1. Introduction
Long before environmental, social, and governance
(“ESG”) entered the corporate world’s vernacular,
these principles were very much present in various aspects of
project development and in the policies and procedures of owners
and investors. ESG in project finance has always been key to
understanding risk, due to the long-term nature of the investment.
Now, the increased prominence of ESG presents a new dimension of
investment, credit, and even reputational risk for a range of
projects, from infrastructure to energy assets.
A report released by S&P Global Ratings in 2020 confirmed
that lenders and investors financing projects face similar, and in
some cases more pronounced, ESG risks as compared to traditional
companies.1 With ESG at the forefront, companies bear
responsibility not only to their shareholders, but also to the
public and the planet. A focus simply on the “bottom
line” of short-term profitability and shareholder returns is
not tenable. Since projects are long-term investments in the
infrastructure, industry, or public services of a community,
investors must consider the long-term stability of a project and
its effects on a broad set of stakeholders, including employees and
local communities. Projects depend on buy-in from the local
community and adaptability in light of pressing climate risks and
changing regulatory environments. ESG risks are particularly
pronounced for projects related to fossil fuels and coal power,
where new and anticipated regulations could constrain operations
and impact viability, ultimately undermining their long-term
investment rationale.
Public policies increasingly favour investments in energy and
infrastructure projects that further environmental and social
justice goals by mitigating the impacts of climate change,
de-carbonising the energy and transportation sectors, and improving
both clean drinking water supplies and digital broadband
connectivity in historically underserved or low-income
communities.2
At the same time, investors and shareholders are demanding
greater ESG transparency and accountability by means of ESG risk
assessment, measurement, and reporting to better understand and
address the impact of their investments. This is evidenced by the
recent shakeup at Exxon, where an activist hedge fund proposed an
alternative slate of Exxon directors and, with the aid of proxy
advisors, institutional investors, and fund managers focused on ESG
concerns, gathered enough votes to seat two directors who they
expected to affect corporate policy to better mitigate and manage
the climate change impacts facing the energy
sector.3
Project companies increasingly leverage interest in ESG to
maximise opportunities to obtain financing or to obtain favourable
financing terms. ESG is a key consideration and top of mind for
investors, according to a study conducted by Harvard Business
Review of 70 senior executives at 43 global institutional
investing firms, including the three largest asset managers –
BlackRock, Vanguard, and State Street.4 In fact, ESG
investing has been seeing record growth in 2021, and the head of
BlackRock’s iShares has predicted that ESG-driven investing
will grow to $1 trillion by 2030.5 To meet this investor
interest, there has been a proliferation of green and
sustainability bonds and other ESG financial instruments. Project
companies and investors of these instruments should use tailored
ESG reporting frameworks that take into consideration the risks and
opportunities specific to their project.
2. ESG Considerations and Risks for Investors, Lenders, and Project
Companies
The three factors of ESG – environmental, social, and
governance – describe considerations that go beyond
traditional financial criteria and relate to sustainable growth,
environmental and social impacts, and the governance arrangements
of the project company. There are other terms used to express
similar ideas to ESG, including the “triple bottom line”
(also known as the “three Ps”, which are profit, people,
and planet), “corporate social responsibility”, and
“socially responsible investment”. In project finance,
although the term ESG is not always used, it is highly present in
various aspects of project development and in the policies and
procedures of owners and sponsors. For example, since 2003, many
financial institutions (including banks) have implemented a risk
management framework known as the Equator Principles for
determining, assessing, and managing environmental and social risk
in project finance.6 As of November 2021, more than 125
financial institutions have adopted the Equator Principles. The
purpose of the Equator Principles is to promote sustainable
environmental and social performance, which can lead to improved
financial, environmental, and social outcomes for projects. The
Equator Principles are primarily intended to provide a minimum
standard for due diligence to support responsible decision-making
based on the careful assessment of risk, and can trigger a need to
conduct certain actions to provide a remedy for or offset any
environmental or social issues identified. The Equator Principles
apply across industry sectors, including renewable energy, and have
helped spur the development of responsible environmental and social
management practices in the financial sector and banking
industry.
Characteristics of Project Financings that Enhance ESG
Risks
Project financings have particular characteristics that provide
protections to creditors – such as all-assets pledges,
structures, and covenants to reduce volatility in project cash
flows and waterfalls prioritising debt servicing over equity
distributions – that allow project companies to have higher
leverage ratios than traditional companies while maintaining
similar credit quality. Nevertheless, project finance lenders and
investors are exposed to similar or enhanced ESG risks. Projects
that involve infrastructure and construction work can have effects
on the environment and require interactions with local
stakeholders. Costs associated with compliance with environmental
regulations and coordinating with local communities can be high
throughout the life of a project and may impact projected cash
flows in the operations phase of a project. To the extent that
project risks are allocated to third parties, reducing commercial
and technical risks, a credit analysis should identify the extent
to which those third parties may be exposed to ESG risks that could
affect costs, revenues, or supply chains.
