Carbon Standards & Risk

All Voluntary and Mandatory Carbon Offset Standards are “Private” or “Hybrid” standards based mainly upon existing ISO Standards; however, they are not in themselves ISO Standards. Whereas ISO Standards are devised implementing a rigorous and agnostic process, (ISO Standards Development). The hybrids of these standards are developed in a significantly less rigorous process, a key factor is that these Hybrids are often generated, funded and financed by special interest groups.

While being rigorous in process and design, the basic ISO Standards often included within these Hybrids were never designed to be implemented as Investment Grade Standards, the expectation was that the groups developing private/hybrid carbon related standards would layer significant and appropriate checks and balances that would help to make the standards fit for investment purposes, this has not happened.

A four year study of the main voluntary standards and a similar study of CDM processes highlight some serious and continuing risk factors. A recent Poll showed that 90% of Investment Managers have little or no knowledge of the carbon oset standards by which they invest, no knowledge of the inherent risk factors and only 2% had any knowledge of the vital ESG methodologies implemented to provide assurance that social and environmental integrity is maintained.

The six major voluntary standards analysed displayed similar risk characteristics in terms of lack of corporate due diligence amongst applicants applying to be accredited under these schemes and if accredited, onwardly certifying large and small scale projects. One Scheme accredits its own standard, (no genuine third party verification) which is specifically excluded by ISO and other similar bodies. Several Certifiers carried no product liability insurance at all. In one case we found that the standard permitted a certifier to both validate and subsequently verify projects from which very significant oset certificates were issued, therefore the certifier was verifying its own work without any external oversight. Several cases indicated that there was a direct and continuing conflict of interest between the controllers of the standard and projects being validate & verified under the standard which they controlled. Another problem is and was that the contracts entered into by Certifiers with standard owners were not fit for purpose in terms of the exclusion of conflicts of interest; these contracts often do not differentiate between ownership and control. In an Asian country we found that it was the practice amongst some certifiers to apply for accreditation as two different companies with the shareholdings hidden by trust mechanisms, thus these companies gain accreditation in both names often with exactly the same paperwork. This then permits Validation and Verification to be undertaken by “independent certifiers” who are in fact the same entity.

The study then reviewed the applied rigour of National Accreditation Bodies,(NABs) the entities which accredit the Validators and Verifiers of carbon projects on behalf of the Carbon Oset Standards, (third party independent accreditation), these national bodies process and audit accreditation applications and are relied upon by investors to ensure the competency of Validators & Verifiers. These bodies are purely concerned with ensuring that applicants are complying with the particular standard being accredited. The rules of that accreditation are set by the standard owners. Therefore often flawed methodologies are accredited as a matter of course.

The practice which permits Validators & Verifiers to work for project developers and funders under a “no win no fee basis”, with a “bonus” element dependent upon the number of osets issued has lead to some very questionable practices especially where these Validators & Verifiers have a direct influence upon standard owners.


Pursuant to the four year study, Probus has developed modules which are designed to address the “hidden” risk aspects of individual Voluntary Standards, while relying on the core objectives of a standard, a series of risk reduction strategies are applied via modules, these modules also address the issues of contractual obligations, corporate control declarations and other key aspects of risk.

A note on the ISEAL Alliance & what private standards in the GHG industry can learn from its Code of Practice for Setting Social & Environmental Standards

The International Standard Environmental Accreditation and Labelling (ISEAL) Alliance is a “formal collaboration of leading international standard-setting and conformity assessment organizations focused on social and environmental issues”.[1] The ISEAL Alliance was established only ten years ago by a group of “pioneering group of sustainability standard-setters”[2] (namely the Forest Stewardship Council, International Federation of Organic Agriculture Movements, Fairtrade and Marine Stewardship Council) and has since grown to incorporate four additional organizations. What is interesting about ISEAL Alliance is the cross-industry reach of its members suggesting that while the sectors covered can differ considerably, the systems, objectives and overriding motive of sustainability are constant. There is in this structure both a common purpose and an inferred level of accountability.

