There is no denying that ESG is something of a trend going into 2022. How might hedge funds use litigation to pursue their ESG goals, and potentially to profit?
Shareholder litigation and class actions are not commonplace in England and Wales, compared with the US, but commentators are forecasting growth in 2022, particularly in group claims. Observers will recall large shareholder actions in recent years against Tesco and RBS concerning accounting issues and the accuracy of regulated disclosures.1 Could disclosures around an issuer’s ESG claims fall within the same disputes regime? How, specifically, might hedge funds seek to take advantage?
In a high-profile essay last August, the former chief of sustainable investing at BlackRock labelled ESG “a dangerous placebo” and criticised widespread greenwashing.
The hedge fund industry has not ignored the rise of ESG as an investment theme.
A study from August 2021 showed that ESG-focussed hedge funds appeared to outperform their non-ESG counterparts and the relevant indices over multiple timeframes.2 Their performance was also reported to be less volatile over the relevant periods and, it is hoped, went some way to further ESG objectives more generally.
Sustainable investing is clearly in a period of growth. According to the Global Sustainability Investment Alliance, global sustainable investments hit $35 trillion in 2020, up 15% in two years.3 For 2021, BlackRock’s Larry Fink made ESG the theme of his annual open letter to CEOs, noting that “No issue ranks higher than climate change on our clients’ lists of priorities”; that sustainable investing has sparked “a fundamental reallocation of capital”; and that this represented an “historic investment opportunity”.4
Whilst ESG issuers have attracted fans, investors have also divested from non-ESG businesses. Universities have announced plans to divest fossil fuel companies from their endowments.5 Other investors, institutions and SWFs are following suit in divesting from, or actively avoiding, companies with poor ESG credentials.6 Hedge funds are taking note.
At the same time, corporate issuers have been expanding their market disclosures to encompass ESG topics. The disclosures are now mandatory in a small but growing number of jurisdictions. Issuers’ ESG disclosures today can be thorough but remain largely voluntary and non-uniform.
Criticisms circulate that the term “ESG” can represent form over substance. The SEC is looking closely at funds and products that are marketed as “green” or “sustainable”, without objective evidence to match – a practice known as “greenwashing”.7
In July 2021, the FCA published a “Dear Chair” letter, which set out its “principles on design, delivery and disclosure of ESG and sustainable investment funds”.8
The letter stated that applications it receives for ESG funds “often contain claims [around ESG] that do not bear scrutiny”, i.e. greenwashing. The FCA found that fund applications in the sector often did not contain “sufficient, clear information explaining their chosen strategy and how [it] relates to the assets selected”. In its “strategy for positive change”, published in November 2021, the FCA stated that “ESG matters are high on the regulatory agenda”.9
In a high-profile essay from last August, the former chief of sustainable investing at BlackRock labelled ESG “a dangerous placebo” and criticised widespread greenwashing in the investment management industry.10
A recent study by PwC suggested that 77% of institutional investors plan to stop purchasing non-ESG products this year.
There are clearly concerns that, in some quarters, investors are not being sold what is advertised.
The EU is in the process of introducing and enforcing an ESG disclosure regime under the Sustainable Finance Disclosure Regulation (“SFDR”) and the Taxonomy Regulation. In November 2020, the UK Government published a “Roadmap towards mandatory climate-related disclosures”, which recognised the need to introduce mandatory disclosures across financial and non-financial sectors of the UK economy in the coming years. More recently, in the run up to COP 26, the UK Government published its “Greening Finance” roadmap, which set out details on Sustainability Disclosure Requirements.11 These will eventually require every investment product to disclose the environmental impact of the activities it finances.
International bodies such as the International Financial Reporting Standards Foundation and the CFA Institute are also exploring the development of global sustainability reporting standards for companies.12
It is not difficult, therefore, to identify a trend towards more thorough and mandatory ESG disclosures across markets.
In English statute, the primary avenues for shareholder claims against a listed company are found at s.90 and s.90A/Sch.10A of the Financial Services and Markets Act 2000 (“FSMA”). Section 90 relates to listing documents such as prospectuses and has the effect that individuals responsible for the relevant document can be liable to those who have suffered losses as a result of any false or misleading statement therein, or any omission from the document of “necessary information”.
By contrast, s.90A/Sch.10A concerns ongoing disclosures via a recognised information service, such as an RNS feed. Section 90A creates a liability for an issuer where there is an untrue or misleading statement and a person discharging managerial responsibilities (“PDMR”) within the issuer knew the statement to be untrue or misleading or was reckless as to that fact.
In contrast with s.90, claimants under s.90A/Sch.10A are expressly required to establish that they reasonably relied on the disclosure or omission in question to purchase or continue to hold the securities. This can present an obstacle to claims, particularly in group actions, where the state of mind of numerous claimants may differ, and claimants will need to show that they would have acted differently (in purchasing, holding or disposing of the security) had the correct or omitted information been known.
Reliance can be a difficult hurdle, but it may prove simpler to evidence where an investor is bound by a mandate to invest only in sustainable businesses. Might funds be able to point to an ESG mandate and the disclosures in question as a reason for making/holding their position? To our knowledge, no such claims have yet reached the English courts, and it will be interesting to see how courts react to ESG’s idiosyncrasies.
The hedge fund industry is under pressure, from investors and regulators alike, to engage with ESG investments, themes and disclosures in its work. A recent study by PwC suggested that 77% of institutional investors plan to stop purchasing non-ESG products this year.13
Issuers seeking funds’ capital are similarly looking to bolster their ESG credentials. Issuers with poor ESG records may face product boycotts, falling revenues and difficulties in hiring and retaining staff. The stakes are therefore high. In this context, issuers may look to cut corners in their public disclosures, to investors’ detriment.
Hedge funds may approach this issue, and potential shareholder litigation, in two ways. First, they might consider taking short positions in issuers that they suspect of exaggerating or misstating their ESG disclosures. Second, if firms hold long positions in issuers that have given incorrect disclosures and have experienced adverse share price reactions to those errors becoming known, those funds can potentially seek to recover losses through litigation, as detailed above. Should funds wish to litigate on this basis, specialist third-party funders are likely to be keen to underwrite the claims.
As a first priority, hedge funds should consider whether they have the necessary understanding of ESG matters to make appropriate disclosures themselves, and that they are up to date with fast-changing regulation in the space. Secondly, hedge funds should regularly assess whether they have shareholder claims to pursue. Those who think they may have such claims should know that these are potentially complex actions to bring and should contact a specialist accordingly.
ESG Litigation – A Route to Profit?
English-law securities litigation and ESG
Jason Yardley, co-chair of Complex Commercial Litigation, Elizabeth Shimmin, Partner, Complex Commercial Litigation, and Oliver Thomson, Associate, Complex Commercial Litigation, Jenner & Block
Originally published in the July | August 2021 issue