Recent years have seen an ever increasing density of ESG regulation on the national, European and global level. With significant regulations already or about to enter into force, enforcement actions on different levels, including authority investigations, are also increasing.
ESG investigations carry a number of particularities that companies must take into consideration. Given the nature of ESG-related topics, investigations will often include a variety of authorities, stakeholders and jurisdictions involved in the matter. The underlying legal situation is often similarly complex and uncertain. Added pressure arises from public scrutiny that companies and authorities themselves are put under.
Part I of this two part article takes a look at the current enforcement situation and sheds light on the specific challenges that ESG investigations pose for companies in Europe and globally.
Increased regulatory and public expectations on ESG topics
The focus on Environmental, Social and Governance (ESG), in particular in Europe, has been keeping lawmakers, authorities and companies alike busy and the increasing scrutiny of the topic is not likely to stop soon.
On the regulatory side, national and European lawmakers have and still are introducing new ESG-related legislation that focus on two main topics:
- supply chain due diligence, such as the German Act on Corporate Due Diligence Obligations in Supply Chains (“SCDDA”), the EU Corporate Sustainability Due Diligence Directive (“CSDDD”), the EU Deforestation Regulation (“EUDR”), or the EU Battery Regulation ("EUBR"), and
- environmental reporting and transparency such as the EU Corporate Sustainability Reporting Directive (“CSRD”) or the EU Sustainable Finance Disclosure Regulation (“SFDR”), to name but a few.
Along with the growing regulatory framework comes an increasing public focus on companies to comply with the existing and upcoming regulations, adding scrutiny and pressure on authorities to enforce them (see e.g. the Policy Paper on the Enforcement of Mandatory Due Diligence of Shift and the Office of the UN High Commissioner for Human Rights1 or a paper by different German civil rights organization on the authority enforcement of the SCDDA2).
Meanwhile, the change of administration in the US has seen a backlash on certain ESG-related topics that may trigger scrutiny and investigations from authorities from a different angle. In short, the topic remains dynamic while enforcement risks are increasing.
Increasing focus on enforcement
With many of the recent European ESG regulations already or about to be implemented, the focus of authorities is likely to shift towards enforcing the existing, but especially the newly introduced ESG rules. Apart from reviewing companies’ publicly available regular reporting, the new regulations equip authorities with a number of measures to assess and effectively ensure compliance with these regulations. Enforcement instruments range from the right to request information to access rights up to the full administrative and criminal investigation competencies under national law.
As can be seen using the example of the German SCDDA, now in its third year of application, authorities are likely to take a staggered approach. With the reporting obligation currently being paused, BAFA3, the competent German authority for enforcing the SCDDA and sanctioning violations, has made extensive use of its right to request information.4 In the first 18 months of its application alone, BAFA has conducted 1,231 risk-based “controls” of companies. 118 of these controls were triggered by external information. Yet, BAFA emphasized a “collaborative approach”.5
The longer these new laws such as the SCDDA are in place, the more likely authorities are to move onto more intensive measures, such as formal investigations, especially in cases where previous control measures have shown indications of incompliance.
Recent cases of ESG-related investigations have focused on greenwashing allegations and alleged human rights infringements, especially further down the supply chain. With increasing reporting obligations and public scrutiny, investigations are likely to expand to further areas as well. Companies should therefore be prepared for increasing enforcement actions and should get acquainted with some of the particularities that come with ESG investigations.
Particularities of ESG Investigations
Just as there is no clear-cut definition on what ESG entails, there is also no definite distinction on what can be considered an ESG investigation. However, investigations that deal with topics of environmental protection, human rights or corporate social responsibility as well as greenwashing allegations in a wider sense do have some characteristics in common, that should be noted.
Diversity of stakeholders
ESG investigations often involve a broader range of stakeholders compared to other types of investigations. Starting with possibly affected parties, these can include employees, upstream or downstream business partners such as customers or suppliers, competitors, community members or investors. Given the increasing focus on the deep supply chain by EU supply chain due diligence regulations such as the CSDDD, the EUDR or the EUBR, more remote stakeholders may also become in involved.
Each stakeholder may have their own, potentially conflicting, interest in the outcome of the investigation and may seek measures to influence the authority investigation. Given the often complex factual situation, it may become necessary to actively involve some of the stakeholders in the investigation to gather the required evidence and clarify the facts.
Public focus on investigations
One of the most notable particularity in many ESG investigations is the distinct public interest either in the specific investigation itself or in the underlying topic, making the public another relevant stakeholder in the overall investigation.