In January 2006 the ISEAL Alliance released its Code of Good Practice for Setting Social and Environmental Standards. The objective for publishing this Code of Practice was to provide “a benchmark to assist standard-setting organizations to improve how they develop social and environmental standards.”[3]

Probus Sigma recently completed extensive comparative research into the existing private standards in place within the GHG industry. Part of this research included comparative analysis against the ISEAL Code of Practice. While there is currently no legal obligation for private standards to comply with the Code of Practice, one could argue that there are moral and ethical obligations for the standards to conform to an international benchmark which has at its core the protection, profit and progress of all stakeholders. It is not Probus Sigma’s suggestion that the ISEAL Alliance’s Code of Practice is not to act as a fix all standard setting “how to”. Instead it should serve more to guide and act as a reference for the subsequent development and implementation of this benchmark. Our research went some way to confirming which gaps needed to be filled.

1. The ISEAL Code of Practice is designed to “evaluate and strengthen voluntary standards and to demonstrate their credibility on the basis of how they are developed”. Research has long shown that a lack of transparency within the voluntary (i.e. private) GHG standards has clouded credibility.

2. Several references are made to the ISEAL Code of Practice drawing structure and influence from other internationally recognised standard-setting frameworks namely those set out by the ISO (International Organization of Standardization) and WTO Technical Barriers to Trade (TBT) Agreement.

3. There are numerous guidelines relation to transparency including (but not limited to) its reference to an open and objective complaints procedure and the obligation on an organization, which applies the ISEAL Code of Practice being obligated to inform the ISEAL Alliance.

4. There is a concern in the private standards industry that standards are self-serving and self-monitored. The ISEAL Code of Practice directly tackles this issue by stating that “the standard setting process shall strive for consensus among a balance of interested parties. The standard-setting organization shall establish and document procedures to guide decision-making in the absence of consensus. These procedures shall ensure that no group of interested parties can dominate nor be dominated in the decision-making process.”

5. ISEAL Code of Practice deals with the persistently complex issue of national and regional bureaucratic, political and cultural differences by establishing that “where international standards are designed as the basis for national or regional standards, they shall be accompanied by clear guidance or related policies and procedures for taking into account local economic, social, environmental and regulatory conditions where the standard is applied.“ It is a constant surprise how little consideration was expressly given to this in the private standards analysed in Probus’ research.

6. As is the goal of an umbrella standard, the ISEAL Code of Practice confirms the importance of a harmonization of standards across any sector: “In order for standards to be mutually consistent and free from contradiction for the largest number of user communities, standard-setting organizations shall actively pursue harmonization of standards and/or technical equivalence agreements between standards, where there is a possibility to do so without compromising the rigour of the standard.”

Though they may appear depressing at first glance when we consider that this is what is missing from the current private GHG standards in place, we prefer to think of the above findings as encouraging, insofar as it unanimously supports the case for an umbrella standard against which private GHG standards can align.

So yes the bad news is that the private GHG market has a long way to go to establish a global standard that is compatible with the ISEAL Code of Practice, but the good news is in order to create an effective umbrella standard and benchmark, the guidance is already there to be applied and benefited from.




Environmental Standards

Probus Sigma maintains a dedicated in-house Research, Audit and Analysis Department which is staed by a qualified team who quantatively audit and analyse the ESG, (Environmental, Social and Governance) risks corporations, Investment Houses, governmental entities, financial institutions and NGOs.

The department consists of skilled analysts with significant financial, environmental and social parity experience. Their range of formal qualifications and research experience has been gained from leading seats of learning including the University of Oxford, other UK ‘redbrick’ universities and several international universities including Sidney University and Harvard Business School. Recently, this Group devised a predictive ESG risk methodology with particular application to investment markets, this methodology is now being deployed worldwide.

In addition to academic training, the department’s personnel have senior corporate managerial experience within a number of sectors. This relevant experience means the department delivers high quality research and solutions, meeting the challenges of academic, investment and corporate requirements.

Numerous financial and non financial institutions have benefited from our high quality research, audit and analysis services. This includes leading global financial corporations ranging from stock exchanges to high street banks. In addition, institutional investors have been assisted in identifying risk in their strategies.

