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Environmental, social and governance (ESG) criteria as reporting and investment metrics are evolving at a rapid pace. While the term ‘ESG’ and the push to integrate ESG criteria into a central role in corporate reporting and investment are relatively new, as a conceptual matter, ESG has been on the minds of regulators and corporate monitoring organisations for several decades. The recent increased focus on ESG criteria can be viewed as a call for companies to take a longer-term view of enterprise value in contrast to focusing so heavily on short-term financial returns. Indeed, to some observers, the ESG movement is something of a re-examination of – or even, a referendum on – the modern capitalist focus on maximising short-term returns above all else.
At its broadest, incorporating ESG criteria into business activities requires a more holistic and people-centric approach to business. Countries that require ESG reporting and companies that are benchmarking their operations against ESG standards are declaring their intention to prioritise environmental, social and governance criteria. ESG touches all aspects of a business and has short-, medium- and long-term implications. That being said, ‘measuring’ ESG performance is a complex endeavour and Latin America – and the world – continue to grapple with how to do so.
For investors, ESG considerations are a growing priority as ESG performance has been shown to correlate strongly with financial performance. Stock prices of companies with high ESG rankings tend to be more stable. In contrast, companies that experience controversial ESG events can see their stock lose significant value in the market. Among society’s many current challenges, climate change, social inequality and diversity are often top of mind, and the ESG movement seeks to engage private companies in addressing such issues by requiring that they report on their performance with respect to such ESG matters. What is made clear by the chapters in this book is that all levels of governments, international governmental organisations and non-governmental organisations are grappling with how to ensure that ESG considerations are primary in governmental and corporate decision-making by regulating through adoption, measurement and accompanying disclosure.
While climate change concerns are often used synonymously with the term ESG in the media and in common parlance, it is helpful to recall that ESG is comprised of three separate components: environmental, social and governance. Environmental standards refer to a company’s or government’s environmental impact and environmental risk management practices. Factors when assessing a company’s or government’s environmental impact could include greenhouse gas emissions, water quality, waste management and energy efficiency. Social criteria refer to a company’s or government’s relationship with its employees, consumers and society at large, including its performance with respect to human rights, labour standards in the supply chain, child labour laws, workplace health, community impacts and safety. Finally, governance refers to how a company or government is managed or led with respect to its different stakeholders. This criterion relates to a well-defined corporate governance system that supports a company’s long-term strategy.
Politics are inherently embedded at all levels of ESG efforts. Although, as noted above, the scope of ESG criteria is much broader, recently climate change has been the primary motivator for the heightened focus on ESG criteria. Climate change was the focal point of the Paris Agreement of 2016. UN member countries committed in the Paris Agreement to try to limit the global temperature increase above pre-industrial levels to 1.5 degrees Celsius, which does not appear likely to be achieved. The signatory countries followed up the Paris Conference with the UN Climate Change Conference in Glasgow or COP 26, which took place in November 2021 and resulted in the Glasgow Climate Pact. Among other commitments, the countries agreeing to the Glasgow Climate Pact targeted a 45 percent reduction in global carbon dioxide emissions in order to reach net zero by 2050.
UN member governments also held the UN Climate Change Conference in Sharm-el-Sheik, Egypt or COP 27, in late 2022, and one of the key agreements was compensation from high-polluting countries to the developing countries that are hardest hit by the impacts of global warming. On the other hand, COP 27 itself drew controversy and was accused of promoting greenwashing. Both the venue – Egypt, a country with a checkered record on human rights – and one of the main sponsors – Coca-Cola, the world’s largest plastics polluter – were openly criticised in the global media with respect to their involvement in the event. At the time of this writing, the UN member governments are soon to gather again at the UN Climate Change Conference in the United Arab Emirates for COP28. Yet again, the venue has generated controversy, with reports of migrant workers working in life-threatening heat to build conference facilities.
In each country, the regulation of ESG disclosure has fallen mainly on securities and stock exchange regulators. There is something of a natural fit for these authorities given that they already regulate financial reporting and projections. In certain countries such as the United States, Latin America’s most important trading partner, there is currently a wave of political backlash against the focus on ESG as an investment strategy and as a regulatory topic, with certain politicians and pundits railing against the use of ESG criteria as an investment tool or subject worthy of regulatory oversight, and many state governments prohibiting the use of ESG tools in the making of investment decisions, for example, by state pension fund managers. Nevertheless, major businesses have already made ESG criteria important investment and evaluation tools and are seeking to promote themselves as ESG-friendly.
In Latin America, where economic development is critical and there is a substantial energy and infrastructure gap, balancing ESG frameworks and standard-setting with development goals can be difficult. Though many governments and companies in Latin America are rightfully pursuing more sustainable energy, infrastructure and industry practices, the need to develop and maintain economic stability for their citizens in the short- and medium-term will still often take precedence. The challenge is to balance the short-term demands of electoral politics and putting food on the table with the longer-term threats to the planet and society that can result from a failure to deal with ESG issues. Many, if not most, of the countries in the region have a significant percentage of impoverished citizens and large informal economies – people living and trying to survive under such circumstances can hardly be expected to make ESG-mindedness a priority. Some smaller, relatively wealthier, and more homogeneous countries, such as Costa Rica and Chile, have shown an ability to redirect their political economy towards an ESG-centric approach in relatively short order. On the other hand, larger, more diverse, and populous countries in the region are finding it more challenging to prioritise ESG criteria while also addressing critical development needs.
This book will examine the ESG movement across a variety of timely topics. There is a mix of topics and approaches, and other chapters are monographs, which take a deep dive into how a particular country is dealing with a particular ESG issue. It’s a truism, but each country in Latin America is unique in its history and current politics; nevertheless, countries can learn from each other and can adopt ideas that are working in one country and apply them in another.
Chapter 1 examines the current state of play with respect to ESG framework and standard-setting, including the potential for greenwashing and the likelihood of more consistent standardisation in reporting. In Chapter 2, Cleary Gottlieb Steen & Hamilton LLP surveys recent litigation and arbitration relating to ESG matters. In Chapter 3, Demarest Advogados reviews what is happening in the corporate boardroom in Brazil and how companies are addressing the surging ESG reporting requirements.
Chapter 4 takes a hard look at the essential nature of the social licence in the natural resources sector in Mexico, including recent case studies, lessons learned and what steps extractive companies can take to ensure they remain ‘onsides’ with the local communities in which they operate. Chapter 5 reviews the range of financing instruments being utilised to generate sustainable development and the preservation of natural resources, such as blue and green bonds. In Chapter 6, Arnold & Porter surveys the state of the carbon credit market, a key element to the move to low carbon economies. In Chapter 7, Morrison & Foerster focuses on the importance of ESG factors in due diligence for M&A transactions in the region, given the scope and beadth of rules and regulations required for compliance.
In Chapter 8, Latham & Watkins LLP examines the increased ESG scrutiny placed on companies’ supply chains, in respect of which Latin American countries play a critical role. In Chapter 9, Brigard Urrutia discusses the development of ESG reporting and the process of developing a taxonomy in Colombia.