Financial institutions are grappling with the legal implications of a raft of new regulations that impact sustainable finance and are taking steps to limit their liability to avoid potential climate litigation.
Underwriters of debt and equity instruments are treading carefully around anti-greenwashing and labelling rules that differ in the UK and Europe and are taking legal advice to try to avoid lawsuits as transition finance takes the market into the increasingly controversial area of financing high-emitting companies.
"Financial institutions are very conscious of the risk of misrepresentation claims being brought against them and are taking steps to ensure that they limit their liability as much as possible in the agreements that they enter into," said Tom Cummins, a partner at Ashurst in dispute resolution and arbitration.
Top of the list is the UK anti-greenwashing rule, which was introduced by the Financial Conduct Authority on May 31 as part of its Sustainable Disclosure Requirements. Firms are implementing it using FCA guidance scenarios published in April, starting with gaps in operational and compliance processes and the wording of communications and prospectuses.
However it is proving difficult in practise to tell when institutions are in breach of the rules due to the FCA's lack of action to date, which could be further delayed by the recent change of UK government in July.
"The UK anti-greenwashing rule is something that I think should be taken very seriously. However it might be some time before we see any form of FCA enforcement in that space," said Anna Varga, a counsel at Ashurst in dispute resolution.
Prior to the UK anti-greenwashing rule, the FCA had already been focusing on the quality of sustainability-linked loans and outlined its concerns about the product in a letter last June, which prompted banks to consult lawyers on the quality of deals and changing targets.
"We have spoken to financial institutions about the risk of issuing sustainability-linked instruments with unambitious KPIs. We have also looked at the extent to which issuers of sustainable debt would be able to unilaterally change KPIs," Cummins said.
The main concern is around misrepresentation claims, where investors in bonds or loans claim that underwriters failed to do due diligence after an issue arises with a borrowers' creditworthiness and so seek recourse from the banks.
Banks are beefing up due diligence and seeking legal opinions that their assumptions are reasonable and are also using second-party opinions from reputable providers to support their claims. However some banks are still concerned about the potential risks of leading transactions.
"Banks have asked if there are risks around the sustainability co-ordinator role, the answer is yes. Banks are looking closely at whether its is worth the hassle of taking on the role of ESG or sustainability co-ordinator," Cummins said.
In addition to concern in the debt markets, lawyers are also seeing greater risk in the equities market, particularly in the UK. The FCA said on July 11 that it was overhauling UK listing rules in a move to boost growth and innovation.
The new rules will simplify the listing regime with a single category and streamline eligibility, which will allow more companies to issue shares on a UK exchange, but lawyers are concerned that less proscriptive rules about what goes in offering circulars and prospectuses will give rise to litigation when investors suffer losses.
"We are talking to colleagues who do equity listings about the increased risk of investor sustainability litigation given the more liberal listing regime that we’re moving towards in the UK," Cummins said.
Carbon offsets are another potential minefield. The use of carbon offsets is the issuers' responsibility and banks will not verify the offsets or the way that companies are using them. Banks will therefore be reporting that offsets are part of the way that companies are trying to meet Scope 3 targets rather than expressing a view as to whether it is appropriate.
Legal work is currently focusing on technical disputes around the definitions of carbon offsets or energy attribution certificates from renewable energy and there has been little work to date on additionality or what carbon the offsets are compensating for in the industrial process, which could give rise to legal disputes.
"There's so much controversy around carbon offsets. We are seeing technical disputes on how you characterise particular instruments under a contract. The whole world of carbon offsets is potentially an area for litigation," Cummins said.