If you would like more information please consult our information downloads section.
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Socially Responsible Investment (SRI): Good corporate citizenship or hidden portfolio risk?

Reprinted with kind permission of Law and Financial Markets Review. To purchase this
article please visit:

Chris Yates-Smith
Managing Partner, Environmetrics at Probus Sigma Lda

The legacy of the inherently subjective SRI methodologies is that the gathering of basic data for assessing a company’s environmental, social and governance (ESG) rating has been inconsistent, unreliable and, more crucially, almost entirely based upon corporate self reporting. All of the existing ratings agencies – DJSI, CSI, FTSE4Good etc., are relying on information provided by the companies and corporations themselves, with little or no external verification of fact.

The point is that ESG is still an emerging area, and has outpaced the existing sphere of legal knowledge. Amongst other things this has led to the wide perception of ESG ratings and their vital analysis of a company’s performance and risks, as little more than PR tools. The importance of ESG ratings and CSR compliance as an accurate quantitive based calculation of company value and defined ESG risks has become widely accepted. Ranging from the effect on corporate reputation and brand equity valuation to the financial impact of sustainable development as drivers of industrial change, sustainability and ESG compliance are accepted as factors that drive equity returns in their own right. What is needed is a single global credible standard, with robust legal definition and supported by a genuinely unbiased rating system that is not only based upon reliable proof of claim but also generally accepted and applicable to practitioners and participants in the SRI industry.

A. Introduction

Socially Responsible Investment (SRI) and its sibling, Corporate Social Responsibility (CSR), are subjective terms that have become embedded in the global investment industry and in the fine print of company reports, business reviews and press releases. Yet their definitions, implications and legal liabilities are effectively ignored. Legal liability involving SRI and CSR has become an area clouded by a lack of a specific legal foundation upon which to base the assertions made by some very significant investment funds. However, recent financial studies into the assessment of risk in SRI-based investment and the substantial contingent legal liabilities thereof should encourage the legal profession to think again. Some well-intended actions are likely to have had an unintended effect; instead of improving SRI and reducing risk, companies are likely to have increased their shareholders’ risk and potentially incurred complex legal liabilities.

B. Reporting & Disclosure in Socially Responsible Investment (SRI)

The very nature of current SRI risk assessment methodologies involves the implementation, tracking and self-reporting of corporate behaviour relating to Environmental, Social and Governance management issues. From “Green” initiatives to community service, to responsible hiring and workforce practices, the SRI movement has taken hold in companies keen to improve and promote their corporate image in a “green” light. SRI has created global compliance issues for many of these companies, triggering internal control obligations, litigation risk and the risk of severe detriment to brand equity for non-compliance. Further complications include the plethora of differing Codes of Practice, a fundamental lack of common compliance and the absence of global norms for SRI issues.

As nations find themselves ill-equipped to address global environmental, social and economic issues on their own, business stakeholders have discovered that global corporations ensconced in the social and economic fabric of many countries have the ability within their own organizations to establish their own rules and guidance to address SRI issues. In this context, encouraged by increasingly powerful special-interest groups and public opinion, SRI began as a voluntary, positive business initiative that looked beyond legal compliance toward a diverse range of environmental, social and economic areas. As it now progressively reshapes the business landscape, it is increasingly becoming the subject of legal scrutiny and everyday operational consequences.

The ever-increasing volume and embedding of current SRI rating agencies and methodologies, brings with it substantial new business risks. Many investors mistakenly view SRI as a means of mitigating a corporation’s reputational and regulatory risk and as a performance factor capable of enhancing stakeholder relations, brand image, risk assessment and management, customer loyalty, and employee recruitment, retention and motivation: in fact SRI is the opposite.

The phrase “Socially Responsible Investment”, was the most common name given to initiatives, PR campaigns, and similar moves by companies to harness the paradigm shift by consumers to a more “caring” attitude to business, environmental conservation, social upliftment and improved governance of companies to decrease the amounts of financial scandals and to restore trust and ensure that shareholder and consumer concerns were recognised.

