HL
ESG
Risk Reader

Commitments to decarbonise the power sector to help achieve net zero outcomes by 2050 present unique challenges for governments and power producers in emerging markets who are simultaneously pursuing economic growth to advance the living conditions of their people. According to the Asian Development Bank (ADB), the majority of the world’s energy poor are living in Asia and the Pacific. More than 350 million people in the region have only limited access to electricity and 150 million people still have no access to electricity at all. 

Over the past 30 years, substantial investment has been made in developing base load power generation capacity in Asia to support economic growth. This has relied heavily on fossil fuels, primarily coal and gas.    

Financing for these projects has been reliant on export credit agencies and development banks, who have provided long term, stable, and economic sources of finance for these projects.  This financing has encouraged commercial lenders and other private sources of capital to underwrite the substantial investment in power generation capacity in these emerging markets.

Financial institutions and investors (both public and private), have come under increasing pressure from shareholders, civil society organizations and their own governments to withdraw financial support for power projects relying on fossil fuels.  Some public sector funders, such as the Asian Development Bank, have publicly stated that they will not fund new coal-fired power projects – others have noticeably reduced their support for new coal-fired generation, even if they have not publicly committed to no new funding.

The end result is that there are now very limited sources of debt and equity finance for any new coal fired power projects in the region, notwithstanding a number of governments are still contemplating the addition of further coal fired generation as part of their future power development plans.  

While the focus to date has been on lenders withdrawing support for new coal-fired power projects, there remains a risk that support for existing projects may also be withdrawn. To date this has not been observed at the project level, but there are certainly examples of lenders withdrawing support for corporate level facilities. Power developers should remain vigilant to the ongoing risk of project level financing being affected in the future and consider whether strategies can be put in place to mitigate such risk.

Recognizing these challenges, the ADB has recently announced an Energy Transition Mechanism, which will financially support the early retirement of coal fired generation capacity.  The first project, located in Indonesia, has been identified and ADB hopes to successfully reach agreement with the Indonesian Government, the power producer and their lenders within 2024.  It is hoped that this initial project, if successfully closed, can provide a blueprint for the early retirement of other coal fired generation capacity in the region, with replacement sustainable energy sources, thus ensuring that the replacement of coal fired generating capacity does not come at the expense of socioeconomic development in emerging markets.  

Climate change is an issue that is demanding action across the economy.  While each industry sector will face its own specific challenges, all companies must contend with issues that include the cost of directly controlling greenhouse gas (“GHG”) emissions without an assist from new technology, the challenge of offsetting emissions that cannot be controlled through third-party actions, and the intense level of scrutiny now being leveled against most, if not all, assertions a company makes about its climate action plan.

Government has the potential to be the “heavy hand” in this uncertain environment, but the choices it faces are likewise difficult. It can be hard to obtain political buy-in for limits on GHG emissions, in part because such limits risk creating an unacceptable near-term drag on the economy that is particularly tough on those who must stand for re-election. Identifying the most effective incentive programs is not necessarily straightforward, and there is a lag between incentivizing reductions and achieving them.  Additionally, incentives can be quite costly and beyond the reach of many governments. Government action is susceptible to changes in the political winds, which may create foot-dragging among regulated entities, although large, generous incentives may be too tempting to pass up and hard to end once they are in place.

With this sweeping array of challenges, what is most encouraging is the recognition across the global economy that business as usual is not an option.  Political and commercial consensus around the urgent need for climate action is emerging.

Spurred on by government incentives, private investments are pouring into climate-friendly technologies at an unprecedented level, and those embracing change are showing others the way. Additionally, the ability to export emissions-creation is declining as more governments accept the need for climate controls. Technologies thought to be far in the future are coming to market.  A hydrogen fuel economy, large-scale energy storage, and maybe even fusion, to name just a few new technologies, are no longer distant dreams.

So what climate-responsive strategies are available to organizations?  Among them are ongoing engagement in regulatory processes, as climate is not a “one and done” proposition.  Businesses are also taking a careful look at new technologies and the unprecedented levels of government support for them, recognizing the need to take advantage of incentives while they are available and learning to accept the accompanying policy “strings.”

