Despite this we remain in the relative infancy of the ESG movement and Sustainability Reporting evolution. Companies need help to understand the specialist resources they require to improve the sophistication and reliability of their non-financial disclosures and to manage the resulting workload on finance and accounting teams. Most critically, companies caught by the mandatory reporting obligations must establish robust sustainability accounting systems to enable the identification, measurement, and reporting of material non-financial information as required by the Sustainability Reporting standards. These companies must then obtain assurance opinions on these statements to provide external validation of the representations and information reported. Owing to the need to capture upstream input data (Scope 2) and downstream output data (Scope 3), even those entities not yet captured by mandatory reporting obligations will have to do the same if they transact with an entity that is in the mandatory group – this is a monumental shift.
The International Sustainability Standards Board (ISSB) issued two Sustainability Standards in 2023, with a structured framework for companies to disclose climate-related information. The two standards are:
- IFRS S1 – General Requirements for Disclosure of Sustainability-related Financial Information; and
- IFRS S2 – Climate-related Disclosures.
The Australian Accounting Standards Board (AASB) has released draft Australian Sustainability Reporting Standards ASRS 1 and ASRS 2, which align with the IFRS standards. For details of the key points relating to ASRS 1 and ASRS 2, please see our insight article.
Companies are now expected to instil rigour and discipline to their Sustainability Reporting obligations that for many will be uncharted waters. Non-financial disclosures, including reporting on ESG initiatives, are no less susceptible to error as financial disclosures and – since most companies do not yet have the same comprehensive systems and processes for non-financial reporting as they do for financial reporting – the risks of misstatement are greater. Unmitigated, these risks expose companies and boards to claims of Greenwashing, leading to costly, distracting and harmful litigation.
Organisations will face additional challenges as a fundamental disconnect persists between the ostensible aims of the ESG movement and Sustainability Reporting on the one hand, and the methodology of the ESG ratings industry on the other. It might seem reasonable to expect that ESG-conscious investors are interested in obtaining a better understanding of how a company is performing on carbon emissions, pollution, ethical supply chains, and human rights. However, it is surprising that ESG scores produced by the ratings agencies do not aim to measure these factors. Rather, they are only interested in how a company manages these ESG-related factors in relation to their own bottom line. To summarise, ESG ratings are only concerned with inputs affecting a company’s profits, not its outputs impacting the world.
Many companies will struggle to keep up with the Sustainability Reporting requirements and some will, unwittingly or otherwise, produce false or misleading statements that give rise to a legal claim.
ESG-related litigation
Strategic
This is where claimants seek to bring about social change via court actions. Targets can be governments as well as companies.
Tactical
Litigation against companies brought by stakeholders seeking better disclosure, transparency and a clear sustainability action plan.
Financial
This type of litigation seeks compensation for loss and damage, and can include class actions, B2B litigation, and consumer claims. The most common types of financial litigation where an expert assessment of economic loss and damages is applicable include:
- Securities litigation: These claims can arise from misleading statements (including Greenwashing or Bluewashing), omissions, and false accounting. The actions centre on the question of reliance by a party on a disclosure in respect of an ESG-related risk that affects the company and its value. An example of this is a claim made against a company subject to fines or penalties for bribery/sanctions violations. Another is the failure to disclose an environmental liability, such as polluting of a river system. Both these examples can cause the company – and investors – financial loss and damage.
- B2B claims: These actions involve a company that claims it relied on a representation made by another company with which it has a business relationship, such as a supplier, customer or joint venture partner. These actions can also involve misleading statements (including Greenwashing or Bluewashing), and the key question is what financial loss has the claimant suffered? Examples include an Australian consumer goods company that depends on an image of ethical sourcing finding out that its key local supplier has used sweatshop labour in Asia to manufacture its goods.
- Consumer claims: As with the others above, consumer claims depend on the reliance of a party on a disclosure or assertion that has caused that party financial loss. Consumer claims are likely to be brought as a class action. An example might be a class of consumers who purchased a motor vehicle from a particular manufacturer relying on that company’s representations about the carbon emissions produced in manufacture – and paid a premium price for the product on this basis – and it being discovered those representations were false. The claim might be for the premium price paid over that of a comparable product.
Where could companies become targets?
The new Sustainability Reporting standards require more consideration, assessment and disclosure of sustainability-related risk and impacts. These go way beyond carbon emissions and climate matters more broadly. Expect more standards over the next few years specifically targeting biodiversity, human rights, ethical supply chains, with more to be added. Essentially, the new standards adopt the framework established in the Taskforce on Climate-related Financial Disclosures (TCFD), and the four pillars of Governance, Strategy, Risks & Opportunities, and Targets & Metrics. Many companies have adopted the TCFD framework voluntarily in part or in full, in varying degrees of rigour.
The standards require companies to determine and test its approach to underlying assumptions, data collection, documentation of plans and intentions, measurement methods and disclosures. The scrutiny to which sustainability disclosures will be subjected is unprecedented. Companies will need to demonstrate how they have verified the data used, what risk management processes have been implemented, how robust estimates have been tested, and what accounting systems have been utilised. Once disclosures have been made in a public document, companies will also be scored on the clarity of their disclosures and Sustainability Reporting, and the type of assurance opinions expressed on these disclosures.
When issues arise with your non-financial disclosures, and the information relied upon to make them, be prepared to seek advice to enable you to address the matters with confidence. Our Forensic experts can help.
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