On 28 July 2008, AXA Investment Managers issued the results of a global survey amongst 350 investment professionals. Given a choice of the sixteen most-used descriptions of “Ethical Investment”, (which included, Green, Eco, Ethical, CSR, SRI, etc) 64% of the poll chose Environmental, Social and Governance, (ESG) as the preferred description and sustainability as the general description. From that day these became the preferred descriptions based purely upon investment manager preferences. No technical research was undertaken to define what these terms referred to and what the technical basis for their use was. The SRI/CSR, Green, Eco and Ethical ratings agencies merely changed their product names to suit the new preferred descriptions. With £billions being expended by major corporations to “prove their ESG and Sustainability” credentials, the business model chosen by these ratings agencies was the exact same circularity model that had been at the centre of the sub-prime banking collapse. The ESG and Sustainability ranking depends upon the ratings and the ratings depend upon how much an organisation pays to be “rated”, often using “consultants” connected to the ratings agency to “improve” the ratings. This is an entirely unregulated industry and many of the previous sub-prime players are now firmly ensconced in the ESG/Sustainability industry. It may be recalled that self-certification was at the heart of the sub-prime banking crisis; self-certification of ESG and sustainability is the same flaw, repeated by a number of the same or closely related players. The local insurance salesman or financial adviser is substantially more regulated than an entity that supposedly provides specialist, environmental, social and governance advice to global investment houses.

C. The reality of ESG and Sustainability ratings

The 34 major “ESG and Sustainability” ratings agencies rely upon their own definition of ESG and Sustainability. Often quoting the well known Brundtland Report of 1987, they go on to claim that, within that report, the definition of Sustainability calls for the subjective assessment of good and bad products: they therefore base their “ratings” upon filters and methodologies, thereby excluding companies or penalizing companies purely based upon their (ratings agency’s) moral judgment of products.

Viewed properly, sustainability is agnostic with regard to products. The Brundtland Report defines sustainability as the management of the process of manufacturing a product or a service, not the end product. Sustainability is agnostic and does not call for moral judgments. The accepted technical basis of Sustainability, known as “the three pillars of sustainability” (or the three P’s), People, Planet and Profit, must interact in a defined and transparent manner to provide assurance of sustainability. In this context it is clear that a quantitively based ESG risk metric must be established prior to applying subjectively based exclusionary filters, since to apply these filters before defining the real risks substantially increases investor risk and the risk of legal challenges.

The basis for what these ESG/sustainability ratings agencies claim to be “objective methodologies” defining risk are:

1. Reading Annual Reports;
2. Reading media reports;
3. “Engaging” with companies; and
4. Awarding high scores based upon a company being a member of a Self-Disclosure Protocol.

Consequently, all information is at least a year old when studied and is simply the product of the reporting company’s PR and legal department.

Media reports are notoriously inaccurate and “engaging with companies” is in fact engaging with their PR and legal departments.

The awarding of high moral and ethical scores based upon self reported information under protocols, agreements and any of the existing 41 global initiatives such as the GRI, PRI and similar, merely adds yet more risk to the subjective and dangerous nature of SRI and CSR methodologies. None of these Protocols and Guides have any recourse in the event of fraudulent reporting or indeed, not reporting at all. Then factor in the potential 18 month wait before these are published and it can quickly be seen that, when this is added to the year-long wait for the Annual Report, that none of the methodologies are or can be fit for purpose,they are likely to increase investor risk and just as importantly, bring into focus key fiduciary duty questions.

Fiduciary Duties & ESG Integration– where are we today?

Fiduciary duties in an investment context

The 2005 Freshfields, Bruckhouse, Deringer Report in conjunction with UNEP, ( ) was recently updated as, Freshfields Bruckhaus Deringer, 2005; Stalebrink O J, Kriz A and Guo W ,2010) complemented with additional information from Berry (2011), Dhaliwal et al. (2010), Freshfields Bruckhaus Deringer (2005), Renneboog et al. (2008a) and UNEP FI (2009). And is now titled, Fiduciary duties in an investment context, the updated report clearly states that , according to US modern prudent investor rule for an Investment Manager to be in compliance with his or her Fiduciary Duty ;

The prudence of an investment is to be judged at the time the investment was made – not in hindsight.

