Institutional investors across Europe are increasingly exploring legal action in response to the dismantling of environmental, social, and governance (ESG) regulations, marking a new phase in their efforts to hold companies accountable for sustainability issues.

Long considered a global leader in ESG, Europe is now walking back some of its most ambitious sustainability rules. This reversal has alarmed many asset managers, particularly those in northern Europe, who fear that organizations will use the loosening regulatory environment as an excuse to reduce ESG transparency and risk disclosure.

The changes come amid pressure from within and outside the European Union. France, Germany, and several business groups argue that ESG regulations are making European firms less competitive globally. There's also a growing push from U.S. stakeholders, particularly under the Trump-era agenda, to undermine ESG practices, while recent legal developments in Delaware have made it harder for minority shareholders to influence corporate behavior.

In response, European investors are readying for a fight. Some say they are already reducing their exposure to companies that fail to meet ESG expectations, while others are exploring courtroom options.

“We have engaged with several law firms to better understand how the changing political situation in the US will impact our rights as a minority shareholder,” said Kiran Aziz, head of responsible investments at Norway’s KLP, a pension fund managing $114 billion. She added that more investors are “taking down their exposures” to non-compliant companies.

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Dutch pension fund PME is also reviewing its entire equity portfolio to reduce ESG-related risks. Meanwhile, law firms are actively courting European clients, anticipating a rise in legal disputes around corporate sustainability.

The Managing Partner at U.S. law firm Labaton Keller Sucharow, Jonathan Gardner, said the traditional method of informal shareholder engagement is losing effectiveness. “The U.S. way of using lawyers to really make your point known is becoming increasingly valuable,” said Gardner, who recently met with northern European investors to discuss legal strategies.

These legal concerns are not unfounded. The European Banking Authority recently warned banks that they could face lawsuits if they breach climate targets. Businesses are paying attention, too. A global survey by Baker McKenzie found that over half of companies are now allocating more funds to handle potential ESG-related litigation.

According to Broadridge Financial Solutions, investors recovered more than $5.2 billion last year through class-action lawsuits alone, an indication of rising legal risks in the ESG space.

The regulatory rollback is significant. Under proposed changes, more than 90% of the 50,000 companies originally covered by the EU’s Corporate Sustainability Reporting Directive (CSRD) could be excluded. The Corporate Sustainability Due Diligence Directive (CSDDD) could also shrink to cover just a fifth of its initial target.

In addition, the European Commission recently allowed for “flexibilities” such as carbon offsets in its plan to cut emissions by 90% by 2040, moves that critics argue dilute the original intent of the climate goals.

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Eric Pedersen, head of responsible investments at Nordea Asset Management, warned that without strong regulations, companies will lose the incentive to act. “They aren’t going to burn money on tasks that aren’t backed by regulations,” he said. “If CSRD and CSDDD get watered down materially, that’s one less card in our hand to convince companies to act.”

Anders Schelde, chief investment officer at Denmark’s AkademikerPension, called the rollback “a very sad development.” While his fund prefers constructive dialogue with companies, “using the courtrooms more is definitely also something we have been thinking about,” he added.

As Europe steps back from its once-bold ESG agenda, its investors appear ready to step forward, this time, with lawyers by their side.

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Source: Bloomberg