The Impact of Environmental, Social and Governance (“ESG”) in the Legal Industry
ESG has been gaining more traction among various stakeholders in Malaysia especially with the increasing cases of Covid-19 and the recent issues surrounding a number of Malaysian companies.
The recent Covid-19 outbreak at the world’s largest glove maker’s staff accommodations and the allegations of deforestation and force labour practices involving some of the foreign workers in the palm oil and forestry industries are some of the recent examples.
Coming from the abbreviation of ‘environmental’, ‘social’ and ‘governance’, ESG encompasses a range of non-financial performance indicators, comprising of sustainability, ethics and corporate governance issues that are used by investors to assess corporate behaviour and to determine the future performance of companies.
These ESG performance indicators assist the investors to look beyond the bottom line financial performance of a company and ascertain how the companies operate as a corporate citizen.
ESG a growing importance
Having grown dramatically across all sectors, the ESG indicators are seen to have been more mainstream in the financial sector and investment community.
This can be evidenced through the increasing value of global assets by using ESG data to better inform investment decisions, which has almost doubled over the past four years to reach USD40.5 trillion in 2020. The main catalysts for this growth are believed to have been the heightened social, governmental and consumer attention on the broader impact of corporations.
ESG investing is also not an alien concept in Malaysia. Bursa Malaysia, in partnership with FTSE Russell, launched the FTSE4Good ESG Index in 2014 to encourage listed companies to adopt good ESG practices.
Impact of ESG in legal industry
As the importance of ESG factors on profitability can no longer be ignored and there has been an increasing need for high level expert advice on issues surrounding ESG, the legal industry has begun to evolve in order to integrate ESG into the legal practice. A desktop survey conducted by The Blended Capital Group in 2020 showed that over 50 law firms worldwide are now offering integrated ESG advice.
Apart from law firms, the increasing commitment by companies to sustainability and responsible business has also resulted in the general counsels and in-house legal teams to be proactively involved in integrating material ESG risks and opportunities in business organisation, their operational policies and go-to-market strategies.
ESG in legal industry
The followings are some of the roles of the legal practitioners in delivering their clients’ or their organisations’ sustainability and ESG objectives[1]:
(a) Sustainability strategy and integration into decision-making
The legal teams are becoming more involved in setting the strategic direction of sustainability and ESG within organisations and in ensuring sustainability is embedded into corporate governance and integrated into broader business operations.
Their roles include incorporating ESG factors into investment decision-making and ensuring adequate ESG due diligence strategies are in place for any transactions. The legal teams are also required to ensure any time-bound sustainability commitments and targets of a company are commercially and legally viable and may be able to stand up to external scrutiny.
(b) Recognising ESG opportunities and risks
Lawyers and in-house legal counsels are expected to be able to horizon-scan and recognise what ESG opportunities and risks are there for the companies.
Although the risk for sustainability is derived from fundamental global challenges and moulded by stakeholders’ expectations rather than regulations or core commercial considerations, it is, nevertheless, a risk.
As identifying and dealing with risks, and detecting trends in the evolution of regulations that can have material impact on the business are among the expertise of legal practitioners, they should be able to pre-empt and prepare the company for any such changes.
General counsels should be able to highlight and communicate ESG risks to the organisations and at the same time ensure that the risks are effectively managed by incorporating the same into corporate management, adequate protocols and policies.
(c) Transparency and disclosure
In addition to ensuring transparent sustainability progress reporting, legal teams should also be able to explain material issues as well as the pathways and actions to manage them. Lawyers will make sure that corporate reporting meets the relevant reporting standards, and that disclosure addresses the ESG factors that are important to all stakeholders.
The legal teams too have a pivotal role to play in providing legal and strategic advice on how transparent and open does a company wish to be about their sustainability and their journey, beyond the minimum reporting requirements.
(d) Policies and procedures
Development of robust ESG policies and procedures that are operationalised and met the stakeholders’ expectation with inputs from the general counsels and legal teams can help shape the culture and corporate decision-making of companies. Alongside human resources departments, the in-house legal team can encourage employees to uphold good levels of responsible business and compliance and ensure the employees are appropriately incentivised to deliver against the company’s sustainability objectives.
(e) Grievance procedures
Effective grievance mechanisms are the keystone of any sustainable business and are a vital component of ongoing due diligence, risk management and stakeholder engagement. They are important in mitigating the legal, financial and reputational risks that can arise regarding ESG issues in companies’ operations, relationships and value chain.
The legal team plays an integral role to ensure that stakeholders have an adequate and transparent route to raise concerns and that the appropriate remediation will take place.
(f) Managing indirect impacts
Environmental and social impacts may go beyond a company’s own operations and into their value chain, both at the supplier and customer level. Lawyers are therefore required to lead due diligence reviews of their value chain for environmental, governance and human rights risks, and advise the management of broader ESG risks and impacts.
(g) Crisis management
Lawyers also play a vital role whenever there are social, ethical or environmental challenges that have the probable impact on the organisation’s financial position and reputation. This is especially when it results in regulatory intervention or litigation.
Integrated ESG legal practice
The role of legal firms, as a whole, in ESG may extend beyond the roles listed above. Although law firms have been providing legal advice in ESG aspects, expertise in ESG in a law firm spread randomly across different fields of legal practice areas with lawyers handling ESG issues in legal silos rather than in integrated ESG legal practice.
Law firms which hold themselves out as providing integrated advice on ESG risk assessment, according to The Blended Capital Group, generally define ESG issues as comprising of nine interrelated areas, which are as follows:
(i) Environmental liability;
(ii) Carbon trading;
(iii) Business and human rights;
(iv) Ownership of natural assets;
(v) ESG capital markets/securities regulation;
(vi) Governance;
(vii) Climate change;
(viii) Corporate responsibility; and
(ix) Sustainable finance.
Conclusion
While ESG is more prevalent in Europe and in the US, and that it is more nascent here, the interest level has been increasing. More companies have been taking cognisance of the importance of ESG especially as a result of the Covid-19 pandemic. Various stakeholders are also beginning to realise that businesses are more than just making money.
As such, in order for legal practitioners to be able to play their parts in ESG, not only that they are required to understand the importance of ESG as a whole, it is also pertinent for them to understand their roles in this space as well as to embed ESG in their own practices and everyday advice.
——————–
1 Luther-Jones, et al., “How general counsel and lawyers must help deliver sustainability and ESG outcomes” https://www.dlapiper.com/en/us/insights/publications/2020/12/general-counseland-lawyers-help-deliver-sustainability-andesg-outcomes/
Written by:
Norhisham Abd Bahrin (Partner) norhisham@azmilaw.com
Hanizah Mohd Huzin (general@azmilaw.com)