This rule clearly excludes use of SRI based ESG ratings as an investment guide or benchmark, on the basis that, the Investment Manager is fully aware that all information implemented in terms of “ESG/SRI”, is based on historic, self-reported unreliable data which precludes an Investment Manager having ability to assess current, present actual ESG risk data. And therefore to implement SRI based historic data is a clear breach of Fiduciary Duty.

The need to have a reputational intermediary (investment bank, corporate broker etc.) present and integrated within the offering of investments, listings, mergers, acquisitions and similar key regulated activities is an established fact: however, offer documents which carefully construct wording that reflects regulatory compliance, truth and transparency but which entirely lack the same rigour with regard ESG matters clearly must be questioned. In sixteen years of practice within the development of global standards implemented as investment benchmarks and research and development in collaboration with recognised financial academia, the author of this paper has never observed any issuer or reputational intermediary attempting to establish proof of any of the ESG and/or sustainability claims made by their clients. Likewise the four leading global accountancy firms ask no such questions, nor do they require any proof of such.

The SRI Practitioners have pitched their brand of unsupported, subjective environmental, social, governance and sustainability claims as if there were no credible quantitively based alternative. In fact this alternative has been available for some years and is already widely implemented. Leading University Business Schools and Professors of Environmetrics have long since established quantitive methodologies with which to define risk when inserting ESG/Sustainability filters into investment portfolios. For instance, neural networks are revolutionising virtually every aspect of financial and investment decision making. Firms worldwide are employing neural networks to tackle dicult tasks involving intuitive judgement or the detection of data patterns which elude conventional analytic techniques. Many observers believe neural networks will eventually outperform even the best traders and investors. They are already being used to trade the securities markets, to forecast the economy and to analyze credit risk. Indeed, apart from the U.S. Department of Defense, the financial services industry has invested more money in neural network research than any other industry or government body. Unlike other types of artificial intelligence, neural networks mimic to some extent the processing characteristics of the human brain. As a result, neural networks can draw conclusions from incomplete data, recognise patterns as they unfold in real time and forecast future trends. The most widely used methodology for identifying existing and predicting future environmental investment portfolio risks emanates from leading financial academia via the study of Environmetrics (which is, broadly termed, the development and use of statistical and other quantitative methods in the environmental sciences, environmental engineering and environmental monitoring, conservation and protection). More recently Environmetrics combined with neural finance technologies has been implemented to identify and define investment portfolio ESG risk.

D. Setting the ESG Standard

The entire SRI and CSR industry refer to “standards” but it appears that even legal professionals continue to misunderstand the term “standard”, when they are actually referring to Protocols, Codes of Practice, Directives, and Agreements etc. The ISO definition is the clearest: a standard is “a document, established by consensus, which provides, for common and repeated use, rules, guidelines or characteristics for activities or their results, aimed at the achievement of the optimum degree of order in a given context” (ISO/IEC, 1996). Consensus, in that context, is defined as a “general agreement, characterised by the absence of sustained opposition to substantial issues by any important part of the concerned interests and by a process that involves seeking to take into account the views of all parties concerned and to reconcile any conflicting arguments” (ISO/IEC, 1996).

These definitions raise several questions in terms of SRI/CSR methodologies and measuring risk: who establishes the consensus, and when can the “concerned interests” be considered as legitimate? On whom is the “optimum degree of order” imposed? And what are the legal liabilities? Since the accepted definition of a standard clearly excludes all 41 of the global PRI, GRI “initiatives” and all current SRI/CSR methodologies, as implemented by all “ESG” ratings agencies, how do we achieve common standards conforming to The World Trade Organisation and ISO definition which can facilitate the quantitive measurement of ESG risk?.

Experience gained from several established global environmental standards, such as The Forest Stewardship Council, Marine Stewardship Council et al, shows that the question of compliance with The World Trade Organisation’s (WTO) rules related to technical barriers to trade has been a constant concern for these ISO-based but private standards. The Voluntary Carbon Standards have ignored this aspect but are now beginning to see the legal risks that arise from non-conformance.

