ESG In Finance Transactions and Investment Funds From An Offshore Law Perspective

2021 saw an unprecedented surge in ESG debt issuance which was arguably underpinned by growing investor appetite for sustainable and green-linked investments. For example, UK insurer Aviva reported that the COVID-19 pandemic influenced the likelihood of taking ESG factors into consideration for over 55 per cent of respondents when deciding how to investⁱ, whilst sustainability and green debt more than doubled year-on-year to US$680 billion in the first half of 2021 according to the Institute of International Finance (the IIF).ⁱⁱ

The IIF has reported that there was almost a four-fold increase to US$160 billion in the issuance of bonds with sustainability-linked pricing ratchets in the first six months of 2021 on a year-on-year basis.ⁱⁱⁱ This was almost certainly driven by the fact that market participants recognised that implementing a sound ESG strategy facilitates access to new pools of capital and opportunities to lock in favourable pricing. For example, SSAB, which is a Swedish company that aspires to be the first fossil fuel-free steel producer, has issued a US$230 million equivalent five-year senior unsecured sustainability-linked bond with a maturity date of 2026. Under the terms of the relevant bond instrument, a redemption premium will be payable at maturity if SSAB fails to meet certain sustainability performance targets linked to greenhouse gas emissions. We expect that the volume of sustainability-linked bonds will continue to grow moving forward.

The IIF has also reported that around 85 per cent of all ESG-linked issuances of debt occur in Europe and North America.^iv However, there is evidence that ESG-linked debt is gaining traction across other regions. For example, Chinese real estate company Minmetals Land, Japanese real estate group Mori Hills and India’s Adani Electricity Mumbai have brought, or are reportedly planning to bring, various sustainable and green bonds to market. In contrast to green bonds, where the use of proceeds is linked to qualifying green projects, general sustainability-linked financings have also been used for a variety of corporate purposes and are based on specific ESG targets rather than a limited set of green projects. This has further opened the market to a broader spread of issuers, which is a trend that we expect will continue moving forward.

With a growing focus on ESG-linked products, the question of standards has intensified. Whilst there are now a raft of different regulations and proposals in the market, such as the Green Loan Principles, the European Green Bond Standard and the Sustainable Finance Disclosure Regulation, there are concerns that greenwashing may cloud the distinction between genuine ESG-linked debt issuance and opportunism. Lenders and other finance parties that are therefore committed to monitoring compliance with ESG targets need to agree upon reporting standards with the relevant obligor group and ensure appropriate external review mechanisms are implemented.

BVI and Cayman Islands companies are widely utilised in cross-border finance transactions, including those with ESG-linked elements. These jurisdictions have a variety of features that make them attractive to lenders and other finance parties, as well as borrowers and other obligors, on ESG-linked financings. Some reasons for this are as follows:

(a) The BVI and the Cayman Islands are widely recognised as creditor friendly jurisdictions due to the range of self-help remedies that are available to secured creditors in an enforcement. The BVI also has a straightforward system of registering security interests which protects the priority of such interests.

(b) BVI and Cayman Islands companies may have unlimited objects and purposes, including with respect to ESG initiatives, and there is significant flexibility as to how such companies are structured in terms of capital structure, management roles and shareholder involvement.

(c) BVI and Cayman Islands companies are subject to low ongoing maintenance costs and there is no requirement for financial statements to be prepared in relation to companies that are not specifically regulated by the BVI Financial Services Commission or the Cayman Islands Monetary Authority (as applicable).

(d) Except for the payment of nominal filing fees in connection with the optional filing of a security interest that is granted by a BVI chargor, there are no income, corporate or capital gain taxes, withholdings, levies, registration taxes, or other similar taxes or charges imposed on BVI or Cayman Islands companies in connection with the execution, delivery or the performance of finance documents by a BVI or a Cayman Islands company, or the finance parties.