ESG issues are important for debt and equity investors in
project companies. Failure to properly address these issues can
adversely impact the development and performance of projects
vulnerable to ESG risks and weaken a project company’s credit
position and profitability. ESG factors can also create financing
and refinancing challenges for projects, since their asset life is
uncertain, particularly considering new environmental regulatory
pressures.
For example, S&P and Moody’s both cited ESG factors as
key drivers in rating the debt of the operator of a coal plant in
West Virginia, noting that as investors increasingly shy away from
coal projects, it has become difficult to attract additional
capital or arrange an extension or refinancing of existing debt
facilities. In 2022, Moody’s continued to highlight the
operator’s overall weak credit position in light of risks
associated with decarbonisation and the energy transition,
anticipating federal regulatory policy that could adversely impact
the coal sector in general and the coal plan in particular, and
increasing investor concerns relating to ESG factors, all of which
had a highly negative impact on the operator’s rating.
Negative social and governance events led S&P to downgrade
debt issued by an owner and operator of a highway project under
construction in Lima, Peru to speculative grade due to the
resulting erosion in the risk profile of the project. From a social
perspective, protesters destroyed a new toll plaza facility over
concerns of toll charges and their impact on wealth inequality and
affordability. Subsequently, the municipality of Lima suspended
toll payments at the facility, which resulted in a loss of revenue.
From a governance perspective, one of the company’s sponsors
had been involved in a probe for paying bribes in Latin America to
win concessions. The project’s relationship to this sponsor
carried reputational risks, which in turn affected its ability to
secure additional financing.
Environmental, Social, and Governance Considerations in
Project Finance
ESG considerations are relevant to all types of large, long-term
infrastructure projects, from highways and bridges to energy
projects (including renewable energy projects), rail lines, and
water or water treatment facilities. Additionally, all three ESG
factors can be interrelated and sometimes inversely related given
the complicated impact that actions in one factor may have on the
other factors. If a coal power plant is shut down for environmental
reasons, for example, there can be cascading impacts on social
issues if the shutdown results in layoffs and unemployment for
local communities.
Environmental
Environmental considerations have always played a central role
in project development, including those related to the siting of
projects and proper disposal of materials after a project is
decommissioned. The “E” can also overlap with the
“S” in the areas of local community relations,
environmental justice, preservation of archaeological and cultural
resources, and Indigenous rights.
- Project siting impacts may be temporary or permanent
in nature. For example, the siting of temporary construction access
roads may disturb wetlands or other sensitive habitats. Other
impacts may be more permanent, such as harm to protected species.
Projects and associated infrastructure (such as transmission lines
for energy projects) can require a large amount of acreage, which
is often agricultural or previously undeveloped land. Project
development can require tree clearing, regrading of the land, and
dredging/filling of wetlands. Temporary or permanent access roads
or staging areas need to be placed, and ground disturbance such as
excavation and filling for foundations must occur. These activities
may disturb the habitat of a variety of wildlife depending on
location, such as fish and other aquatic species for hydroelectric
dam projects, and in some instances, projects may result in
intentional or incidental animal death. Also falling under the
umbrella of environmental are impacts to safe airspace travel; some
types of projects can cause sight hazards or disrupt flight
patterns for aircraft, especially if located in proximity to an
airport, and have the potential to disrupt national air defence
networks. In many jurisdictions, a project will be required to
comply with a statute, such as the National Environmental Policy
Act in the United States, that can trigger the need for a
comprehensive review before issuance of certain permits or other
governmental action. These laws can require that a project company
thoroughly review the environmental impacts of the proposed project
and mitigate those impacts to the extent possible. Project
companies should be mindful to comply with all other environmental
laws, including those that regulate sensitive resources such as
wetlands and protected species. - Community relations, cultural resources, and Indigenous
rights are critical aspects of determining how and where a
project should be sited. ESG reflects an increasing social
awareness of the impacts a project may have on the surrounding
community. For example, if a project is located in proximity to
important cultural or Indigenous resources, sovereignty concerns
should be assessed and mitigated, with Indigenous community
involvement throughout the process. The Equator Principles
specifically require that all projects affecting Indigenous Peoples
will be subject to an informed consultation and participation
process and must comply with the rights and protections for
Indigenous Peoples contained in relevant national law, including
laws implementing host country obligations under international
law.7 Appropriate mitigation can include performing
studies and surveys of the area and preparing mitigation and
preservation plans. - The concept of environmental justice more broadly
strives for the fair treatment of all people when considering the
siting of projects. There are legitimate concerns regarding project
siting near vulnerable communities and the associated risks of
pollution and disturbances resulting from noise, runoff,
excavation, and other features of project operation and
development. This is compounded when a community already has
several similar projects within its borders. Projects are almost
always subject to an approval process that requires an opportunity
for public comment, which can raise these concerns and result in a
better project with fewer community impacts. - Proper disposal of materials at the end of the project
life cycle is an oft-overlooked project consideration.
