Welcome to the Oxford Undergraduate Law Podcast, where we discuss the law, its relationships
with society and its implications on our everyday lives.
I'm Chun.
I'm Dorothea.
And we are your podcast editors.
Today we'll be joined by Professor John Armour and Professor Tom Watzer, who will be discussing
their research paper on green pills in making corporate climate commitments credible.
The research paper is joint work with Professor Luca Enriquez, who unfortunately could not
be present for the discussion today.
Professor John Armour is a Professor of Law and Finance at Oxford University and a Fellow
of the British Academy and the European Corporate Governance Institute.
He studied at the University of Oxford and then Yale Law School and has held visiting
posts at various institutions, including the University of Chicago, Columbia Law School,
the University of Frankfurt, the Max Planck Institute, the Corporate Private Law and Hamburg
and Sydney Law School.
He is a member of the American Law Institute and an academic member of the Chancellor Abar
Association.
Professor Armour has published widely in the fields of company law, financial regulation
and corporate insolvency.
Professor Tom Watzer is Associate Professor of Law and Finance at the University of Oxford
and the founding director of the Oxford Sustainable Law Programme.
At Oxford, Professor Watzer is also a Fellow of Lineker College, Senior Research Fellow
at the Institute for New Economic Thinking at the Oxford Martin School, a member of the
leadership team at the Smith School of Enterprise and the Environment, co-lead at Oxford Net
Zero, lead researcher at the Oxford Martin Initiative for a Net Zero Recovery and a member
of the Oxford Manned Institute of Quantitative Finance.
Professor Watzer's research examines how law and finance can generate value and advance
the public good, focusing on how we can build more resilient financial systems, improve
the governance of corporations and tackle the climate crisis.
Professor Armour and Professor Watzer, welcome to the podcast and thank you for joining us.
Thank you for inviting us.
We're delighted to be here with you today.
The proposal in your joint research paper, Green Pills, responds to the lack of credibility
in corporations' announcements to reduce their carbon emissions.
How does this credibility problem arise and why do credible corporate climate commitments
matter?
So that's a great question to start off with.
And maybe before we delve into it, let's take one step back and ask why we should care about
corporate climate commitments to begin with.
We all know that climate change is a pressing societal challenge and we know that governments
under the Paris Agreement have decided to take action to bring global emissions down
to net zero by 2050.
The question is, what does that governmental commitment mean for companies?
Do companies have an obligation to reduce their emissions to net zero as well?
And perhaps surprisingly, by and large, in most jurisdictions, the answer is that they
do not have such an obligation.
There are, of course, some exceptions to this rule.
In the car industry, for example, there have been net zero requirements introduced for
the cars that are being produced.
There are some companies that have been subjected to court judgments that force these companies
to move to net zero.
But of course, new legislation may be introduced that introduces a broader requirement for
companies to move to net zero.
But at this stage, for most companies in most jurisdictions, there is no such requirement
yet.
And that means that taking climate action, by and large, is a voluntary affair for most
corporations.
And that then raises the question, what is the value of the announced climate commitments,
the voluntary climate commitments that companies have shown to the world, if you will?
So against that background that Tom set out, we characterize the credibility problem with
corporate climate commitments as being one that arises where a firm, a private company,
expresses an intention to reduce its carbon emissions in the future.
So that intention may look great, but in many cases, the intention appears only to be an
aspiration, a hope, and is not backed by action or any form of commitment to actually delivering
on that aspiration.
An example, and this is just one of many that we could pick, is Shell, which announced last
year very publicly its aspiration to become a net zero emissions energy business by 2050,
in line with the Paris Agreement.
But the pathway to this is arguably inconsistent with Shell's current plans and strategies.
And if we look closely at what Shell has said, the small print explains that Shell's delivery
on net zero emissions by 2050 is dependent on societies changing along the way.
And we can understand that as meaning that Shell expects carbon taxes and other policies
to be introduced by governments that will make it more economic for Shell to shift to
net zero.
And conversely, that if that doesn't happen, then a voluntary shift is not something that
it's anticipating.
So why does this matter?
Why does the credibility of these undertakings matter?
