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Climate litigation is a growing risk for financial institutions

Financial institutions are feeling the heat when it comes to climate litigation. Read our latest article to explore what is driving the increase in climate litigation.
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By Zoe Rawson , 

Vice President, Financial Institutions

20/03/2024 · 5 minute read

Financial institutions are feeling the heat when it comes to climate litigation. The Paris Agreement in 2015 specifically identified financial institutions as changemakers to address and respond to climate change due to their influence and ability to make high-value investments in strategies to reduce emissions and reach net zero. Perhaps it is this classification that makes financial institutions more susceptible to scrutiny by regulators, governments, and litigators assessing their impact on climate change. 

A number of investment banks, large asset managers, and insurance companies have already faced legal and regulatory action centring around climate change issues. According to the Global trends in climate litigation: 2022 snapshot, the cumulative number of climate litigation cases globally has more than doubled since 2015. Climate litigation is quickly advancing from greenwashing claims into regulatory claims and mismanagement allegations. Accordingly, the boards of financial institutions need to ensure they are prepared to mitigate and manage this risk. 

What is driving the increase in climate litigation?

1. Greenwashing

Usually, the first thing that springs to mind when thinking about climate litigation is greenwashing, partly due to the growing number of high-profile cases. Broadly, greenwashing is when misleading statements or claims are made by an organisation regarding environmental or social factors. These often concern corporate strategy or investment and are included in marketing materials, annual reports, or corporate statements. 

Multiple factors are fuelling the increase in greenwashing claims, including:

  • Greater public attention to green credentials.
  • An increase in the availability of data that could disprove the claims made by organisations on environmental, social, and governance (ESG) issues.
  • A greater willingness on the part of organisations to publish ESG credentials.
  • Increased regulation and regulatory scrutiny of ESG disclosures.

The US Securities and Exchange Commission (SEC), Federal Financial Supervisory Authority (BaFin) in Germany, and Financial Conduct Authority (FCA) in the UK have issued fines to high-profile financial institutions related to greenwashing in the past year, according to reports, and show no signs of easing off in 2024.

2. Scrutiny of Scope 3 data

The increase in attention to financial institutions’ Scope 3 emissions data is also contributing to the rise in climate litigation. Scope 3 emissions encompass indirect emissions that an organisation is responsible for in its value chain. For financial institutions, this can relate back to statements on their corporate strategy, the investments they hold, and the loans they grant and for insurers, the risks they insure. For many industries, Scope 3 emissions are difficult to accurately quantify as companies rarely have full transparency of their supply chains and the fate of their goods after sale.  This further exposes business leaders and board members to potential litigation related to Scope 3 emissions calculations.

3. Shareholder activism

There has also been an increase in legal action from shareholders that brings alleged breaches in directors’ duties to exercise reasonable care, skill, and diligence regarding their decisions that may influence climate change. 

In one case, a non-governmental organisation purchased shares in an energy company and then made a shareholder class action alleging the organisation’s directors had breached their duties. The NGO had two main arguments, namely that there was a breach of: (a) the statutory duty for directors to promote the success of the company and (b) the statutory duty to exercise reasonable care, skill, and diligence. The courts dismissed the case on the grounds that there is not necessarily a link between the success of a company and preserving the environment.

More of these types of cases are likely to be brought against energy companies, financial institutions, and other organisations in the future due to the Paris Agreement identifying them as changemakers in reducing emissions and in the transition to net zero. However, there is a generally held view that future claimants will need to prove material loss and have evidence of a breach of duty by directors or failure to act in good faith to win their case. Publicly-listed financial institutions will be more exposed to litigation due to the shareholder element needed to bring public derivative class actions.

How can financial institutions prepare for and mitigate against climate litigation?

First, to manage and mitigate the risk of climate litigation, financial institutions must ensure their corporate strategy concerning climate and ESG information is robust. The financial exposures brought about by that strategy should be considered.

Financial institutions should also keep abreast of regulations surrounding ESG and any necessary disclosures. Some regulators admit the lack of a standardised global framework makes compliance difficult, and there are moves to establish consistency. Nonetheless, despite the challenges, regulators are not holding back on enforcing ESG regulations. Therefore, financial institutions must ensure that they consider all the regulations to which they may be exposed.

Finally, financial institutions must ensure that they vigorously consider their Scope 3 emissions —especially in investments made, loans provided, and insurance policies underwritten. For insurers, ESG considerations are gaining ground in underwriting frameworks but there is more change to come, according to Marsh. Similarly, with asset managers, although there is evident enthusiasm around better stewardship of the ESG credentials of their investments, there is reportedly reluctance to enforce a greener agenda. Banks also face the balancing act of wanting to promote greener lending while navigating a challenging economic macroeconomic environment. For retail banks, the conflict between environmental and social obligations adds another layer of complexity, as they strive to follow a green agenda. 

Key climate litigation areas to monitor

Many financial institutions remain underprepared to manage potential climate litigation and consequently are more exposed to legal action that will no doubt increase in the coming years. 

Five areas of climate litigation to watch include cases that: 

  • Involve personal responsibility
  • Challenge commitments that over rely on greenhouse gas removals or “negative emissions” technologies 
  • Focus on short-lived climate pollutants 
  • Explicitly concern the climate and biodiversity nexus
  • Centre on strategies exploring legal recourse for the “loss and damage” resulting from climate change

Good governance is the anchor for financial institutions to successfully manage their risk of climate litigation. The boards of financial institutions can begin to address climate litigation risk by getting the balance right between climate and ESG objectives that demonstrate their duty of care and actions that promote overall success.

For more information, please speak to your usual Marsh adviser.

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