Companies should conduct thorough due diligence in light of closer scrutiny from stakeholders and governmental and non-governmental bodies.

By James Inness and Natasha Hamilton-Foyn

Companies are facing increasing pressure to report on environmental, social, and governance (ESG) matters in terms of their legal obligations, stakeholder pressure, and reputational issues. Companies are subject to both mandatory and non-mandatory non-financial reporting obligations. For the first time, in 2018, under the Non-Financial Reporting Directive (NFRD), certain companies must publish in their annual reports information relating to environmental, social, and employee matters, respect for human rights, and anti-corruption and bribery matters. The NFRD therefore bolsters existing mandatory disclosure obligations under the Modern Slavery Act 2015 and the Climate Change Act 2008. The forthcoming Conflicts Minerals Regulation will further strengthen these obligations.

ESG is no longer a public relations exercise, and the risks related to reporting on non-financial matters are evolving. Stakeholders have a growing appetite for companies to report on non-financial matters, therefore companies should consider engaging proactively and appropriately with stakeholders in order to manage expectations on ESG matters. In particular, companies also need to be aware of potential risks as non-governmental organisations increasingly scrutinise financial reports — specifically human rights policies and comments on ESG matters — with a view to comparing what companies have said against what companies have done. Such scrutiny has also been used as part of some transnational litigation. For example, in the US, certain companies are facing shareholder-led lawsuits with respect to alleged misleading disclosures related to climate risk.

Equally, failing to report on non-financial matters may involve risks. For example, if a company fails to adequately report on ESG issues, regulators may require the company to amend their report. The UK Financial Reporting Council has taken action in connection with certain complaints related to ESG reporting. Additionally, if a company agrees to adhere to particular reporting standards and fails to do so through non-reporting, this divergence may also expose a company to litigation risk.

The trend towards companies reporting on ESG matters will likely continue. For example, companies can choose to make climate-related financial disclosures, in accordance with the recommendations published by the Task Force on Climate-Related Financial Disclosures. However, the Department for Business, Energy & Industrial Strategy (BEIS) and the Treasury recently hinted to the Environmental Audit Committee that it may look to make such disclosures mandatory if the take-up on making such disclosures does not meet expectations. Further, BEIS published a consultation in October 2017 related to streamlining energy and carbon reporting for businesses, proposing new mandatory reporting requirements.

In a landscape of increasing disclosure obligations and stakeholder activism, companies must be prepared for greater scrutiny and disclosure. With the help of professional advisors, companies should conduct thorough due diligence on all aspects of their business to ensure accurate disclosures and to address areas for improvement, before stakeholders can highlight any issues. Companies can use this due diligence to scrutinise and manage information that enters into the public domain as a result of mandatory and voluntary reporting.

This post was prepared with the assistance of Olivia Featherstone in the London office of Latham & Watkins.