Given the increasing focus of environment and human rights-related topics also in the broader public, ESG investigations or even mere allegations of incompliance will likely be accompanied by public scrutiny, e.g. through NGOs and extensive media coverage. This is likely to put additional pressure both on the companies under investigation and on the investigating authorities themselves. As seen in recent cases, the public focus may also turn towards authorities to pressure them to take enforcement actions.
When it comes to ESG-related topics such as human rights violations, environmental crimes, or greenwashing allegations, the potential reputational damage for companies may be a considerable risk independent from the potential legal and financial sanctions. Even if sanctions or legal proceedings can be prevented, the reputational damage may still persist if not handled carefully. Also, even after investigations are closed, they may be followed on by litigation, including class actions or strategic lawsuits.
Involvement of different investigating global authorities
Given that the range of ESG-related topics is wide, not always clearly defined, and often global, investigations may be led jointly or separately by different authorities, including in different jurisdictions. Depending on the nature of the investigation and the underlying allegations, financial, environmental, labour law, tax or criminal enforcement authorities may become involved in or lead their own investigation. Especially on a national level, cooperation and sharing of information between authorities is likely.
Complex legal and factual situation
Consequently, potential allegations may come from different legal angles, reaching from environmental and administrative law to labour or criminal law. The applicable regulations are often complex, dispersed, and there may be limited guidance available, especially with newly introduced legal provisions.
The underlying facts can be equally complex and may involve significant technical or scientific knowledge, most likely in environment-related cases, making an interdisciplinary approach and the involvement of external experts necessary.
International dimension
Due to the nature of the underlying legal matter, ESG investigations will more often than not carry an international dimension. This is most prominent in the European supply chain due diligence regulations that focus especially on global supply chains. In these cases, the triggering event, such as an alleged human rights violation or the deforestation of woodland, may have taken place down the supply chain in countries or areas of the world where the companies against which the allegations are directed have only limited access to and control over. This can also make the evidence collecting procedure difficult and may again require the involvement of external parties or experts.
Local laws may also play a role in what investigative measures can be carried out and what information can be received from third countries. Depending at the allegations at stake, the underlying topic may also have a political dimension that companies must need to navigate.
Finally, acts may have taken place in countries that have elevated risks for other compliance issues such as bribery and corruption or sanctions violations that may be revealed further down the investigation.
Public information
Given the increasing reporting obligations for companies on ESG topics, public information on a company’s ESG compliance measures and its ESG related goals are or will soon become more easily available for the general public. This will make it easier to compare a company’s public statements on its ESG performance to the allegations under investigation, adding to the reputational risk at stake.
This is especially important given the increased focus on greenwashing in recent enforcement and lawmaking, with the EU now having adopted the EU Green Claims Directive.
Equally, reporting obligations under transparency regulations, such as the CSRD, may conflict with the company’s interest to claim legal privilege over the results of the investigation.
Conclusion and outlook
A rise in ESG investigations is likely to be reckoned with in the time to come. Authorities in Europe are likely to still take a rather collaborative and lenient approach in the early phases of newly introduced ESG compliance regulations. Companies should take the opportunity to develop robust compliance processes and document their ESG compliance efforts thoroughly. This will put them in a position to react confidently to authority requests.
Especially at the current stage, companies should consider a collaborative approach and work together with authorities to meet the expectations on their ESG compliance system and avoid further enforcement measures.
Nevertheless, companies should get familiar with the particularities of ESG-related investigations and make sure that they have the systems in place to be prepared for more severe enforcement actions. In Part II of this article, we will look at some of the practical measures that companies can take before and during ESG investigations that can enable them to navigate these difficult situations and limit their exposure as best as possible.
References
1 Shift and Office of the UN High Commissioner for Human Rights, 2021: Enforcement of Mandatory Due Diligence: Key Design Considerations for Administrative Supervision. https://shiftproject.org/wp-content/uploads/2021/10/Enforcementof-Mandatory-Due-Diligence_Shift_UN-Human-Rights_Policy-Paper-2.pdf
2 Authority enforcement of the Act on Corporate Due Diligence Obligations in Supply Chains: Requirements from a civil society perspective (in German), March 2022: https://www.germanwatch.org/sites/default/files/anforderungspapier_behoerdliche_durchsetzung_des_lieferkettensorgfaltspflichtengesetzes.pdf
3 Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle)
4 See answers to parliamentary request (in German): https://dserver.bundestag.de/btd/20/132/2013245.pdf
5 See BAFA press release of 21 December 2023: https://www.bafa.de/SharedDocs/Pressemitteilungen/DE/Lieferketten/2023_21_1_jahr_lksg_-_bafa_zieht_positive_bilanz.html