Well, it matters in a relatively narrow sense for parties who deal with firms because they
increasingly care about what firms are doing.
Customers increasingly care about the way in which their products are sourced.
Investors increasingly care about the carbon emissions of companies that they're looking
money into.
And these parties need to know whether firms mean what they say when they make undertakings
about reducing emissions.
More fundamentally, and going back to the background that Tom set out, this is a problem
for society because governments have made undertakings, but notoriously they're dragging
their feet on bringing in the necessary change.
So we may hope that the private sector can put a foot forward.
And we need to know whether these undertakings are real.
Thank you for contextualising this problem and explaining the importance of corporate
climate commitments.
On that point, given the increasing costs of climate change and the opportunities which
can arise from a transition to a net zero economy, is there a business case for a transition
to a net zero economy which could sufficiently compel firms to credibly commit?
So there is a business case, but not everyone agrees on how strong that business case is.
So what's the challenge?
The challenge is that because there is no requirement on the part of the government
to that companies decarbonise, and there's actually not a very clear policy framework
in general around decarbonisation, there's a lot of policy uncertainty.
And investors have to grapple with that uncertainty.
And to simplify things a little bit, what we say is that investors, broadly speaking,
they differ on two dimensions.
The first is the expectation and whether they think effectively that the economy is going
to transition to a net zero economy.
And they also differ on the normative dimension, which is how much do they actually care about
climate change.
And based on these two dimensions, we can distinguish between two classes of shareholders.
The first class is what we call the class of climate-indifferent shareholders.
These are not shareholders and investors that are driven by normative commitments to fighting
climate change.
They are driven by profit maximisation.
And on average, these climate-indifferent shareholders do not necessarily put a high
expectation on the transition happening.
And so even though they may account for the costs and benefits associated with the transition,
they are not by themselves necessarily sufficiently motivated to drive forward the transition
at the company level.
The second class of investors might be, and the second class is what we call the climate-conscious
investors.
Climate-conscious investors place a higher value on transition.
And that might be because they attach a higher probability to society transitioning, or they
may have a higher normative value associated with the companies they invest in transitioning.
Whichever it may be, in fact, it may be both simultaneously, that means that these kinds
of investors are likely to push companies to decarbonise.
Now what's complicated is that boards are kind of caught in the middle of these two
groups of investors.
So they are having an investor base that is heterogeneous.
That means some investors will be climate-indifferent, others will be climate-conscious.
And the challenge for the board is that they have a fiduciary duty to act in the best interests
of the company.
And that's generally understood as maximising value.
And that fiduciary duty is overlaid with executive compensation that is paid out in stock.
And of course by the threat of removal by shareholders.
And so the board being stuck in the middle is trying to satisfy both investors, both
classes of investors, at the same time.
And one way in which they might do that is by seeking to satisfy the climate-indifferent
investors whilst also benefiting from the investments from climate-conscious investors.
And how much you do that?
Well, you might do that by effectively committing to going green, but doing so at minimum cost.
And that might mean that you make a promise to transition in the future rather than today,
or that you promise to go green, but retain sufficient flex as part of that promise to
be able to transition away from going green, if that is what shareholders would like you
to do in a future date.
And that is a perfect example of greenwash, because what it means is that all kinds of
investors who do care about climate change may look at your commitments and say, well,
wait a second, this is very interesting for us and we're going to invest.
That means the company benefits from a lower cost of capital, but they don't actually deserve
that.
They don't take the actions to back up their green claims.
It's a standard greenwashing problem, and it's the kind of problem that the mechanism
that we discuss in this paper is meant to address.
Yes, and your explanation of the different classes of investors is really useful in explaining
firms' attitudes to credibly committing and how the problem of greenwashing actually arises
from that.
So thank you.
So you've demonstrated the need for corporate climate commitments, but in your paper, you
argue that traditional corporate governance mechanisms are inadequate in ensuring that
firms deliver credible commitments to reduce emissions.
Why is this the case?
So that's a great question.
Before I start talking about governance mechanisms, let me just elaborate on the core problem.
The core problem here is uncertainty over the costs and benefits of transition to lower
carbon emissions.