Businesses are also finding new partners with whom to collaborate on climate strategies because going it alone may make it harder than it has to be. They are learning to bring realism to their climate strategies.  They understand that, if they over-promise, they are likely to under-deliver. Finally, they are recognizing that getting started is key to avoid being left behind by competitors.

In Germany, public scrutiny of an organization’s ESG stance and actions are increasingly intense,  creating a quickly evolving regulatory ESG landscape that is transforming former “soft” law to “hard” law and accompanied by expanding enforcement activities.

In Europe, the German Supply Chain Due Diligence Act (“SCDDA”) forms the spearhead of ESG compliance requirements and enforcement. The SCDDA requires companies with a local nexus to and over 1,000 employees in Germany to implement a comprehensive human rights and environmental risk management system. This includes inter alia,

• the appointment of a human rights officer,
• a risk analysis,
• preventive measures and a grievance mechanism, and
• remedial actions in case of suspected violations.

Companies also have to issue annual reports on their efforts which are submitted to the enforcement authority and must be published on the companies’ website.

To illustrate this environment, a manufacturer of tech products recently came under fire for allegations of forced labor in its supply chain. NGOs in a specific region in China have pointed to a potential significant human rights violation and accused the company of forced labor at its suppliers.

Due to this suspicion, the enforcement authority approached the company with a formal request for information to establish the facts of the case. The responses of the authority to this suspicion can have significant ramifications for the company, both financially and legally.

The potential consequences of inadequate human rights risk management are substantial. Aside from reputational damage, companies risk fines up to 2% of their global annual turnover for non-compliance. While to date there is no civil liability for breaches of SCDDA obligations, this will change with the adoption of the EU Corporate Sustainability Due Diligence Directive (“CS3D”) into national law. Criminal risks are also increasing with new legislation ahead and intensified enforcement.

Cases like this underscore the urgency and complexity of ESG risks in global supply chains. To effectively address the various risks, strong compliance processes are vital. Companies must take measures and implement appropriate risk management strategies to mitigate legal, financial and reputational risks. Companies with operations in Germany can consider the SCDDA as a blue print for compliance with the upcoming CS3D by implementing an effective risk management system as the basis for risk-based and appropriate measures to prevent human rights violations.

In recent years, ESG considerations have gained prominence in global investment decisions. However, alongside this sustainability focus, instances of greenwashing are increasing, raising doubts about the authenticity of corporate ESG practices. Latin America, known for its rich biodiversity and socio-economic diversity, provides a compelling case study on ESG risks, including the deceptive practice of greenwashing.

A significant ESG risk in Latin America results from its economic dependence on industries with substantial environmental footprints. Countries like Brazil and Mexico exemplify this reliance, with extractive industries often facing criticism for habitat destruction. Given the growing sustainability pressure, some corporations resort to greenwashing, portraying false environmental commitments while continuing unsustainable practices.

Mexico faces the challenge of balancing economic development with environmental preservation. Consequently, it has issued a series of public policies and legislation including a "Sustainable Taxonomy" guideline to categorize sustainable activities, aiding ESG risk management by offering clarity and investment guidance. Expansion of these guidelines is anticipated to ensure companies understand sustainable activity criteria.

One notable case of greenwashing in 2019, involved Greenpeace Mexico accusing a major fashion retailer of failing to provide transparency regarding its environmental impact. Despite claiming sustainability measures, the retailer did not disclose material usage in its products. This case underscored the challenges of verifying corporate claims of environmental responsibility and prompted public scrutiny of sustainability efforts within Mexico's fashion industry.

Similarly, Brazil faces ESG risks from deforestation and land degradation, primarily driven by agricultural expansion and logging activities. While agribusinesses promote sustainability initiatives, reports of illegal deforestation and land grabbing reveal the prevalence of greenwashing. Resultingly, Brazil has implemented policies to combat deforestation, including increased monitoring and enforcement efforts along with engagement in international partnerships and initiatives aimed at promoting sustainable development.

