The imminence of COP28 provides an opportunity to reflect on how international commercial courts in the MEA region can play a role in supervising compliance with environmental, social, and governance (ESG) investment obligations.
ESG investing standards and criteria are typically used by socially and environmentally conscious investors to assess business practices and performance on various sustainability and ethical issues, with respect to their investments. The duties of investment managers in this context have often been viewed as importing only soft investment obligations, given the aspirational breadth of many ESG goals and the subjective and political factors in deciding on what is and what is not an ethical investment within the meaning of the constitutive ESG instruments or more generally.
Two questions consistently arise when ESG ratings are discussed: (i) “who decides” and (ii) what remedies are left to stakeholders who believe that ESG criteria have not been satisfied.
The first question is quite straightforward. ESG ratings are set by leading ratings agencies who rely on a variety of different methodologies, metrics and sets of data. Examples of such agencies include MSCI, Sustainalytics, Bloomberg, and Refinitiv. Moody’s, S&P and Fitch also issue ESG ratings. These ratings typically range from 0 to 100, with a score of less than 50 considered relatively poor and more than 70 considered good.
A more complex issue arises with respect to the tangible consequences for failure to meet ESG criteria. At present, ESG metrics are voluntary and not mandated by any generally applicable law. It follows that a party will only be bound to meet certain ESG criteria if they are contained in a contract or other legally binding document. This can leave stakeholders without protection.
Considering the following scenario:
A retail investor purchases units of an “ESG fund”. The fund initially has an ESG rating of 75 (issued by Bloomberg) but this rating is reduced to 50 after the fund manager makes a new investment. The fund manager disputes Bloomberg’s decision to downgrade the ESG rating of the fund. The change in underlying investments causes the fund to increase in value so the retail investor suffers no financial loss. What remedies are open to the retail investor?
At present, the regulatory remedies available in the UAE are unclear. The terms and conditions of an ESG fund generally give the investment manager full discretion to make investments without a strict requirement to refer to ESG standards. Likewise, it will be difficult to establish any mis-selling as the fund had a high ESG rating when sold. It is also unlikely that a regulatory complaint will result in the reversal of the disputed transaction.
However, consider the significance of adding a carefully drafted dispute resolution clause to the terms and conditions governing the ESG fund. Such a clause could give a retail investor the specific right to challenge investment decisions on ESG criteria, in an appropriate forum that recognises the emergence of sustainable finance policies in the region and internationally. Funds which included such a clause would likely be more marketable to dedicated ESG investors, as ensuring greater accountability and adherence to ESG criteria to the extent that investment decisions are open to challenge and correction.
To be operable and effective, such a dispute resolution clause would require to be immediately or ultimately policed by a court or tribunal of competent jurisdiction. In many cases, it may be more aligned with ESG investment goals to opt in to the jurisdiction of an international commercial court, in preference to an arbitration mechanism, and on the judicial side the ADGM Court or the DIFC Court could be ideal candidates for MEA investments, as both courts:
- Have an established opt in jurisdiction;
- Are familiar with complex financial products and the specific agenda of regional financial regulators (such as the UAE Sustainable Finance Working Group which includes the Central Bank of the UAE, the Securities and Commodities Authority, the Financial Services Regulatory Authority of ADGM and the Dubai Financial Services Authority in the DIFC);
- Operate through English on common law principles;
- Have transparent processes with hearings open to the public;
- Are well respected internationally as neutral venues for the resolution of disputes.
In the years to come, the ADGM Court and the DIFC Court may therefore play a greater role in the resolution of ESG disputes.