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ESG issues are driving demand for legal expertise

October 27, 2021
By: Remco Feuth

It is an undeniable reality that a company is a legal structure designed to bring together stakeholders (employees, investors, customers, and suppliers) and the company itself to achieve business objectives. Companies act autonomously and “exist” as independent legal entities, separate from those who work for them and finance them. Legal personality is both a legal concept and a lived reality.

In short, the traditional economic view of a company is that it consists of a series of contracts, whereby the company is owned by its shareholders with the goal of maximizing shareholder value. The famous economist Milton Friedman once said, roughly translated: “The sole purpose of a company is to make as much money as possible.” (from: *Capitalism and Freedom*, 1962). This idea has had a major influence on thinking about the actual purpose of companies. The practice, common until then, of executives also considering the interests of other stakeholders (consumers, employees, suppliers, society, the environment) in their decisions was increasingly abandoned. (Financial) globalism, coupled with fewer and fewer regulations, led to a focus on making everything more efficient and profitable, at the expense of the previously positive relationships between management and stakeholders. Fortunately, this view of the role of businesses in society is shifting.

As Klaus Schwab stated at the 50th anniversary of the World Economic Forum (WEF) in January 2020: “Stakeholder capitalism has finally become mainstream—or is becoming mainstream.” The idea that organizations would no longer prioritize profit above all else, but would instead embrace a broader social purpose, is gaining increasing traction. Issues related to the environment, society, and governance (ESG) are higher on the agenda of corporate boards of directors and executive management. ESG is now also recognized as a central component of legal, business, and financial risk assessment. Companies and financial institutions can no longer ignore the significance of ESG’s impact on profitability and therefore require legal advice when assessing ESG risks.

Before the world was thrown into turmoil by COVID-19 and its consequences, the business community was, as mentioned, already at a turning point regarding its role in society. There was a greater focus on social justice and a loud and widespread call for companies to take all stakeholders into account to a greater extent.

Businesses and the profits they generate inherently provide many benefits to society, including jobs and training, income for suppliers, R&D investments for innovation, and so on. They all yield potential social and economic returns for individuals and companies beyond the company’s walls.  ESG enables this to be done in an even more responsible manner with an eye toward the future—for the planet and future generations, but above all for the companies themselves.  The COVID-19 pandemic has served as a catalyst for accelerated change. The connections between ESG, business strategy, and risks have never been clearer than during the pandemic, when companies had to adapt quickly and respond to critical risks that were previously considered unlikely.

ESG factors are becoming a key determinant of financial strength. Recent research shows that the top 20 percent of ESG-ranked stocks outperformed generic index funds by more than 5 percentage points during a recent period of volatility. Financial strength and resilience are certainly not the only benefits. There are ample opportunities for brand differentiation, attracting and retaining top talent, greater innovation, operational efficiency, and the ability to raise capital and increase market valuation. Companies that have already built ESG strategies, metrics, and high-quality information into their business models are likely well-positioned to capitalize on these opportunities and create long-term value in the wake of the crisis. It is therefore increasingly recognized that companies that fulfill their ESG obligations generally outperform their competitors.

Law firms and legal departments are embracing ESG—whether or not under pressure from the financial sector to pursue ESG investments—because they recognize its potential and can make a significant contribution to achieving ESG goals. For example, lawyers are working with clients to include a wide range of environmental clauses in contracts. In construction projects, for example, it is becoming an increasingly standard requirement for contractors to mandate an Energy Performance Certificate (EPC) of at least an “A” for buildings, to demonstrate that they are energy-efficient. Lawyers are also busy with companies’ ESG disclosures, especially since regulators are on the hunt for misleading claims that indicate “greenwashing.” This carries risks ranging from lawsuits to reputational damage.

We are on the cusp of—or may even already be in the midst of—major (societal) changes and shifts in our relationships with one another. Legal professionals are in a prime position to contribute to these changes.