revived as Bill S-5 takes force, requiring the Government not only protect the right to a healthy environment but also “uphold related principles, such as environmental justice, non-regression and intergenerational equity.”

Scrutiny gets serious on carbon-neutral, net-zero and ESG claims

The surge in corporate net-zero commitments is facing increased scrutiny, especially with the countdown to COP28. Many companies are struggling to progress credible decarbonization plans as shown by a 2022 report where only 7% of the those with net-zero targets are predicted to be successful. More recently, the first report to take stock of global climate efforts was published this September with a clear conclusion: more ambitious action and targets are needed.

Although a key component of many net-zero plans is the use of voluntary carbon offsets. These offsets are losing credibility due to long lead times, questionable emissions reductions and lack of core business integration and impact. Specifically, the type of offsets known as Reducing Emissions from Deforestation and Forest Degradation (REDD+) is seen as the main culprit. It’s unclear whether this tone of inquiry informed Shell’s pull back from carbon credits in September, or the U.K. Carbon Trust’s decision to discontinue its carbon neutral verification. Nonetheless, corporates will likely reevaluate their reliance on carbon offsets and communications with carbon-neutral claims based on offset projects.

Within the finance sector, a new rule aims to cut down on greenwashing by U.S. investment funds. Adopted during Climate Week in New York City, the SEC’s Name Rule now requires that 80% of a fund’s portfolio matches the asset advertised by its name. Importantly, a Texas court’s decision regarding anti-ESG investing means we may see an increase in ESG marketing by investment funds. Once in force, investigations by the SEC’s Climate and ESG Task Force are likely to continue and lead to enforcement actions such as the recent $25-million penalty against DWS for misleading marketing.

Insurers are also grappling with climate-related risks and claims. In 2023, Canada’s Office of the Superintendent for Financial Institutions (OSFI) suggested insurers prepare for climate-related claims under corporate liability policies. Several studies have long warned that director and officer (D&O) policies are exposed to increased risk of climate litigation, impacting coverage cost and availability. To mitigate such risks, many insurers have committed to reducing their exposure to carbon-intensive industries. Whether GHG emissions count as pollutants under corporate insurance coverage is now up for review in the Hawaii Supreme Court. As lawsuits progress across North America and Europe, insights will emerge as to the dynamic between net-zero commitments, emissions profiles, and insurance claims, coverage, and climate litigation.

Climate litigation arrives in international courts

Between now and the end of 2024, historic proceedings on climate policy and action are unfolding before three international courts and tribunals in response to a request from the Commission of Small Island States (COSIS). This is first time guidance is being sought on climate change by drawing on the United Nations Law of the Sea Convention that applies to more than 160 countries. The proceedings will issue Advisory Opinions regarding states’ legal duties to mitigate climate change and protect the marine environment from impacts including ocean warming, sea level rise and ocean acidification. While not legally binding, these Opinions will shape climate policy and future litigation, emphasizing governments’ duty to align with the Paris Agreement.

MLT Aikins ESG practice group has wide-ranging and multi-disciplinary experience advising clients in all industries on their ESG strategies, governance and disclosure. Even if your company has substantial experience in publicly disclosing ESG and climate-related information, it is worth taking a fresh look at your governance, risk management, and disclosure practices in light of upcoming mandatory reporting requirements and legal risks. Contact us to learn how we can help.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.