That uncertainty means that the position that boards and others acting on behalf of the
company take about how desirable it is to reduce emissions will also change over time
as information emerges about those costs and benefits.
So just to give a flavor of this, firstly, our scientific understanding of the costs
of climate change and the physical costs associated with that is evolving all the time, and those
estimates are changing as a result.
Secondly, the costs and benefits of companies reducing emissions depend on government policies,
in particular, the introduction of taxes and subsidies that are helping them to make it
economic to reduce emissions.
And the speed at which that's happening, the extent to which it's happening, is uncertain.
New information is emerging all the time.
And then thirdly, there are just geopolitical events that create shocks periodically to
the framework that change the costs and benefits.
So Russia's invasion of Ukraine last year, the Saudis' announcement that they're going
to reduce oil production just today are examples of these that impact the costs and benefits
of having clean energy and will therefore affect the pricing that firms put on decisions
to move.
So against this background of uncertainty, how does that interact with corporate governance?
Well, the central corporate governance is the board of directors, and they are tasked
with overseeing the strategy and they have fiduciary duties to act in the best interests
of the company and what they believe to be the best interests of the company.
And so in doing so, they're going to act on the basis of information that they have available
to them.
If that information changes, what they may want to do may change.
And their thinking about this is typically mediated through compensation arrangements,
remuneration arrangements that pay them in a way that is aligned with the value of the
firm's shares.
So if the firm's shares are publicly traded in the stock market, then as the price of
those shares moves, the value of the pay that the directors get will move accordingly.
So they're thinking about things that will affect the stock price, their thinking as
new information is revealed that may affect the stock price, they will adjust their actions
accordingly.
So this means that we can think about their decision making as responding to new information
about costs and benefits.
And against that background of uncertainty, that makes it hard to be sure exactly what
companies are going to be doing, because their governance structures impel them to follow
or respond to these wider drivers of the emissions background.
There are other mechanisms of corporate governance that we might look to.
So one would be to structure the board in a way is to have some members of it specifically
assign responsibility for the firm's climate policy.
So to have a climate committee on the board, and we might put people on there who have
some expertise in understanding the issues at stake and give them the remit of formulating
the firm's policy in response to that.
And you might think that if they've articulated a policy that would then embed the firm on
a particular pathway.
But we can explore how binding and commitment that would be by thinking about what would
happen if there's a sudden shock that made it suddenly more costly than expected for
firms to stick to the pathway that they had articulated.
And a climate committee is appointed by the shareholders, the boards of directors of all
companies are appointed by the shareholders.
And if the majority of the shareholders didn't want the firm to continue on a particular
pathway, then they would be able to remove the director if they wanted to.
And the directors could be expected to anticipate that, to respond to it, and to change course
if what they were composing to be has suddenly become more expensive.
Another mechanism that we discuss in the paper that some people think is a possible means
of implementing through disclosure.
So companies are required to disclose information about their financial affairs to public markets.
And obviously, to ensure that this information is disclosed truthfully, there are liability
regimes in place that make sure that if firms make misleading material statements or omissions,
then they can face liability to invest in.
So we might think that if the firm discloses that it is intending to pursue a transition
pathway, there might be liability associated with a failure to deliver on that.
Actually, as it turns out, we think the risk of liability is relatively modest.
And that means that this doesn't really serve to function as a credible commitment mechanism.
The risk of liability is modest for two principal reasons.
The first is that if the firm discloses that it is intending to move on a pathway to transition,
that's a statement of fact at the time when it makes the disclosure.
And if new information emerges that means that the firm changes its intention, then
as long as the firm tells the markets at a time that it's changing its intention and
hasn't made any false disclosure at all.
Secondly, even if the firm did make a disclosure, which was found to be false, the quantum of
liability of quantum damages rather than it would face to investors is measured by reference
to the investor's financial loss as a result of the misstatement.
But the harm that's triggered by changing tack on a commitment to reducing emissions
is far beyond the quantum of any financial loss that investors might suffer.
Indeed, investors might be better off financially if the firm reneges on a commitment that turns
out to be expensive for them.
And so for these reasons, disclosure and liability associated with it also doesn't deliver a
credible commitment.
