AIQ: Cleaning up capitalism

Law and climate

Using the legal stick to accelerate change

Energy majors, cement producers, utilities and financial services providers are among the latest targets of legal action designed to make them move faster towards a lower carbon world. Could this be an inflection point?

In May 2021, oil giant Royal Dutch Shell was ordered by a judge in a district court in the Hague to cut scope 1, 2 and 3 emissions by 45 per cent from 2019 levels by the end of the decade. The judgement is seen as a major step forward by environmental campaigners.

The volume of climate-related litigation being taken around the world is stepping up, with cases having almost doubled from 884 to 1550 since 2017.1 Most litigation (79 per cent) has been in the US; just 10 per cent has been directed at corporates.

The majority of the 135 businesses facing challenges are energy and natural resources companies, with litigation concentrated in six areas: the rights to life and a clean environment, the need to keep carbon in the ground, areas of corporate responsibility, enforcement of climate targets, adaptation impacts and climate disclosures. The last category includes a growing number of financial markets cases, focusing on financial risks, fiduciary duty and corporate due diligence, affecting banks, pension funds and asset managers.2

Although the financial consequences to those facing action are unclear, the costs may prove much higher than headline fines or court orders, particularly if litigation results in long-lasting reputational damage.

Figure 1: Climate-related litigation: Total cases 1986-20193
Climate-related litigation: Total cases 1986-2019
Note: Each dot represents one case.
Source: Freshfields Bruckhaus Deringer, December 2019
Figure 2: Climate-related litigation: Cases against companies 1986-20194
Climate-related litigation: Cases against companies 1986-2019
Source: Freshfields Bruckhaus Deringer, December 2019

The key analytical tool that might prove pertinent is climate attribution. This rapidly evolving science allows human impacts on climate change to be assessed, right down to the individual company level. By taking a pre-industrial climate scenario, then comparing it with one that takes man-made emissions into account, it may be possible to define the human contribution.

These developments are significant because until recently it was not possible to be definitive about causative relationships: to establish a single company’s actions might have contributed to a particular weather event.

One important consideration in legal action is whether greenhouse gas emitters can be shown to have known about environmental risks but pressed ahead with harmful activities regardless. If evidence like this coexists with information from an internationally recognised body like the Intergovernmental Panel on Climate Change, companies may find it harder to have the cases against them dismissed.

“The ruling against Shell is game changing,” says Sora Utzinger, senior environmental, social and governance (ESG) analyst at Aviva Investors. “Prior to now, most of the behaviour change related to climate has come about from top-down regulation. More governments have announced plans to reach net zero, and companies have changed their behaviour accordingly, to reflect what society wants to achieve. This is different; it makes company commitments binding.”

The complex web linking social values and risk

The analytical framework that has developed to encapsulate the changing environment involves an intricate web of physical, transition and litigation risk. “As physical risks become larger, so does the litigation risk,” explains Joana Setzer, assistant professorial research fellow at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics.

“But transition risks also increase litigation risk. This is why it is important for private actors to track cases against states, not just cases against companies they invest in or insure.” (Read a detailed interview with Setzer here.)

There is plenty of stakeholder tension to contemplate as well. If carbon-heavy businesses accelerate towards transition, will their return on capital fall? Could that leave emitters open to criticism from climate change activists as well as disgruntled shareholders, with risk on both counts?

“Climate transition risks are being taken much more seriously by the oil majors,” Utzinger says. “Those on the path to net zero know they have to de-risk their traditional upstream business; that’s why they talk about ‘advantaged resources’, where there is a sweet spot between low breakeven prices and lower emissions intensity.

Companies that could be targets of climate action need to build provisions and ensure material risks are reported

“Of course, returns on invested capital (ROIC) vary across hydrocarbon and low-carbon energy sources,” she adds. “We think companies should not just focus on ROIC but on the underlying risk profile – knowing where to play and understanding where established capabilities can create value in the low-carbon space is going to be a critical component of strategy.”

Ultimately, best practise means companies that could be targets of climate action need to inform their shareholders, build provisions, and ensure material risks are reported. In the background, they need to recognise the potential to be challenged in jurisdictions in which they do not operate.

These changes reflect the complex way the environment is changing, how environmental protest has become global and how climate action is part of an evolving social debate.  

“Litigation is being used in every direction, and we are going to see more of it,” Setzer warns. “The terrain becomes complex, risks and uncertainty are high, and the players involved are powerful. It will be a hard fight.”

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