Amongst the range of criticisms aimed at the SRI Ratings Industry in relation to WTO rules is the fact that SRI ratings agencies are only able to “rate” large listed companies in developed countries, and therefore may possess an unfair advantage because they may absorb more readily the substantial fees and costs associated with gaining “ESG” ratings, which in turn leads to investment not being available to smaller emerging economy listed companies.

The rules of the WTO’s Technical Barriers to Trade (TBT) stipulate that Members shall ensure that technical regulations and standards do not create unnecessary obstacles to trade (TBT Article 2.2 and Annex 3). Furthermore, States are required to ensure that technical regulations use international standards that already exist (or that are near completion), or relevant parts of them, as a basis for their technical regulations, except when the international standards would be an ineective or inappropriate means for the fulfillment of the regulations’ objectives. In the case of technical regulations, if a regulation is applied in accordance with a relevant international standard, it is presumed not to create an unnecessary obstacle to trade (TBT Article 2.5).

All current SRI based ESG ratings agencies implement non-disclosed, individual, opaque ratings methodologies, therefore cannot be compliant with either WTO or published and accepted environmental industry norms that relate to environmental or social benchmarks.

In a move to eradicate similar practices within the global labeling and definition of environmentally benign products and services the ISO Organisation on February 18th 2013 outlined how its standards help manufacturers and consumer representatives ensure that environmental claims can be trusted. The ISO’s 14020 series of standards for environmental labels and declarations provide businesses with a globally recognized and credible set of international benchmarks against which they can prepare their environmental labeling. The series includes three types of labeling. An example is ISO 14021 which deals with all self-declared environmental claims made on products and packaging, including the use of symbols, pictures or logos. It also covers advertising and trade-report claims, and encompasses environmental claims made about services. The standard requires that these claims must be verified before they are made, and prohibits vague or non-specific claims such as “environmentally friendly,” “green,” or “nature’s friend”. Testing of a product or service’s environmental claims must use “accepted test methods” and the information must be disclosed to anyone who requests it, ISO says. An environmental declaration related to climate change that describes greenhouse gas (GHG) emissions in terms of CO2 would fall under this standard, for example.[1]

Any common ESG standard would therefore have to be based upon existing (or very near to launch) ISO Standards for management programmes, implemented to manage the risks involved. Such management standards exist, are well established and are proven; they are based upon the rigorous ISO process and updating procedures and benefit from reciprocity in 163 Countries. Examples are ISO 14001 and ISO 9001 (and there are many others). Sustainability calls for the management of the manufacturing process, not the end product. It is therefore necessary to demonstrate rigorous third-party audited management of these risks both in terms of mitigation of risk and in terms of demonstrating the legal aspects of these risks; all these aforementioned standards contain the required rigorous third party audit requirements.

ISO risk management programmes are widely implemented by the global financial industry to mitigate risk. These programmes conform to the financial industry’s compliance norms and enjoy reciprocity across 163 countries. The implementation of ISO risk management programmes to manage environmental, social and governance risks therefore entirely comply with established financial industry norms.

1 – SRI ratings and the SME Community

A leading European based ISO Standards [2] based ESG Analyst has substantially questioned the SRI based ratings agencies inability to rate non-listed companies who make up over 90% of European employment and GNP and this has become a major concern for governments. This SME sector is the lifeblood of commerce across the EU but even though the SMEs produce the vast majority of Pension Fund Investment (from their contributions); these same SMEs are barred from receiving vital funding support under most pension fund mandates. Since existing SRI based company ratings cannot risk rate the SME’s that make up over 90% of employment and GNP whereas ISO standards based technologies achieve this easily, there may be an interesting question based upon SRI ratings acting as exclusionary mechanisms or barriers to investment and trade.