The emergence of ESG principles is not confined to debt finance, as the topic of sustainable investing has quickly gathered momentum in the investment funds space. Indeed, in its Supervisory and Issues Information Circular dated 13 April 2022 (the Circular), the Cayman Islands Monetary Authority (CIMA) recognises that ESG considerations and sustainable investing “is increasingly becoming the fastest growing investment strategy within the financial services sector”.

However, as has been observed in the boom of digital asset funds over the last few years, the emergence of a new investment strategy at such a rapid pace does present various regulatory issues. Indeed, CIMA notes in the Circular that whilst ESG strategies have the potential to make significant contributions to addressing matters such as climate change and in encouraging sustainable investing, as the regulator in the Cayman Islands, it must strike a balance between allowing this sector to flourish whilst also mitigating the emerging risks that are unique to this investment strategy.

It is perhaps for these reasons that in late 2021, the Cayman Islands government announced that it is due to consult on legislation which will introduce a framework for ESG criteria in the Cayman Islands and which will, in particular, target the issue of greenwashing with a view to enhancing investor protection. The International Organization of Securities Commissions (IOSCO) recognises the risk of greenwashing in its November 2021 report entitled ‘Recommendations on Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management’, where it recommends, amongst other things, that regulators should strongly consider reviewing their existing regulations that ensure accurate disclosure against sustainability standards and, where necessary, to make these more robust. Given the prevalence of Cayman Islands and BVI funds in the international funds market, these jurisdictions have a unique opportunity to be at the forefront of tackling these issues and leading the way in our view.

Greenwashing presents itself in a variety of ways in the funds market; ranging from inadvertently mis-describing an investment’s green credentials to a deliberate misrepresentation of them with a view to attracting investment as a result. The IOSCO has identified the following ways in which greenwashing typically presents itself in the context of investment funds:

Unsurprisingly, it is the marketing of a fund that poses one of the main greenwashing risks as this provides an opportunity for ESG credentials to be overstated or left open to interpretation by potential investors where intentionally loose language is adopted. Further, something as simple as the name of the fund can also imply that the fund has sustainable objectives and strategies that it might not in reality have. In its report, the IOSCO gives the examples of a produce that includes ESG factors in its name, but “its investment objectives only state that it seeks to provide capital appreciation by investing primarily in global equity securities” or alternatively the fund might adopt only basic or limited negative screening to exclude investments that would not meet its stated ESG criteria;

A deviation from the original investment strategy once the fund has successfully launched. The IOSCO notes that such a failure can be “intentional or be the result of poor asset management”, which emphasises the need to ensure that investment funds have, where applicable, investment managers who are aware of and who fully buy into the ESG objectives. This risk can be amplified in circumstances where there is a ‘fund of funds’ with an ESG focus. For example, if a fund invests in another fund which espouses its ESG credentials in its marketing materials which aren’t accurate, the investor fund may unwittingly undermine its own commitment to ESG principles; and

The making of misleading claims about a product’s ESG performance, which the IOSCO notes is “perhaps one of the most prevalent types of greenwashing”. This can happen, for example, where a product claims that it will achieve certain measurable outputs (e.g. reduced energy usage) but the actual performance is not as good as is claimed.

It will therefore be interesting to observe what measures the Cayman Islands government suggests to tackle these issues in a meaningful way. Indeed, perhaps the greatest challenge faced by the Cayman Islands government is developing a framework that can be of universal application, given the varied and highly nuanced nature of ESG regulation across the globe.

1. Interest in ESG investing boosted by Covid – Aviva plc
2. Global sustainable debt issuance will crack $1 trillion mark in 2021 -IIF | Reuters
3. The Institute of International Finance > Advocacy old > Policy Issues > Sustainable Finance Working Group (SFWG) (iif.com)
4. As above.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice, please contact:

Peter Vas
Partner
E: peter.vas@loebsmith.com

Santiago Carvajal
Senior Legal Consultant
E: santiago.carvajal@loebsmith.com

Robert Farrell
Senior Associate
E: robert.farrell@loebsmith.com

This Article was first published in IFC Review –

https://www.ifcreview.com/articles/2022/september/esg-in-finance-transactions-and-investment-funds-from-an-offshore-law-perspective/