Big Law came late to the ESG party compared to regulated financial services industries, with many law firms only getting the memo as recently as the pandemic.
At the forefront of this movement for approaching 20 years are professor Paul Watchman, senior UN legal adviser and former Freshfields partner, and Paul Clements-Hunt, founder of The Blended Capital Group, a former adviser to the UN on sustainable finance and the person who coined the term ESG. Legal Business sat down with these trailblazers to discuss why lawyers must embrace good corporate citizenship.
Nathalie Tidman (NT): How did you first come to work together on ESG?
Paul Clements-Hunt (PCH): I first met Paul in July 2005, when the bombings happened in London. I’d flown over from Switzerland that morning and disappeared into his office on Fleet Street. I was a UN official working on the UNEP [United Nations Environment Programme] finance initiative, a partnership between the UN, banks, insurers and asset managers. In 2003 we started work on what ultimately became the principles for responsible investment (PRI) which we launched in 2006. We’d decided at the UN to get major pension funds on board and all of the big asset owners. We needed to do the research on what became ESG issues relating to equity pricing. We needed the legal underpinning, which became the Freshfields Report, to really be credible with asset owners so we commissioned Paul and Freshfields. It was launched in October 2005 at the UN headquarters at a global meeting on finance. I’ve owed him money ever since so he hasn’t let me out of his sight!
Paul Watchman (PW): They came to me because at the time I was doing a lot of work on the business and human rights side and sustainable finance, corporate responsibility. I was advising quite a few of the banks and the sponsoring companies, BP, various government bodies, EBRD [European Bank for Reconstruction and Development], on what would become ESG considerations – certainly the ‘E’ for environmental impact. We did the Baku-Ceyhan pipeline, which goes through Asia Minor, and we also did the ‘S’, because the community impacts are really important. That was really at the beginning.
‘People said they couldn’t take into account environmental impact, human rights, the way in which you govern your business. We said that all these things have financial impacts.’
Paul Watchman
PCH: We had the research, the legal piece and then we had the theatre – Kofi Annan, secretary-general of the UN launching the PRI in April 2006 at the New York Stock Exchange with the 9.30am bell ringing, opening the American markets. It was an iconic moment. We were concerned no-one would know who he was on the trading floor – there was such a mismatch between cultures.
NT: How much of an impact has the Freshfields Report had?
PCH: We would not have had a sensible conversation with asset owners or have the $83trn dollars now backing the PRI if it hadn’t been for the legal underpinning. It was a hand grenade being rolled into the investment community. It was so profound in its findings.
Why is the legal community running helter-skelter, pelting into ESG? If you had not had this massive movement over the last 15 years of major investors and financial institutions into this space, the legal community would not be doing what it’s doing now.
The original values of the UN, humanitarian, security (relevant to Ukraine), environment and development were fully aligned with the values of long-term asset owners. If you have the world going to hell in a handbasket, your investment returns are going to be poor.
PW: The report was not universally welcomed, even by Freshfields. It said you need to look at a longer horizon than the next quarter’s bonus. You have to think about where this business is going to be by investing in the future, not just taking out money in the short term. That upset some of the City partners who were working closely with the likes of – well, let’s give them a nom de plume – White Pebble.
They were not happy because it required a wholly different mindset and set of skills. This whole industry has come out of the joint effort between us and the UN. It was astonishingly brave, looking back.
‘Now there is a frantic race to get ESG capability and the legal community is late to the game.’
Paul Clements-Hunt
I didn’t want this to take a single step beyond what we could fully justify. Someone would be looking to rip this up. Page 13 says it is consistent with fiduciary duties to have regard to ESG. The real kicker was the part that says: ‘and in some cases necessary’. For mineral and fossil fuel companies, and banks, everything that happened with the financial collapse was because they didn’t want to look at ESG.
People said they couldn’t take into account environmental impact, human rights, the way in which you govern your business. We said that all these things have financial impacts. If you’re a food manufacturer and have child labour, a fossil fuel company and don’t maintain your rigs and you have leaks in your pipeline, these are all critical to your financial returns.
PCH: There was ethical investing, and there was nothing wrong with that, but it was never going to move trillions. We had to say to the finance sector and the investment community that these are real risk issues. The past 30 years, the whole sustainability mix, with the exception of Freshfields, was voluntary and it was market-facing. That’s changed now and the prudential regulators have stepped in. The International Organisation of Securities Commissions, the Bank for International Settlements, the Basel Committee on Banking Supervision – all of these have stepped in over the last few years. It has flipped from being nice-to-have to being embedded in European policy. Now there is a frantic race to get ESG capability and the legal community is late to the game.