E. Environmental and SRI reporting obligations in the UK

Listed companies registered in UK are, inter alia, subject to FSA regulations and UK company law. As a result of the recent financial climate, companies are subject to an increasing number of regulations and laws aimed at ensuring the accuracy of both financial reporting and non-financial communications. (MiFID 11)However, as yet little legal guidance has been introduced to oblige verified mandatory disclosure of ESG issues. Such issues have not, for example, featured in the development of the MiFID II proposals which will reform the regulatory framework for investment firms and financial markets in the EU. [3]

Under the Companies Act 2006, directors have a number of duties the very language of which goes a long way to highlighting the potential for variable interpretation: thus, it is a director’s legal duty to “promote the success of the company” as opposed to ensure or pursue that objective. However, there is some clarification of what is to be meant by this in terms of their environmental reporting duties. It includes the duty to have due regard to “the impact of the company’s operations on the community and the environment”, the duty to have regard for “the likely consequences of any decision in the long term” and the “desirability of the company maintaining a reputation for high standards of business conduct,” all of which could be construed to include ESG liabilities. Interestingly, it was noted by Deborah Doane of World Development Movement that when introduced this was the only clause of its kind in the world at the time (in 2007). [4]

Further legal obligations on company directors were introduced in response to the corporate scandals like Enron and Parmalat in the early 2000s as part of an extension of the Act’s reporting requirements (implemented on 1st October 2007) aimed at improving corporate transparency and accountability. They allude to increased environmental and ESG liability by providing that reporting on the environmental impact and any social and community issues should be part of a Business Review that large companies are required to submit. [5] However, it appears to be an “optional” requirement; companies are exempt from providing this information if they declare that they are not sharing it. Therefore the pertinence of these obligations is somewhat diluted.

What is also of greater concern (and contributes fully to the “greenwashing” that costs communities and companies so dearly) is that there is no guidance on how environmental, social or community impact is or can be measured. This lack of guidance and the firmer position introduced by the Companies Act has ultimately led to a climate of self-reporting and increased opacity.

F. SRI and Environmental Reporting in Europe

In Europe, the tools to hold listed companies accountable for disclosing misleading non-financial information are progressively being put into place. In France, a listed company’s annual report must include information about the manner in which the company deals with the social and environmental consequences of its business and key performance indicators (an SRI term) of a non- financial nature relating to the company’s specific business, such as information about environmental and personnel matters. The annual report must also include a description of the main risks the company faces, and since 3rd July 2008, French Law 2008-649 requires a specific reporting of “internal control and risk management procedures put in place.” The wording of the law suggests that the reporting requirement goes beyond internal controls and risk management procedures that pertain to purely financial matters. Thus, it appears to require a company to have effective internal controls in place to manage and reduce risks related to material information that a company communicates to the market, including information about SRI initiatives.

In Germany, management must pursue business in the best interest of the corporation. Under the business judgement rule, decisions should take into account all relevant factors – both those likely to contribute to the corporation’s sustainability and success, and those which may endanger such success. Also, management reports must include non-financial performance indicators (such as employees and environment), and corporate governance reports must include reference to corporate governance codes and practices which the company voluntarily applies. If a company communicates that ESG issues are factors in its success and sustainability, the company should be able to demonstrate that its decisions have effectively taken ESG into account.

The comparative scenario was examined in a paper prepared by International Decisions Strategies Inc. entitled “Environmental, Social and Governance Investing in Europe. A Review and Analysis”, which concluded: “There appears to be ample legal support in Europe for the idea that ESG investing is both proper and appropriate. In marked contrast to the U.S., there is ocial (i.e. government) support for consideration of environmental and other ESG factors in Europe”. [6]

G. What is the global position?

Case law offers some guidance as to the current position in the United States. In 2008 in a case involving Pax World Management Corp in the USA, the Securities and Exchange Commission (SEC) alleged [7] that Pax’s negligent failure to comply with its self-imposed, socially-responsible investment restrictions as announced to the market violated securities laws. Pax also failed to consistently follow its own SRI-related policies and procedures requiring that all securities be screened by its Social Research Department prior to purchase to ensure compliance with SRI disclosures. In addition, Pax did not consistently adhere to other SRI-related policies and procedures, including continuous monitoring of fund holdings. The alleged failures did not result in any loss for the investors. Nevertheless, in August 2008, Pax agreed to a $500,000 civil settlement. This case highlights the growing importance of SRI in the United States; it underlines the risk that a company’s negligent failure to comply with its own SRI policy may result in a securities law violation.

