Clifford Chance

The ESG specific aspects of those instruments, such as ESG related KPIs, continue to evolve and become more sophisticated and tailored to reflect the relevant businesses and industries involved and are likely to face increasing scrutiny with the growing focus on greenwashing.

We expect to see continued discussion around the role that blended finance can play in emerging markets. At COP 27, held in Egypt in November 2022, there was a focus on the fact that the current flows of finance to developing countries, where the greatest impact of climate change is felt, are well below where they need to be in order to bring about meaningful mitigation action and to address inequalities in access to finance.

In particular, fund managers with products that are categorised as either Article 8 "plus" or Article 9 for the purposes of the Sustainable Finance Disclosure Regulation (SFDR) need to consider how the requirement to assess whether an investment is a ‘sustainable investment’ can be incorporated into their transaction processes and also monitored over the course of the holding period.

For an investment to be considered a 'sustainable investment' under the SFDR: (i) it must contribute to either an environmental or a social objective; (ii) it must do no significant harm (DNSH) to any of those objectives; and (iii) any investee companies must follow good governance practices. There is still significant legal uncertainty as to how this definition should be interpreted and concepts such as 'do no significant harm' have proved difficult to navigate. Regulatory guidance has clarified that principal adverse impact (PAI) indicators should be measured in order to assess DNSH, although managers are still given discretion to determine the value for each indicator that represents the "tipping point" for DNSH.

Managers also need to update their investment checklists to ensure that the latest SFDR requirements for each product are captured. Changes may also be required to transaction documentation in order to ensure that the due diligence undertaken is supported by appropriate contractual projections, that portfolio companies provide the relevant information at the requisite intervals and that the portfolio company remains a "sustainable investment" throughout the fund's holding period.

In particular, we are starting to see the same approach adopted by managers with respect to their counterparty borrowers and increasingly, borrowers are being requested to complete checklists pre-contracting and agree to ongoing reporting covenants relating to the SFDR. This is being accepted with mixed results in the market, as in many cases the requests are made in the context of legacy deals where borrowers may have no obvious contractual obligation to provide such information and often requests are made where credit funds participate in transactions in secondary trading where it may be too late for the credit funds to require changes to the finance documents.

Claims of 'greenwashing' have been brought before national courts across the world and complaints have been made to advertising ombudsmen and before the national contact points of OECD-adhering countries which monitor the OECD Guidelines for Multinational Enterprises. The recipients of complaints and litigation include a broad range of industries from energy companies and high carbon emitters to financial institutions. In 2022, parallel NGO litigation and a putative class action suit were filed in the Netherlands and the United States, respectively challenging the sustainability claims of a major global airline.

States are most commonly the target of climaterelated litigation but there is an increasing focus on corporates. For example:

• A ruling in a Dutch court in the Netherlands required a multinational energy company to reduce its carbon emissions by 45% as against its reported 2019 emissions by 2030. The ruling is currently subject to appeal.
• In the United States, multiple climate suits under state nuisance law against oil and gas companies face a potential decision by the Supreme Court regarding the proper venue.

Supply chain litigation relating to alleged victims of forced labour is prevalent. For example, multiple Nepali and Bangladeshi migrant workers are seeking damages in the torts of negligence, false imprisonment, intimidation, assault, along with remedies for restitution of unjust enrichment against a technology company in the UK.

Increasingly, businesses are seeking long-term carbon offset supply via investment in the supply chains through being either the primary offtaker for a carbon project or taking equity investment or project ownership in projects. The focus on this method of sourcing through the supply chain (referred to as carbon 'insetting') can help facilitate control over emission reductions and thereby ultimately the credibility of the net zero, or other carbon, commitments of the business.

We are also seeing increased M&A activity in this space as private capital providers, such as infrastructure funds and private equity, look to invest in the carbon markets value chain in businesses which derive contracted revenue from performing services (for example consultancy, project development, agency and/or brokerage) and/or selling carbon credits.

Momentum has been building on the formal development of the Voluntary Carbon Market (VCM) structures and, in particular, building on improvements to the quality and integrity of carbon credits and offsetting claims, and this work will continue through the Integrity Council for the Voluntary Carbon Market (on the sellside) and the Voluntary Carbon Markets Integrity Initiative (on the buy-side).

Meanwhile, pressure is intensifying on businesses making net zero or other carbon claims which rely to any extent on offsets, to clarify and justify that reliance.