So I hope that helps to clarify why we think that firms need to think outside the framework
of traditional corporate governance mechanisms when seeking to craft credible commitments
to reducing emissions.
Yes, thank you for clarifying that there seems to be a governance gap almost in terms of
traditional corporate governance being insufficient in ensuring credible climate commitments.
That moves on quite nicely to your own proposal of Green Hills.
So could you explain what this entails and how this mechanism helps to fill the governance
gap ensuring corporate climate commitments are credible?
So what we propose in our paper, and it's joint work with Professor Luke Enriquez, who's
not able to be here today, is that firms enter into a contractual undertaking to make a fixed
payment if they don't deliver on performance indicator regarding their reduction in emissions.
So they set a target for emissions reduction to be delivered by a certain date.
And then there is a payment that the firm undertakes to make if it doesn't deliver on
that.
And that payment then gives a signal of the credibility of the firm's commitment to deliver
on the undertaking because it's saying we're either going to meet this target by the specified
day or we're going to pay this amount of money.
So if we go back to what I was saying a moment ago about the variability in cost and benefit,
what this is saying is the firm is committing that as long as the cost and benefits don't
change by more than the amount of the payment, then investors can rely on the firm delivering
its commitment.
So what this does is it unites the interests of investors who are climate conscious, who
want the firm to reduce its emissions, and those who are climate indifferent, who don't
care about the firm's emissions, they just care about maximizing the value of its stock.
So once the firm has undertaken to make this payment, the climate-indifferent investors
will not want the firm to pay the money out, it's cheaper for the firm to deliver on the
emission reduction, and the climate-conscious investors will want the firm to deliver on
the emission reduction per se.
And so as long as the difference in cost and benefits is less than the amount of the payment
that's promised, then all the third investors will want it to reduce its emissions.
Thank you for explaining this.
And the fact that your proposal unites the interests of traditional investors and climate-conscious
investors highlights its utility.
Moving on to examining the Green Pill mechanism in further detail, you state that Green Pills
are contractual mechanisms.
How does their contractual nature enhance the credibility of corporate climate commitment?
How do they differ from standard contracts?
Thanks, yeah, so having a contractual undertaking means that the firm is legally bound to pay
the sum of money that is promised in the alternative if it doesn't meet its emission reduction
undertaking.
What this does is it puts a finite bound on the level of commitment that the firm is making.
So it's not making zero commitment, and it's not making an unlimited commitment.
So if it specifies X million pounds as the amount that it's going to pay if the target
is not met, that's the amount that the firm is committing by.
That's the amount that the firm is willing to spend on reducing emissions before it becomes
cheaper for the firm just to make a payment and not reduce emissions going further.
So as you said before, the costs and benefits of emission reduction are changing over time,
and it may well be that an event occurs that makes it suddenly much more expensive or more
expensive than the firm thought to reduce its emissions in the way that it had previously
undertaken.
And if that additional cost is greater than the size of the payment, it will make sense
to the firm just to make the payment and not continue to reduce emissions.
But as long as the changing cost and benefits is less than the amount of the payment, then
the firm is committing to reducing emissions.
And that then allows people to plan, it allows people to make sense of the degree of commitment.
So it's not just the same as making a commitment, which is credible, but the degree of credibility
is given by the size of the amount that it's promising to pay if it doesn't deliver.
Yes, thank you for explaining that.
The fact that a contract-based mechanism can be used to deliver a degree of commitment
that can be tailored to the firm circumstances is really interesting and novel.
So thank you for that.
So what examples are there of green pills already in use?
So the good news is that green pills are no longer purely hypothetical.
We do in fact see a number of mechanisms that companies have adopted that really mirror
the kind of mechanism that we propose.
Perhaps the most common example is that of sustainability in these bonds.
Let me just tell you something about one company that has adopted such a box, an Italian energy
company called Enel.
And Enel has issued bonds, the sustainability bonds, that have an interest rate that moves
around depending on whether Enel needs a sustainability commitment.
So Enel has established certain KPIs, for example, the amount of installed renewable
energy capacity.
And the interest rate of the bonds that they've issued will move around on whether they're
going to meet that KPI.