PW: A lot of the reason for the 2008 financial collapse was because people were not assessing things properly – the big short – just pushing out money. They almost brought down the world financial system but they were frozen in the headlights and everyone was trying to stop it spinning out of control.
In 2006, Hank Paulson and I were named among the six most important people in the world. It’s on my LinkedIn! Just before this crisis happened. At the time, the Freshfields Report and PRI were starting to have some traction. I said climate change was going to change the way we looked at investment. It was going to be the big driver. At Freshfields, I was told it would all blow up in my face. A lot of partners didn’t like it, or me. By 2016 I was getting pissed off. All these law firms started opening up ESG practices. How did they learn that stuff? One of the things that drove me to distraction, some of the people who were passing themselves off as ESG lawyers were tobacco litigation defenders. The only way they were human rights lawyers were if you put ‘In’ in front of ‘human’.
NT: Which lawyers and firms are getting ESG right?
PW: Vanessa Havard-Williams at Linklaters is genuine. She has been doing this for a very long time. Paul Davies at Latham & Watkins is genuine. I like Jeff Twentyman at Slaughter and May. He and his team are genuine. One day, four US law firms launched ESG practices on the same day and I said to Paul I’d had enough! People get me wrong and they think because I’ve been doing this for a long time I want to keep it for myself. We want them to go into ESG, but with the proper knowledge.
PCH: Our Chasing the Dragon report began as a UN process after Covid started. Paul and I were working for one of the UN agencies, asking how business would be after Covid. The reason the legal element came in was because professional services have a massive impact in shaping the value set along the investment chain. We looked at 55 law firms and in the latest report, Riding the Dragon, we looked at 100. We reckon 27% of the firms are unable to substantiate or validate their ESG credentials at all. Over a quarter of the firms looked at are claiming ESG but they are not substantiating.
PW: The whole idea that you didn’t look behind the corporate veil, one of the fundamentals of company law, has completely gone after the Shell case and the Vendanta case in the UK Supreme Court a couple of years ago.
You’re finding people talking about intergenerational justice. It’s an interesting concept because we’re not saying there’s damage now, we’re saying there’ll be damage in 20 years so we’ve got to act now. Normally for a court, the damage has to be done. Although you can attribute climate change to certain companies, pinning legal liability on them is difficult. You’ve got clients and general counsel coming to you saying: ‘We’ve got to make a disclosure according to these rules – how do we do that? What does it mean?’
NT: How do you spot the signs of greenwashing?
PW: Sometimes someone is put forward as head of bonds in the ESG group and has never done a green bond in their life.
PCH: You’d see all these lines on someone’s bio about their capital markets experience and then a short sentence added on about ESG expertise. That was classic. It’s obvious that the person is all over capital markets but there’s a sentence tacked on about ESG. It doesn’t stack up. It’s actually got a bit better. There’s been a bit of profile cleaning.
‘ESG is a way of thinking, it’s a way of culture. How the different risks interact. You have converging complex systemic risks. You can link climate to biodiversity, mass migration, Islamic terrorism, sovereign corruption.’
Paul Clements-Hunt
NT: Has there been a shift in focus towards governance?
PCH: If you don’t get the governance right, you can’t get the environmental and social bits right either. The environmental part is sexy and established, let’s put that at the front. ‘S’, the social, is by far the most difficult for investors and financial institutions to deal with. If you put that on the end it gets taken off so it was put in the middle. ‘G’, governance, is at the end, pinning it all together.
Investment institutions silo it as three different risks and it’s not. It’s a way of thinking, it’s a way of culture. How the different risks interact. You have converging complex systemic risks. You can link climate to biodiversity, mass migration, Islamic terrorism, sovereign corruption. The market always wants to slice and dice and silo risk, but you have to look at the way they interrelate in a more complex world.
NT: How is this playing out with the Russia/Ukraine war?
PW: The ‘G’ is the unifying part. A lot of law firms have been really bad at governance, gender equality and dealing with harassment. They had few moral codes. Clients are saying to law firms: ‘Align with our values’. Law firms are moving but partly because clients are demanding it. Russia is a great example. For years I’ve been arguing that the cab rank rule does not apply to law firms. People said the rule of law means that you should be able to choose your lawyer, with no exceptions. It’s the same with the Russian oligarchs. Suddenly the law firms could get out of Russia, they could get rid of these clients, because the impact on their business was going to be so negative.