Decommissioned project components must be disposed of in ways that
preserve the health and safety of the physical environment and of
individuals and communities. The Equator Principles can trigger the
need for a decommissioning plan, even if not required by a host
country’s laws.
Social
The social aspects of project finance encompass labour and human
rights, supply chain considerations and the ethical procurement of
materials, and diversity, equity, and inclusion
(“DEI”).
- Labour and human rights considerations include
improving working conditions, addressing work stoppage risks,
preventing modern slavery, and preventing the acquisition of
materials from industries or jurisdictions identified as being
vulnerable to labour exploitation and forced labour in violation of
international standards. Child labour, slavery, and general
compliance with employment and fair wage regulations are a few
examples of risks that should be mitigated or avoided, including by
contractual means. - Supply chain considerations arise during the
procurement of materials for a project. Project companies should
conduct supply chain due diligence to understand the business and
employment practices of their vendors and suppliers and ensure that
materials are not sourced from environmentally fragile locations or
using illegal or unethical employment practices. Enhanced supply
chain due diligence should be implemented when procuring materials
from countries where human rights and forced labour issues are
prevalent, or from suppliers that source inputs from such
countries. A resource for identifying goods produced by child or
forced labour is the U.S. Department of Labor’s
(“DOL”) List of Goods Produced by Child Labor or Forced
Labor.8 - DEI measures should involve the representation and
participation of a diverse workforce across all levels of a project
up to leadership. DEI considerations have not traditionally been a
focus in project financing, but diversity can strengthen a project
company’s reputation and bring in different perspectives and
ideas. When diversity is coupled with equity and inclusion, it has
been shown to drive innovation and produce better outcomes through
increased productivity and profitability. Project companies can
demonstrate this commitment through onboarding and developing
diverse talent internally. Project companies are also able to
mandate certain diversity standards and guidelines when they hire
outside vendors, such as construction companies, engineers, and
attorneys.
Governance
“Governance” is a term that has an increasingly broad
reach, encompassing not only traditional notions of corporate
governance, but also the structures in place to manage significant
areas of risk for the project company, such as transaction
requirements imposed by lenders and sponsors, cybersecurity and
data privacy, anti-corruption, and trade compliance.
- Corporate governance relates to the composition and
procedures of supervisory bodies. Additional considerations include
proper separation of a project company with the sponsor or holding
company. An important feature of corporate governance is regulatory
compliance and the maintenance of compliance policies, procedures,
and controls designed to promote compliance with relevant laws and
regulations and mitigate risks associated with the jurisdiction,
sector, and operations of the project. - Transaction requirements can include information
disclosures and reporting requirements. Investors may build these
requirements into project financing documentation to improve
transparency and strengthen the integrity of a project. Such
requirements may include documentation that will allow financial
institution investors to verify the identity of project company
borrowers and their beneficial owners, pursuant to their
obligations under anti-money laundering laws. Transaction
governance can also include internal processes to manage the
proceeds of green or sustainability financing and track the
allocation of funds. - Cybersecurity and data privacy issues, if not
addressed, can pose significant operational and financial risks,
and can halt an entire project. Project companies should review
their corporate security and business continuity plans and invest
in strengthening their data and cyber protection and resiliency
systems. They can look to guidance issued by the White
House,9 the U.S. Federal Trade Commission,10
and the U.S. Securities and Exchange Commission
(“SEC”)11 to understand what is considered
reasonable cybersecurity practice. Proposed rules issued by the SEC
on February 9, 2022 include requirements for the reporting of
material cybersecurity incidents, cybersecurity and the maintenance
of procedures to minimise user-related risks, all intended to
prevent unauthorised information and systems access and to address
cybersecurity incident response and recovery.12 - Ethics and anti-corruption strategies should promote
accountability, transparency, and integrity, both internally and
externally with customers, suppliers, and third-party agents.
Project companies, particularly project companies with meaningful
non-U.S. dealings and interactions with foreign governments,
including through suppliers or distributors, should be mindful of
their obligations under the U.S. Foreign Corrupt Practices Act and
other anti-corruption laws and should develop policies and
procedures to promote ethical behaviour and prevent bribes and
other corrupt payments. - Trade compliance considerations related to sanctions
and import/export controls may restrict a project’s ability to
engage certain customers, suppliers, distributors, or other
counterparties, or to import certain raw or finished materials. For
example, in recent years, the U.S. Department of the Treasury’s
Office of Foreign Assets Control (“OFAC”) has imposed
blocking sanctions on a number of Chinese individuals and entities
in connection with forced labour and human rights abuses in the
Xinjiang province of China.13 Also, Congress passed the
Uyghur Forced Labor Prevention Act in December 2021, creating a
rebuttable presumption that goods manufactured, wholly or in part,
in the Xinjiang province are produced through forced labour,
therefore barring their release by U.S. Customs and Border
Protection from U.S. ports of entry.14 Solar project
companies, which rely on silica as a raw material in the production
of solar panels, should be aware of these restrictions and
implement appropriate diligence and screening procedures.