So if the company meets its installed renewable capacity target, the interest rate will stay
the same.
If the company fails to meet that KPI, the interest rate on the bonds will go up by something
called 25 basis points.
Now how much is that in practice?
That's an amount of increased borrowing costs that you can measure in the millions.
You might say increased borrowing costs going up by several millions of dollars is not that
much.
It's rather modest in comparison to the market capitalization of the company, which is measured
in the billions.
But what matters here is that the introduction of the sustainability-based bond helped establish
the practice of a green-bill style mechanism in the market.
In the case of Enel, it also made a quite significant cultural difference because what
it means is that the chief financial officer, the CFO, is now invested in the company meeting
its climate KPIs because whether or not the company meets its climate KPIs is going to
affect borrowing costs.
And beyond Enel, more and more companies are now following suit and they're adopting these
sustainability-linked bonds or other sustainability-linked instruments as well.
So we have an emerging market for these kinds of instruments.
So yeah, just as Tom said, it's very interesting because when we started this project two or
three years ago, we weren't actually aware of any examples.
It was a purely hypothetical exercise.
And then as we got into it, we discovered the Enel example, which we think is perhaps
the first one that we're aware of.
But then in the time since then, this type of undertaking by firms has really taken off
dramatically within very, very rapid growth in North America and elsewhere in these kinds
of sustainability covenants in corporate borrowing agreements.
Yes.
And it's important to highlight that, as you say, the green pill was not just a hypothetical
model, but it's one that can be implemented by corporations in practice.
So thank you for that.
If we look to the theoretical issues that may arise in implementing green pills, can
it be said that the adoption of green pills aligns with existing principles under corporate
law?
Yes, we think it very much does say.
So as I said before, at the heart of the board's corporate law obligations are their fiduciary
duties.
So the board of directors of the UK company, or indeed, most public companies, most jurisdictions,
owe a duty to act in the best interests of the company.
And that is a duty that is framed in terms of the subjective beliefs of the directors,
so what they believe to be the interests of the company.
So they have to act in good faith in accordance with what they believe to be the interests
of the company.
In English law under Section 122 of the Companies Act 2006, there's a list of factors that
the board has to take into consideration in discharging their duties to act in the best
interests of the company.
And that includes the impact of the company's actions on the environment.
So entering into a commitment to reduce emissions, a commitment that is bounded by a figure in
the way that we have described, is consistent with the board's duty to act in what they
believe to be the interests of the company.
Where, by making this commitment, as we explained, the firm is able to secure investment more
cheaply from climate conscious investors.
Just to run through the steps, the climate conscious investors want to buy investments
which are associated with lower carbon emissions, as well as financial returns.
So they're willing to pay more for investment for lower carbon emissions.
They will increasingly look for credibility in firms' commitments to lowering emissions
because they don't want to pay extra for firms that don't actually deliver.
So making the commitment credible will be key to actually attracting the premium investment
from the climate conscious investors.
So by entering into the commitment, the firm can attract capital more cheaply.
So that means that the directors will be able to say that they think it's in the interest
of the company because they've attracted this capital more cheaply and they've also done
so through their emissions.
If things change and costs emerge that make it more expensive for the firm to stick to
this commitment, then by locking it in to a certain quantum of payments if the firm
doesn't deliver, the directors may have made things more expensive for themselves if that
happened.
So we might say, well, hang on a minute.
Is it really in the interest of the company to lock yourself into this commitment?
Wouldn't it be more in the interest of the company to retain flexibility so that you
can change course if new costs emerge?
Well, yes, no, it is in the interest of the company to have flexibility.
But if they keep complete flexibility, the climate conscious investors won't believe
them at the start.
They won't be willing to invest and the firm won't be able to secure a low cost of capital
from them.
So it needs to make some level of commitment in order to induce the climate conscious investors
to invest.
But equally, it doesn't want to set that commitment in concrete so that the firm can never really
renege on it because if the costs were to increase dramatically, it might be more than
the amounts of the discount from the cost of capital that they can get from the climate
conscious investors.
So that's why having a finite undertaking is desirable.