PCH: From 1991 when the Soviet Union broke down, the liberal democracies and western companies from the word go normalised corruption. There’s a 30-year process of making money and being totally complicit in corruption. It was a vast theft of state assets by a very limited number of political figures and oligarchs. We bought into that. Dealing with the impact of the war on your firm internally is part of the cost of normalising corruption.
NT: What have been your personal reckonings?
PW: I’m not perfect. A lot of oil is off Scottish waters. I’ve acted for every villain you can name. We’re not naïve boys and we’re not tree-huggers. We do like biodiversity but we’ve come at it from a different angle. In Liverpool and Lanarkshire you have to be streetwise.
An associate once anonymously said about me that I was physically and intellectually intimidating. I asked my wife if it was true. She said: ‘You know you are.’ I didn’t want to have the fear factor. I could be rude and aggressive. I had to change and I turned it around. That’s why Freshfields was the first international law firm to have a CSR report.
PCH: We purposefully distance ESG from ethical. It’s about the materiality of the financial risk. To reject a client on ethical grounds is understandable but it’s not necessarily ESG. If you have a client that is egregiously breaking soft law – what is increasingly becoming hard law – that’s a red signal. We will see more clarity as the soft law begins to be codified into harder law. If you’re not dealing with modern slavery and human rights in your supply chain, are you complicit? That ultimately speaks to the culture of your law firm.
PW: I gave a presentation on diversity, saying we need more gender equality and we need to recruit from different colleges and make sure women can progress. Someone got up and said: ‘Quite a lot of partners at this firm are Wykehamists and we went to Sidney Sussex College, Cambridge. With this diversity stuff, what other colleges in Cambridge are you thinking of?’
NT: How serious a threat is greenwashing?
PW: France has passed a law to make greenwashing a crime. It is important that we are seeing a change happening. Greenwashing is becoming part of the risk assessment. If a company like BP says it’s spending $10bn this year on renewables, how much is that compared with your total budget? If it’s something like 0.55%, you’re making a big statement about something that isn’t true.
PCH: If you take climate and COP26, and the fact that Mark Carney gathered $130trn around GFANZ, Glasgow Financial Alliance for Net Zero. All the world’s biggest financial institutions and investors were on a public platform, saying they are committing to the pathway to Net Zero. That’s direct accountability. It is a target on the back. They will have to show forward movement toward that, because the law in and around climate change in the EU and other jurisdictions globally is tightening up. The financial tectonic plates and policy plates are colliding. The ability through digital platforms to track the use of data and what institutions do against a very public claim is getting easier over time.
‘If we’re right in saying ESG is becoming part of the DNA of business, it’s going to become important for firms to have real expertise, not people who don’t know what a scope three emission is.’
Paul Watchman
I was involved in an investment research company a few years ago. We came up with an idea for a new fund and thought we’d call it the Smart Carbon Fund. The French market regulator picked us up on it straight away, asked us why it was a smart carbon fund. Told us to prove it. We had to change the name of the fund because the French securities market regulates this and they were already on it, even before this new law was passed.
NT: What will be the biggest challenges over the next few years?
PW: It takes time to shift the dial. People come to me now and ask about disclosures in the US or Europe. I give the same advice I’ve given for years. Pick the toughest one and go for that – you can’t go wrong.
PCH: All the stuff at the moment about greenwashing goes on and on, it’s endless. Where it becomes powerful, from an investment or a corporate standpoint, is whether you use ESG in unison at all three levels. Do you use it systemically across the portfolio? It’s fundamentally around changing culture and that takes time.
One of the challenges to the legal sector is the culture is quite rotten at a lot of these firms. How can you be a trusted adviser on ESG if your own internal culture is faulty? How do you identify, secure and retain real talent? The fact that the prudential oversight players, the financial institutions and ministries, are beginning to look at these issues in a harder way because of the materiality of the risk will change everything for the legal community. They will have to be onside.
PW: Accountants will change law firms. The Big Four are investing literally billions in ESG, either training their staff up or expanding their law offerings. If we’re right in saying ESG is becoming part of the DNA of business, it’s going to become important for firms to have real expertise, not people who don’t know what a scope three emission is. Give Paul £5m and he will make you the best ESG firm in the world!
PCH: He actually means me! Maybe £10-£15m for both of us? LB