Additionally, in response to Russia’s invasion of Ukraine, the
United States has imposed a number of sanctions measures targeting
certain Russia individuals and entities and dealings involving
certain sectors. The United States has also prohibited U.S. persons
from engaging in any new investment activity in Russia, directly or
indirectly. Investors will have to be mindful of these restrictions
in relation to projects in Russia or involving Russian
counterparties.15
3. Financial Instruments for ESG Investment in Projects
There are a number of financial instruments available to project
companies engaged in ESG activities. These include green, social,
and sustainability bonds, whose proceeds are linked to ESG
activities, as well as sustainability-linked bonds, whose financial
terms are linked to ESG metrics.
Green Bonds, Social Bonds, and Sustainability
Bonds
Green, social, and sustainability bond financing are
activity-based bonds that link the proceeds of the financing or
refinancing provided to project companies to ESG activities, such
that project companies must use the proceeds in a manner that meets
the criteria of a “green” or “social” activity,
or a mix of the two for sustainability bonds.
The eligibility of projects to qualify for this type of
financing can be based on a multitude of frameworks, including the
International Capital Market Association’s (“ICMA”)
Green Bond Principles,16 Social Bond
Principles,17 and Sustainability Bond
Guidelines.18 The four core components for alignment
with these principles are related to the following: (i) use of
proceeds; (ii) process for project evaluation and selection; (iii)
management of proceeds; and (iv) reporting.
Use of Proceeds and Project Selection
Green bonds are instruments where the proceeds are used solely
to finance projects with environmental benefits. They can include
projects in renewable energy, energy efficiency, land and water
management, biodiversity conservation, clean transportation,
pollution prevention and control, and climate change adaptation.
The proceeds for social bonds, meanwhile, finance projects that
address a social issue by mitigating social harms or attempting to
achieve positive social outcomes. Such projects can seek to improve
a community’s access to, or the affordability of, essential
services, housing, infrastructure, employment, and food, and may be
aimed at socioeconomic advancement and empowerment. Sustainability
bonds are bond instruments whose proceeds are used to finance a
particular goal (such as decarbonisation) or a combination of
“green” and “social” projects.
Proceeds Management and Reporting
Project companies issuing these types of bonds should implement
an internal process to manage the proceeds and for reporting on
uses of proceeds. Issuers should report on the use of bond proceeds
by describing the projects and their impact, at least on an annual
basis. It is recommended that issuers use both qualitative and
quantitative performance indicators. For projects where the actual
impact cannot be calculated until projects are completed and
operational, which may not be at bond issuance, issuers can report
on the estimated impact of their projects. This is common for
social projects like the construction of affordable housing or
healthcare facilities. Green bonds are generally certified at
issuance by an independent third party. Of late, credit ratings
agencies are introducing ratings methodologies for debt that is
intended to be sustainable or to meet the green or social goals of
the issuer.
For green bonds, the Harmonised Framework for Impact
Reporting,19 developed by multilateral development banks
and international financial institutions, lays out principles and
recommendations for impact reporting. Harmonised frameworks have
been released for energy efficiency and renewable energy projects,
sustainable water and wastewater management projects, sustainable
waste management and resource-efficiency projects, clean
transportation projects, green building projects, biodiversity
projects, and climate change adaptation projects. The frameworks
offer sector-specific recommendations for reporting, including core
principles, metrics, and indicators for reporting. For example, the
suggested core indicators for renewable projects include: (i)
annual greenhouse gas emissions reduced or avoided; (ii) annual
renewable energy generation; and (iii) capacity of renewable energy
plants constructed or rehabilitated. The frameworks do not dictate
a single commonly used standard for the calculation of indicators,
and issuers may follow their own methodologies. Issuers are
encouraged to use this guidance to develop their own reporting that
is adapted to their own circumstances and their own approaches to
the management of proceeds.
For social bonds, a working group has been established to
develop a harmonised framework. The outcome of the working group is
a document that sets out principles for reporting.20 In
addition to reporting on the use of bond proceeds and on the
expected impacts, issuers are encouraged to identify the target
populations for which the project is expected to result in positive
socioeconomic outcomes, and why the selected target population is
considered underserved or vulnerable. For projects addressing broad
social issues that impact the general population, like health
issues and water supply, issuers are still encouraged to identify
any particular segments of the population that are expected to
especially benefit from the project.
In addition, multilateral organisations have established
internal standards for their financing of “green”
projects. For example, green bond financing by the International
Finance Corporation (“IFC”), a member of the World Bank
Group, may include investments in the following types of projects:
(i) investments that result in a reduced use of energy per unit of
product or service generated; (ii) investments that enable the
productive use of energy from renewable resources such as wind,
hydro, solar, and geothermal production; (iii) investments to
improve industrial processes, services, and products that enhance
the conversion efficiency of manufacturing inputs, like energy,
water, and raw materials, to saleable outputs; (iv) investments in
manufacturing of components used in energy efficiency, renewable
energy, or cleaner production; and (v) investments in sustainable
forestry.