And that's why we think our mechanism is clearly one that's compatible with directors'
fiduciary duties.
Now, then, of course, you might say, well, how much is the appropriate level of commitment
for a firm to enter into?
Well, that depends on its investor base, it depends on its cost of transition, it depends
on many factors that the board are probably best placed to assess.
But in setting the quantum, again, that's something that the board should do, acting
consistently without using the best interest of the company.
But if it were to be challenged, if it were to be said that the board had entered into
a commitment that was too big or maybe too little in terms of the amount of money at
stake, we have to bear in mind that the duty to act in the best interest of the company
is a subjective one.
It's what the directors think are the interests of the company, not what the core thing.
And so this is a mechanism where to attract liability, somebody who was challenging it
would need to show that what the board had done was so unreasonable that no reasonable
board of directors could have thought it was in the interest of the company.
But it was beyond the bounds of what a rational board of directors could have thought was
in the interest of the company.
And that's quite a difficult standard for somebody challenging it to meet.
We have to show that it was wholly outside the realm of plausibility, that the level
of commitment that the firm had entered into was compatible with the framework that we've
set down.
And by the way, it was harmful to the interests of the company.
So the subjective nature of the duty gives boards some space to set business policy space
free from legal challenge.
And within that space, they can use the finite level of commitment to secure investment from
client conscious investors, and that is in the interest of the company, and that is how
this is aligned with existing principles.
So it's important to emphasize that point, because you can come up with all kinds of
policy changes that would mean companies move to get zero.
But the problem with all of that is that it's contingent on governments actually acting.
And as we discussed before, governments are notoriously slow to act on this particular
issue.
And that is why it is so valuable to be able to conclude that introducing a green pill
is actually consistent with existing principles of corporate law, because what that means
is that in principle, a company could adopt a green pill tomorrow.
Yes, thank you.
And as you've explained, if there aren't any issues with the adoption of green pills, coming
into tension with existing principles in corporate law, that does make it easier to implement
green pills as soon as possible.
Moving to examining the issue of implementation of green pills in practice, are there any
issues that may arise from the implementation of green pills in practice?
Yeah, so I think I'd just like to focus on two that we have in the paper.
So one is a potential legal issue for listeners who have studied or are studying contract
law.
This may be something that you're already aware of.
And that's what's called the rule and penalty clauses.
So this applies where somebody enters into a promise, they say they can do something,
and then if they don't do it, they have to pay a large sum of money.
And the law generally is suspicious of these kinds of promises because they think that
they can be used as a means of coercion for vulnerable parties to become required to meet
their contractual promises, where doing so is out of all proportion to the real value
of the same.
So there are two ways that green pills, as we described in Canon, are structured to avoid
this practical problem.
And so the first is to characterize the undertakings that the firm enters into as alternatives.
So it's not if the firm doesn't deliver its emission reduction, it promises by way of
compensation to make a payment of X million dollars.
Rather, what the firm does is it says it will either deliver on its own or it will make
a payment.
So it's a very formal response to the rule and penalty clauses.
It might be accepted by the courts in some jurisdictions, but in others, they might say,
well, this is just an attempt to evade the rule and we'll characterize it as a penalty
clause.
So probably the more robust way of doing this is to say that the payment that the firm is
making is a genuine pre-estimate of the loss that the climate conscious investors would
suffer if the firm doesn't deliver on its emissions.
Because remember, the climate conscious investors are willing to pay extra for investments that
are green, that are associated with reducing emissions.
And that's because they care about this.
They care not just about the money, but about something else, emissions.
So they're paying for that upfront and if the firm doesn't deliver, they suffer a loss
because they don't get what they pay for.
But in contract law, damages are generally calculated by reference to the financial consequences
for the party that hasn't received performance.
And so in this case, the investors' dissatisfaction about the emissions not being reduced might
not be something that would be easily calculable in the ordinary damages framework.
And so we can understand the green pill payments as a payment of liquidated damages as a pre-agreed
estimate of the non-financial loss that the climate conscious investors would suffer.
That's the first practical issue.
The second is something that we don't see yet, but that we could imagine emerging if
the use of green pill mechanisms were scaled.