For U.S. companies, legal exposure appears not only to be linked to their disclosure obligations, but to the trend of greater corporate accountability and transparency. Under US Federal Law, there is an active and creative plaintis’ Bar that is testing new grounds for liability and legal exposure, a trend that should be carefully monitored in particular with respect to “green-washing” claims.

In recent years, there has been an increase in the number of state law claims being brought on the basis of consumer protection statutes, as well as claims alleging negligence and vicarious liability, breach of contract (including workers alleging claims against companies for breach of their “standards for suppliers”, asserting third-party beneficiary status), unjust enrichment (Claimants alleging that a company was unjustly enriched by its relationship with its suppliers), and voluntary assumption of a legal duty – all with SRI at their core.

Increasingly, class action lawsuits in the USA affect UK companies. The Pax World Management case has increased interest in seeking redress for shareholders, which is no surprise in light of the above SRI practices. According to the French-based research firm Novethic, some 75% of European Pension funds and 45% of Family Oces now demand a clear and concise statement from potential investee entities regarding management of ESG risk and increasingly smaller funds struggle to produce a set of ESG policies and procedures with which to demonstrate compliance. Those smaller fund managers implementing standard SRI based screens are actually increasing ESG risk and therefore may be subject to subsequent claims in the event that losses are incurred.

H. Learning from the collapse of the Carbon Markets

On 26 May 2009 The Wall Street Journal reported the dangers of a “subprime” of carbon: “Even as Treasury Secretary Tim Geithner is urging Congress to adopt greater financial-market regulation, another Capitol Hill hearing room is full of concern about another market subject to price gyrations: the carbon market. The biggest worry is how businesses are meant to adapt to a world where the price for a new must-have asset—the right to emit carbon dioxide—can swing so violently. In Europe, for instance, prices for carbon permits have whipsawed from a high of 30 euros a ton to a low of 2 euros a ton”.

Confirmation of that 2009 warning, in a current carbon market that has experienced a complete collapse, has now come to pass. Endemic fraud in the carbon market place is illustrated in one country alone, demonstrated by Denmark’s Oce of the Auditor General now investigating a $7 Billion carbon fraud, which occurred after the Danish registry dropped requirements that carbon traders be documented. [8]

The estimated $ 3.7 Trillion of assets invested under extremely questionable SRI filters is a mirror image of the Carbon Markets: it is an entirely unregulated environment, with no common standards or definitions, no verification of claim and driven by many of the same players who are active in the Carbon Markets. [9]

Shareholder action groups are becoming ever more educated and will seek punitive redress from companies and funds who base their investment criteria upon SRI methodologies. Compliance ocers within the fund management industry are gradually beginning to address the SRI issue but often find accurate information dicult to find.

I. Conclusion

SRI is a laudable idea but in seeking to implement it a number of widely adopted practices and programmes have actually substantially increased rather than reduced risk. This outcome may have been accidental or may have been opportunistic advantage being taken of an imperfect process or the relative non-regulation of SRI. While initially it is possible to argue that an imperfect process is better than no process at all, now that the ESG investment world has grown to a mega-billion size it requires appropriate and robust levels of due care, stewardship and accountability. To support such a scale of ESG investment, transparent and robust rules are required that have the ability to be measured and monitored.

In support of the above the International ISO Organisation, financial academia and leading European Sustainability and ESG research facilities, continue to call for the implementation of readily available standards that enable quantitive measurement of the risks; not only to rectify the current misappropriation of terminologies and the related increase in risk but to re-establish and enhance investor trust in sustainable investment. Law and professional risk and compliance firms could play a significant role in providing the necessary investor assurance and rebuilding of trust that the Investment Industry currently lacks in respect of the ever more important, (to the investor) area of sustainability and ESG activities. Meanwhile, the combination of growing regulation for ESG and investors becoming more determined to “get-what-they-paid-for” lead to the expectation that there will be a growth in the number of legal disputes in the area.



[3] for an update on the status of MiFID II


[5]Companies Act 2006 s417.