In addition to meeting green bond eligibility criteria, any
project financed through green bond proceeds must also meet the
IFC’s investment process, which includes rigorous due
diligence, including disclosure and consultation requirements and
integrity due diligence using the IFC’s Environmental and
Social Performance Standards21 and Environmental, Health
and Safety Guidelines.22 Projects must also comply with
IFC’s Anti-Corruption Guidelines, with potential penalties for
entities engaging in fraud and corruption being sanctions and
debarment from financing from the IFC and other international
financial institutions and multilateral development
banks.23
Sustainability-Linked Bonds
Sustainability-linked bonds are performance-based bond
instruments, for which proceeds can flow to general corporate
activities, unlike with green, social, and sustainability bonds.
Instead, the interest rate, payment, or other financing terms are
linked to ESG factors and may be adjusted if certain sustainability
performance targets are met. Sustainability performance targets are
tracked by key performance indicators, which should be measurable
and reportable, such as emissions reductions.
The Sustainability-Linked Bond Principles,24 also
developed by the ICMA, can be used to determine eligibility for
sustainability-linked bonds. These principles have five core
components related to: (i) selection of key performance indicators;
(ii) calibration of sustainability performance targets; (iii) bond
characteristics; (iv) reporting; and (v) verification.
Accordingly, project companies issuing sustainability-linked
bonds should implement internal processes and procedures to ensure
proper monitoring, disclosure, and verification of key performance
indicators. Projects should report on key performance indicators
regularly, and in any case for any date or period that may be
relevant for assessing the status of sustainability performance
targets that are established as trigger events leading to a
potential adjustment of the bond’s financial or structural
characteristics.
4. Frameworks for Accurately Assessing Whether a Project Meets
ESG Standards
As noted above, there is significant investor appetite for
understanding and measuring the ESG benefits and risks of a
project. There is a plethora of frameworks that project companies
can use or take inspiration from to identify relevant and material
indicators for reporting on ESG metrics. They include international
agreements and standards adopted by countries, such as the UN
Sustainable Development Goals (“SDGs”), which establish
17 political goals related to peace, climate action, affordable and
clean energy, clean water and sanitation, infrastructure, ending
poverty, and reducing inequality, among others. The SDGs are
defined by 169 targets that are tracked by 232
indicators.25 The Paris Agreement was formed by 197
countries with a goal of reducing the increase in global average
temperatures to 1.5 degrees Celsius and has been reinforced by
subsequent international agreements, most recently at COP-27 in
Sharm El-Sheikh, Egypt in November 2022.26
The UN Principles for Responsible Investing (“PRI”) is
an initiative of the United Nations with large institutional
investors that lays out six principles for responsible investments
relating to the incorporation of ESG issues into investment
analyses, decision-making processes, ownership policies and
practices, and disclosures from the entities in which they
invest.27 PRI, in collaboration with the UN Global
Compact and UN Environment Programme, has also issued practical
guidance on the integration of ESG into investment analyses and
decisions. The UN Guiding Principles on Business and Human Rights,
voluntary principles adopted by the UN Human Rights Council, set
forth the responsibility of companies to respect human rights and
provide a remedy when adverse impacts occur.28
Project companies can also look to guidance or tools such as
those developed by the Global Reporting Initiative
(“GRI”),29 Sustainability Accounting Standards
Board (“SASB”),30 and Task Force on
Climate-Related Financial Disclosures
(“TCFD”).31 Both the GRI and SASB have
published sets of universal standards that provide guidance on
disclosures across companies, as well as sector-specific standards
that account for the sustainability context of a particular sector.
The SASB has developed a set of 77 sector-specific sustainability
accounting standards, which identify financially material
sustainability topics and their associated metrics for a typical
company in that sector. Recently, in August 2022, the Value
Reporting Foundation, which houses the SASB, completed its
consolidation with the Climate Disclosure Standards Board to form
the International Sustainability Standards Board
(“ISSB”).32 The ISSB aims to combine existing
disclosure frameworks and develop an integrated, comprehensive
baseline that would make it easier for companies to distil and
report information to investors.33 The Financial
Stability Board established the TCFD to develop recommendations for
more effective climate-related disclosures that could inform
investment, credit, and insurance underwriting decisions, and
enable investors to better understand climate-related risks to a
company and its counterparties, including its suppliers. Project
companies can also rely on benchmarks and data houses such as
S&P Dow Jones Indices that supply datasets providing
industry-specific and financially material ESG opportunities and
risks.34
Each project company should consider the most appropriate
framework that is tailored to its activities. Ultimately, though,
the metrics that a project company adopts will inevitably reflect
what its investors are demanding.