That is, if the amount of money that was being undertaken were to grow significantly along
with growth in climate conscious investing.
So as soon as we're making bigger and bigger commitments, then this problem might emerge
as a practical one.
And the problem is that what might happen is that if there's a very large amount of
money at stake, which will be paid to investors if the firm doesn't deliver on its emission
reduction, then there might be some unscrupulous parties in the market who might offer to buy
up the securities that have been issued to the climate conscious investor.
And they might also buy shares in the company, use those shares to cause the company to appoint
different directors who change policy and trigger a breach of the green pill undertaking
and a payment then to the investor.
And that might be something that might be a perverse consequence where actually people
who come to hold the securities, they don't care about the reduction in emissions, they
just care about the money.
And they see violation of the green pill undertaking as a way to trigger a large payout in an opportunistic
fashion.
And that's what we characterize as dirty voting.
That is where the people wanting to attract the payout use the boats attached to their
shares to procure the company to breach its undertaking regarding emission reduction in
order to then trigger a payment to investors.
And to avoid that, we suggest that where large, very large amounts are at stake, the firm
should undertake not to pay it to the climate conscious investor themselves, but rather
to a third party such as an NGO that is committed to transitioning or committed to policies
or implementing policies that are conditioning toward net zero or should cause a firm to
make payments to companies that are investing in carbon capture technology.
So basically, the payment would be made to the party that has no incentive to try and
cause the firm to violate its commitment, has no power to do that either.
And the party would use the payment to then help to reduce global emissions.
So that would be consistent with what the climate conscious investors would have wanted.
So how do you prevent the implementation of green pills might develop with greater growth
in climate conscious investment?
So it's a great question because we do in fact see quite a rapid rise in the number
of ESG funds, so the funds that care about environmental, social and governance characteristics
of the companies they invest in.
And of course, if you're running a fund like that, you're going to be interested in the
commitments made by the companies you invest in and therefore you might want to adopt mechanisms
like the green pill.
So in general, we can say in an environment like this, if we see climate conscious investment
increase, we would also expect to see increased demand for credible corporate climate commitments.
And therefore, you would expect to see the increased implementation of mechanisms that
credibly embed that corporate climate commitment.
Now, of course, the green pill is not the only mechanism that could result in something
like that.
In a way, you can think of credible regulatory enforcement against greenwashing and green
pills as being at least partial substitutes.
But then regulatory enforcement at the moment, particularly in Europe, is still quite modest.
And so in the absence of a commitment mechanism of that nature, you would actually expect
the number of green pills that is adopted to rise.
The result of that is actually quite valuable because what it means is that even if once
the company, even if later on the interest in meeting climate objectives fades or reduces
a little bit, then the green pills, because they're in place, still make sure that firms
deliver on their climate commitment, at least up to the point where doing so is still economically
viable.
So that's about the point that John mentioned about the quantum of the payments on the green
pill tailoring the commitment of the firm.
So once firms have these green pills, once the climate conscious investors have managed
to get them adopted, you've actually locked in climate commitment for much longer.
It's worth pointing out, however, that the rise in climate conscious investment isn't
a trend that we can take for granted.
In fact, we also see a counter movement at the moment where companies and boards say,
well, wait a second, we're happy to commit, but only if that commitment is one that is
effectively non-credible, if that's one that we can renege on.
So we've seen actually quite a bit of greenwashing be exposed recently.
Just to give you some examples, an oil manager called BP had committed to go green, but had
recently rolled back its climate commitments.
Another example is that of the Glasgow Financial Alliance for Net Zero, GFANS, which is set
up and spearheaded by Mark Carney, the former governor of the Bank of England.
That's effectively a group of financial institutions that collectively had agreed that they would
move their investments to Net Zero.
But now that it turns out that there may be some legal bite to those commitments, you
can see various companies that had previously signed up now stepping away from that alliance.
And so in that sense, there is a lesson that we can take from the adoption or the lack
of adoption of green bills.
If we don't see credible commitment mechanisms accompanying climate pledges, then we should
be quite worried that the private sector isn't going to practice what it preaches.
And in a way, this flips the takeaway from the paper because there is no excuse not to
adopt a green bill if you're serious about meeting your climate objectives.