For instance, in 2010, a multinational energy corporation faced allegations of greenwashing after portraying itself as environmentally responsible while engaging in controversial projects, such as deep-water oil drilling in ecologically sensitive areas like the Amazon Rainforest. This case sparked debate about corporate transparency and environmental stewardship in Brazil's energy sector.

The above evidences how addressing ESG risks in Latin America demands a multifaceted approach involving regulatory reforms, stakeholder engagement, and enhanced transparency. Governments must enforce stringent environmental regulations and incentivize sustainable practices. Collaboration between corporations, civil society, and local communities is vital for genuine ESG integration and curbing the prevalence of greenwashing.

Increased consumer attention to corporate environmental practices – particularly related to global warming and net zero claims – has increased regulatory scrutiny and the risk of greenwashing enforcement actions by state attorneys general, local prosecutors, and administrative agencies with relevant jurisdiction. 

This rapidly emerging risk is illustrated by New York v. JBS US Food Company et al., N.Y. Sup. Ct. Case No. 450682/2024 (February 28, 2024), where the New York Attorney General (“AG”) filed a complaint against the American subsidiary of the largest beef producer in the world alleging that the company repeatedly mislead the public about its environmental impact.

The core of the complaint alleges that beef production has “the highest total greenhouse gas emissions of any major food commodity” and yet JBS allegedly made “sweeping representations to consumers about its commitment to reducing its greenhouse gas emissions, claiming it will be ‘Net Zero by 2040.’” Despite its broad claims, according to the complaint the company had “no viable plan to meet its commitment to be ‘Net Zero by 2040.’” Citing to filings with the Securities and Exchange Commission, the AG alleges that the company was driven to make false statements because it knew that if it was perceived to produce “unsustainable” beef product, consumer demand would be harmed and its share of the U.S. beef market would decline.

The company’s “Net Zero by 2040” claims, according to the AG, were made “without having calculated the vast majority of greenhouse gas emissions from its supply chain” or taking into account deforestation in the Amazon associated with its supply chain.  In fact, the AG’s position is that there “are no proven agricultural practices to reduce greenhouse gas emissions to net zero at the [company’s] current scale” and that offsetting emissions of such magnitude would be unprecedented. As such, even a “pledge” to reach net-zero at a distant point in the future – like 2040 – was deceptive because, according to the AG, it was neither feasible nor based upon a defined plan of action.

The complaint points to numerous alleged misrepresentations by the company about “Net Zero by 2040” made in multiple media, under a variety of contexts, including (i) on company websites, with particular focus on statements such as being “the first global meat and poultry company to pledge to achieve net-zero greenhouse gas emissions by 2040,” (ii) published sustainability reports, (iii) statements by the CEO at climate-related conferences, and (iv) a full page ad in the New York Times.

In making these, and other, statements, the AG alleges that JBS repeatedly: (i) undertook deceptive acts and practices, by making misrepresentations about greenhouse gas emissions, in violation of General Business Law § 349, (ii) violated General Business Law § 350 by engaging in false advertising on the web and online publications related to achieving net zero emissions by 2040, and (iii) violated Executive Law § 63(12) by engaging in repeated or persistent fraudulent or illegal conduct related to statements claiming the company would achieve net zero by 2040. The complaint asks for broad relief, including an injunction, disgorgement of ill-gotten profits, equitable relief, civil penalties ranging from $1,000 - $5,000 per violation (i.e., per misrepresentation), independent audits, and attorneys’ fees.

The case provides several cautionary insights. First, merely making a “pledge” to reduce greenhouse gas emissions over a period of years – as opposed to falsely claiming such reductions have already occurred – will not protect companies from potential enforcement.  Absent a defined, reasonable plan of action that is deemed feasible by regulators, enforcement alleging that an abstract pledge is deceptive is a real potential.  And, second, regulators will look across a swath of media – including advertising, websites, sustainability reports, SEC reporting, press releases, and public statements, speeches, and interviews by senior management – to build a potential case alleging a pattern of deceptive, misleading, and false claims.