5. Mechanisms to Manage and Mitigate ESG Risks
There are a multitude of positive effects on the “triple
bottom line” when project companies, sponsors, lenders, and
investors take ESG seriously during project development and
funding. There can also be risks associated with the failure to
properly apply ESG metrics to a project. Investors and lenders may
choose to decline to fund projects that do not place emphasis on
ESG. There can be impacts to credit quality – positive or
negative – caused by reviewing a project against ESG
standards. For example, in the energy industry, a renewable energy
project may receive a more favourable credit rating, while projects
producing or using fossil fuels may receive a worse rating due to
uncertainty around future regulatory policy or environmental
impacts. Project location may also receive heightened scrutiny, and
construction in areas vulnerable to extreme weather events may
require higher liquidity reserves and insurance policies. For
projects that are less resilient or have higher ESG risks,
insurance may become more expensive or less available.
The lack of a unified conceptualisation and parameters for ESG
and the variability of ESG factors by sector and by location has
led to challenges within ESG reporting. Since projects can involve
a wide variety of sectors, harmonisation of metrics and
comparability and reliability of reporting is an issue. In the
current formal regulatory vacuum, it can be difficult to choose
which ESG framework to apply and understand how to properly assess
ESG metrics. Other contributing factors are the voluntary nature of
the frameworks, difficulties of monitoring and measurement, and the
absence of mandatory external auditing and verification.
Further, ESG is not a static concept. ESG considerations and
evolving ESG standards are fundamentally a reflection of the
present zeitgeist, and the current events that inform policy
objectives, the interests of consumers and investors, and
technological developments. The field of ESG is just as complicated
and nuanced as the world that informs it. As these features evolve
and change, so do the factors that make up ESG and the methods of
assessing their interconnectedness.
These challenges have made ESG reporting susceptible to
“greenwashing”, where some companies overreport
sustainability, cherry-pick metrics, or otherwise engage in an
inaccurate portrayal of ESG practices to look better to investors
or to qualify for funding. In a noteworthy example, in April 2022,
the SEC charged Vale, a Brazilian mining company and one of the
world’s largest iron ore producers, with making false and
misleading claims about the safety of its dams prior to the January
2019 collapse of its Brumadinho dam, which killed 270 people and
caused immeasurable environmental and social harm.35 The
SEC alleged that Vale intentionally misled investors through its
ESG disclosures in which it made assurances that the company
adhered to the “strictest international practices” in
evaluating dam safety and that one hundred percent of its dams were
certified to be in stable condition. Proposed new ESG disclosure
requirements under securities laws and the establishment of more
objective, consistent standards for claimed environmental
attributes or other ESG metrics may address this complex issue.
Another concerning trend involves companies that engage in
“brownwashing”, which has taken on different meanings. It
could mean investors that are betting against ESG and acquiring
fossil fuel assets at discounted prices relative to projected cash
flows. The term has also been used to describe companies that sell
fossil fuel assets to private equity funds or other buyers so that
their balance sheets appear greener to consumers or investors.
“Brownwashing” may also refer to companies underreporting
their ESG credentials, which may be intentional or may be due to a
lack of understanding of ESG issues or inadequate management of ESG
monitoring.
While approaches to ESG reporting remain in flux, investor
demand for “consistent, comparable, and decision-useful”
disclosures related to ESG risks remains strong, as has been
highlighted by SEC Chair Gary Gensler.36 Taking heed of
these demands, on March 21, 2022 the SEC released its proposed
rules on climate risk disclosures, which amend and build upon
existing climate change disclosure rules and guidance and seek to
enhance and standardise disclosures on climate-related risks that
are like to have a material impact on a public company’s
business and financing performance.37 In crafting the
Proposed Rules, the SEC took guidance from existing third-party
frameworks, standards, and metrics, principally the TCFD and
standards for accounting and reporting on greenhouse gas emissions
established by the Greenhouse Gas Protocol. The SEC has missed its
self-imposed deadline to finalise the rule by October 2022 due to
the large volume of comments received and a technical glitch in its
online comment system that required the reopening of the comment
period for the rule; the rule is now expected to be finalised
sometime in 2023.38 The DOL, on November 22, 2022,
published a final rule allowing plan fiduciaries to consider
climate change and other ESG factors in their selection of
retirement investments.39 In the United Kingdom, the
U.K. Financial Conduct Authority recently published a Consultation
Paper (CP22/20) with proposed rules aimed at addressing
greenwashing that would standardise and qualify specific
sustainable investment labels, with an intent to publish a final
rule by June 30, 2023.40 In response to investor demand
for harmonisation, there have also been efforts to develop a common
reporting framework by the World Economic Forum, the Big 4
accounting firms, the GRI and SASB.41
Yet, over the past year, another trend has been emerging in the
United States: a counter-reaction to companies’ increasing
normalisation of ESG reporting. Vocal critics have framed ESG
efforts as a type of stakeholder capitalism that injects politics
into the decision-making processes of corporations and shifts the
focus away from maximisation of shareholder profits and raising
questions about the future of the SEC’s Proposed
Rules.42
With these considerations in mind, project companies should take
steps to leverage opportunities and mitigate risks by understanding
the ESG considerations of a project from the very beginning of the
development and procurement process. Site selection and initial
design and engineering should reflect ESG goals and risks, for
example by intentionally choosing to site a project in a location
that would not adversely affect vulnerable communities or
environmentally sensitive areas and that would be more resilient to
extreme weather events. Investors and lenders who embrace ESG goals
should create a contractual framework to hold project companies
accountable and encourage the incorporation of ESG into project
development. Increased transparency, verification, and reporting
will be important to maintain a robust market for green, social,
and sustainability bonds and other financial instruments and to
bolster the integrity of market standards for project financings in
the future.