As John said, it is entirely consistent with corporate law to implement a mechanism like
that.
And so in a way, a lack of a commitment mechanism of this nature might also suggest that the
private sector is in fact not serious about transitioning voluntarily to Net Zero.
And that would mean governments have an additional reason to step up their game.
Yes.
Thank you for expanding on the role that green bills can play in building corporate governance.
Would you say that this instrument is limited to ensure a credibility for corporate climate
commitment solely or could it be linked to broader sustainability goals?
So that's a really great question.
In the paper, we limit ourselves to a discussion of corporate climate commitments because there
is a specific investment logic to climate change.
But in theory, the instrument could be used across a whole range of non-financial commitments
that firms may want to enter into.
And so we do in fact see sustainability linked bonds that have KPIs unrelated to climate
change that, for example, focus on equal pay, gender representation on the boards, or cleaning
up of supply chain practices.
And there is no reason why the green bill mechanism that we described couldn't be equally
effective in those contexts as it might be in the context of climate change.
Thank you.
And I think throughout our discussion, you've highlighted that current corporate governance
practices are failing to keep corporations on track to meet commitments of net zero.
And given that this is such an important issue, what can listeners themselves do to get involved
in helping to achieve this goal of ensuring that reducing carbon emissions is taken seriously?
Thank you.
That's a great question.
I think one thing that listeners can do is just to reflect on how basic components of
private law, company law, and more fundamentally contract law can be used to facilitate outcomes
that are helping to encourage companies to reduce emissions and helping to fight the
battle against the climate crisis.
So these subjects are not normally labeled as tools to be used against climate crisis,
but they are at a very basic level frameworks of private law that facilitate what parties
want.
And so if parties do want to engender commitments to reduce emissions, then they can use these
frameworks to do so.
And that's something that listeners who are current students or who are thinking about
how they might direct their studies in the future can think about in approaching those
topics.
So what this all illustrates is that climate change is quite a legally disruptive development
where we can see the adoption and use of legal tools in this novel context being quite innovative.
To understand that legally disruptive nature of climate change and other sustainability
challenges, we have a few years ago created the Oxford Sustainable Law Program, which
is a collaboration between the Faculty of Law and the Smith School of Enterprise and
the Environment here at Oxford.
And what we do at the program is we try to think about how legal tools can catalyze and
reinforce the sustainability transition.
That involves studying how the law is being used in that context, but also trying to be
imaginative about how the law could be used.
And the Green Hills paper that we've talked about today is one very good example of that.
What it also illustrates is that when we think about the climate crisis and its relationship
to the law, we shouldn't just think about the traditional area of environmental law.
We should think across the board around how different subsets of the legal system could
be employed.
And that means that what we do at the Sustainable Law Program is to collaborate across legal
disciplines.
But in fact, we also go beyond that and we work with experts from non-legal disciplines
too.
Because if we really want to understand the way in which the law is or could be used,
we also need to have a really good understanding of the financial environment in which companies
operate and how that financial environment is affected in this case by climate change.
We need to understand climate change itself and the risks and benefits that it generates
in these states for firms.
And that really is the kind of challenge that the Sustainable Law Program is set up to meet.
So it's a multidisciplinary research group.
And it's a research group that students and academics and practitioners who might be listening
to this podcast can get involved in because we're always looking for research assistants.
We're working on a sort of legal clinic where experts can get involved in.
And that is work that involves litigation, it involves policy work, and it involves the
kind of contractual work that we've been talking about today.
So it's very diverse and we're always looking for people who want to help us do this quite
complex but socially important and highly salient mission.
Yes, and I think the message of looking at legal frameworks to resolve such tangible
and important issues is a really key takeaway.
So thank you so much for that.
Professor Arm and Professor Wetzler, thank you so much for joining us on the podcast.
It's been a really great discussion today.
Thank you.
It's been a great pleasure to be here.
That was Professor Arm and Professor Wetzler speaking with us on Green Pills and making
corporate climate commitments credible.
For more legal writings and discussions on other topics, visit the OUULJ's blog and
read our annual publications.
Thank you.