Footnotes
1. Gregg Lemos-Stein, et al., General
Criteria: Environmental, Social, And Governance Principles In
Credit Ratings, S&P Global Inc. (March 9, 2022),
available at(Hyperlink) Diego Weisvein, How ESG
Factors Have Begun To Influence Our Project Finance Rating
Outcomes, S&P Global Inc. (January 27, 2020),
available at(Hyperlink)
2. See, e.g., H.R. 3684 – Infrastructure
Investment and Jobs Act, Public Law No. 117-58 (passed into law
November 15, 2021), available at(Hyperlink)See also Allan Marks,
Biden Signs Infrastructure Law: Here’s How It Will
Streamline $1 Trillion in Spending, Forbes (November 16,
2021), available at(Hyperlink)
3. Jennifer Hiller and Jessica Resnick-ault, The Two
New Exxon Board Members Poised to Shake up Insular Culture,
Reuters (May 26, 2021), available at(Hyperlink) On the point of the increasing
influence of proxy advisors in the ESG context, see Neil
Whoriskey and Allan Marks, Corporate Governance & Proxy
Advisors: “Who Watches the Watchers?”, Milbank LLP
Law, Policy & Markets Podcast (January 29, 2021), available
at(Hyperlink)
4. Robert G. Eccles and Svetlana Klimenko, The
Investor Revolution, Harvard Business Review (2019),
available at(Hyperlink)
5. ESG May Surpass $41 Trillion Assets in 2022, But
Not Without Challenges, Finds Bloomberg Intelligence,
Bloomberg (Jan. 24, 2022), (Hyperlink)
6. Equator Principles EP4, Equator Principles (2020),
available at(Hyperlink). See also Matthew H.
Ahrens, Munib Hussain, and Ryan Harman, The New Equator
Principles – Climate Change, US Application and What EP4
Means For You, Milbank LLP, available at(Hyperlink)
7. Guidance Note: Evaluating Projects with Affected
Indigenous Peoples, Equator Principles (September 2020),
available at(Hyperlink)
8. List of Goods Produced by Child Labor or Forced Labor,
U.S. Department of Labor, Bureau of International Labor Affairs
(2020), available at(Hyperlink)
9. See, e.g., Executive Order No. 14028, 86 Fed.
Reg. 26,633 (May 17, 2021).
10. Start with Security: A Guide for Business, U.S.
Federal Trade Commission (2015), available at(Hyperlink)
11. Cybersecurity and Resiliency Observations, SEC Office
of Compliance Inspections and Examinations (2020), available
at(Hyperlink)
12. Cybersecurity Risk Management for Investment
Advisers, Registered Investment Companies, and Business Development
Companies, SEC (2022), available at(Hyperlink)
13. See, e.g., Treasury Sanctions Chinese
Entity and Officials Pursuant to Global Magnitsky Human Rights
Executive Order, U.S. Department of the Treasury (July 31,
2020), (Hyperlink)
14. Uyghur Forced Labor Prevention Act (2021),
available at(Hyperlink)
15. See generally Ukraine-/Russia-related
Sanctions, OFAC, (Hyperlink)
16. Green Bond Principles, ICMA (2021), available
at(Hyperlink) In June 2022, the Appendix 1 of
the Green Bond Principles was updated to distinguish between
secured and unsecured debt structures.
17. Social Bond Principles, ICMA (2021), available
at (Hyperlink) Appendix 1 of the Social Bond
Principles was similarly updated in June 2022 to provide guidance
on securitisation.
18. Sustainability Bond Guidelines, ICMA (2021),
available at(Hyperlink)
19. Harmonised Framework for Impact Reporting, ICMA
(2021), available at(Hyperlink)
20. Working Towards a Harmonized Framework for Impact
Reporting for Social Bonds, ICMA (2019), available at(Hyperlink)
21. Performance Standards on Environmental and Social
Sustainability, IFC, (January 1, 2012), available at(Hyperlink)
22. Environmental, Health, and Safety Guidelines, IFC,
(April 30, 2007), available at(Hyperlink)
23. IFC Sanctions Procedures and Anti-Corruption
Guidelines, IFC (2012), available at(Hyperlink)see also Anti-Corruption
Guidelines and Sanctions Reform, World Bank, available
at(Hyperlink)
24. Sustainability Linked Bond Principles, ICMA (2020),
available at(Hyperlink)
25. Transforming our World: the 2030 Agenda for
Sustainable Development, A/RES/70/1, UN General Assembly (adopted
October 21, 2015), available at(Hyperlink)see also Sustainable
Development Goals, United Nations, available at(Hyperlink)
26. Paris Agreement, United Nations (adopted December 12,
2015, entered into force November 4, 2016), available at(Hyperlink)
27. Principles for Responsible Investment, United
Nations, available at(Hyperlink).
28. Report of the Special Representative of the
Secretary-General on the Issue of Human Rights and Transnational
Corporations and Other Business Enterprises: Guiding Principles on
Business and Human Rights, A/HRC/17/31, Human Rights Council (March
21, 2011), available at(Hyperlink)see also Guiding Principles
on Business and Human Rights, United Nations (2011), available
at(Hyperlink)
29. GRI Standards, GRI (2021), available at(Hyperlink)
30. SASB Standards, SASB, available at(Hyperlink)
31. See various reports and guidance documents
including Guidance on Metrics, Targets and Transition Plans (2021)
and Recommendations of the Task Force on Climate-Related Financial
Disclosures (2017), TCFD, available at (Hyperlink)
32. IFRS Foundation completes consolidation with
Value Reporting Foundation, IFRS (August 1, 2022), (Hyperlink)
33. See SASB Investor Advisory Group (IAG) Welcomes
Formation of the International Sustainability Standards Board
(ISSB), Value Reporting Foundation (November 18, 2021), (Hyperlink)
34. Investment Theme: ESG, S&P Dow Jones Indices,
available at(Hyperlink)
35. SEC Charges Brazilian Mining Company with
Misleading Investors about Safety Prior to Deadly Dam
Collapse, SEC (April 28, 2022), (Hyperlink)
36. Chair Gary Gensler, Prepared Remarks Before the
Principles for Responsible Investment “Climate and Global
Financial Markets” Webinar, U.S. Securities and Exchange
Commission (July 28, 2021), available at(Hyperlink)
37. The Enhancement and Standardization of
Climate-Related Disclosures for Investors, 87 Fed. Register
21334 (April 11, 2022), SEC, (Hyperlink) Matt H. Ahrens, Pinky P. Mehta,
and Allison E. Sloto, An Overview of the SEC’s Proposed
Climate-Related Risk Disclosure Rules, The New York
Environmental Lawyer, New York State Bar Association, Vol. 42, No.
2 at 33 (2022), (Hyperlink) Matt H. Ahrens, Pinky P. Mehta,
Allison E. Sloto, Brett Nadritch, Teresa Chen, and Sean Strasburg,
The SEC Proposes Enhanced Climate Disclosure Rules,
Milbank General Counsel Blog (April 4, 2022), (Hyperlink)
38. SEC Climate Rules Pushed Back Amid Bureaucratic,
Legal Woes, Bloomberg Law (Oct. 19, 2022), (Hyperlink)
39. Prudence and Loyalty in Selecting Plan
Investments and Exercising Shareholder Rights, DOL, (Hyperlink)
40. William Charles and Vasiliki Katsarou, Milbank
Insights, Combatting ‘Greenwashing’: New Proposals from the
UK Financial Conduct Authority (“FCA”) (Nov. 8, 2022), (Hyperlink) Sustainability Disclosure
Requirements (SDR) and investment labels Consultation Paper
CP22/20, Financial Conduct Authority (Oct. 2022), (Hyperlink)
41. Toward Common Metrics and Consistent Reporting of
Sustainable Value Creation, World Economic Forum (2020),
available at(Hyperlink)
42. Andrew Ross Sorkin, Bernhard Warner, Vivian Giang,
Sarah Kessler, Stephen Gandel, Michael J. de la Merced, Lauren
Hersch, and Ephrat Livni, An Anti-E.S.G. Activist Takes on
Apple and Disney, The New York Times (Sept. 20, 2022), (Hyperlink) Andrew Petillon, The
Republican War on “Woke Capitalism” Is Really Just a War
on Capitalism, Slate (June 23, 2022), (Hyperlink)
Acknowledgments
The authors would like to thank Iliana Ongun and Neil Whoriskey,
partners in the Global Corporate Group at Milbank LLP, for their
valuable contributions to this chapter. Iliana advises public and
private companies across various industries on mergers and
acquisitions, joint ventures, private equity transactions,
recapitalisations, and spin-offs. She also focuses on advising
clients on ESG matters, shareholder activism, takeover defence
strategies and other corporate governance matters. Neil’s
practice focuses primarily on mergers, acquisitions, and corporate
governance matters and he has authored numerous articles on these
topics. He also has experience in advising on ESG matters, with
respect to governance.
This article was first published in ICLG – Environmental, Social, & Governance
Law.
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