Category: Investment

Investing in SAFE and Convertible Note Rounds ꟷKnow Your Bedmates!

Early-stage companies often rely on Simple Agreements for Future Equity (SAFEs) and convertible promissory notes to raise capital either prior to a company’s first priced preferred equity round, or to raise bridge capital between priced equity raises. In addition to the economic terms, investors considering participation in these financings should seek visibility as to the other investors in the round, and the potential misalignment of incentives among those investors.

Raising funds via SAFEs and convertible notes has a number of advantages for the issuer, not least of which is the speed with which such financings can be achieved. SAFE and convertible note financings involve significantly less documentation, legal lift, and expense than a standard preferred stock financing. Further, depending on how a SAFE or convertible note is structured, it can allow an early-stage company experiencing rapid growth (and, accordingly, valuation) to raise capital without selling equity at a valuation materially lower than the valuation it can justify in the next 12-24 months.

Similarly, SAFEs and convertible note rounds can appeal to early-stage investors. Again, the documentation is relatively straightforward and, to a large extent, consistent from transaction to transaction. Further, more recent iterations of Y-Combinator’s form SAFE include investor-favorite provisions that protect investors from dilution associated with the issuance of other convertible instruments.

That said, most SAFEs and convertible promissory notes include amendment provisions providing that their terms can be amended or waived with the approval of holders representing a majority of the total invested amount. Such amendments can fundamentally change the terms on which investors originally based their decision to participate in the SAFE or note round. For example, common amendments include reductions in the conversion discount, valuation cap, and/or required equity financing threshold at which the SAFE or note is required to convert. Perhaps more drastic, we increasingly see companies raising significant funds in multiple SAFE or note rounds without ever needing to do an equity financing prior to a liquidity event. In those instances, it is not uncommon for the company to get a majority-in-interest of the SAFE or noteholders to convert into equity on terms that bear little or no relation to what was contemplated in the original investment instrument.

Of course, you may ask, why would a majority-in-interest of the SAFE or noteholders agree to an amendment or adjustment that is not in their best interests? The answer is that savvy founders will often ensure that a majority-in-interest of the investors are “company-friendly,” with incentives that may be very different than those of a passive investor. For example, founders and their friends and family may control a majority of the round. Similarly, SAFE and noteholders may already have equity interests in the company, such that they see a net benefit to agreeing to changes in their note or SAFE terms that, viewed in isolation, are subpar.

Accordingly, before making a material investment in a SAFE or convertible note financing, investors should have a clear understanding of the maximum amount that can be raised, and the likelihood that a significant number of those investors may sign off on amendments that undermine the original deal terms.

© 2024 Winstead PC.

Deep-Sea Mining–Article 1: What Is Happening With Deep-Sea Mining?

Debate continues on whether the UAE Consensus achieved at COP28 represents a promising step forward or a missed opportunity in the drive towards climate neutral energy systems. However, the agreement that countries should “transition away from fossil fuels” and triple green power capacity by 2030 spotlights the need for countries to further embrace renewable power.

This series will examine the issues stakeholders need to consider in connection with deep-sea mining. We first provide an introduction to deep-sea mining and its current status. Future articles will consider in greater detail the regulatory and contractual landscape, important practical considerations, and future developments, including decisions of the ISA Council.

POLYMETALLIC NODULES

Current technology for the generation of wind and solar power (as well as the batteries needed to store such power) requires scarce raw materials, including nickel, manganese, cobalt, and copper. The fact that these minerals are found in the millions of polymetallic nodules scattered on areas of the ocean floor gives rise to another debate on whether the deep-sea mining of these nodules should be pursued.
This issue attracted considerable attention over the summer of 2023, when the International Seabed Authority (ISA) Assembly and Council held its 28th Session and, in January 2024, when Norway’s parliament (the Storting) made Norway the first country to formally authorise seabed mining activities in its waters.

INTERNATIONAL REGULATION OF DEEP-SEA MINERALS: UNCLOS AND ISA

The United Nations Convention on the Law of the Sea (UNCLOS) provides a comprehensive regime for the management of the world’s oceans. It also established ISA.

ISA is the body that authorises international seabed exploration and mining. It also collects and distributes the seabed mining royalties in relation to those areas outside each nation’s exclusive economic zone (EEZ).

Since 1994, ISA has approved over 30 ocean-floor mining exploration contracts in the Atlantic, Pacific, and Indian oceans, with most covering the so-called ‘Clarion-Clipperton Zone’ (an environmental management area of the Pacific Ocean, between Hawaii and Mexico). These currently-approved contracts run for 15 years and permit contract holders to seek out (but not commercially exploit) polymetallic nodules, polymetallic sulphides, and cobalt-rich ferromanganese crusts from the deep seabed.

UNCLOS TWO-YEAR RULE AND ISA’S 28TH SESSION

Section 1(15) of the annex to the 1994 Implementation Agreement includes a provision known as the “two-year rule.” This provision allows any member state of ISA that intends to apply for the approval of a plan of work for exploitation of the seabed to request that the ISA Council draw up and adopt regulations governing such exploitation within two years.

In July 2021, the Republic of Nauru triggered the two-year rule, seeking authority to undertake commercial exploitation of polymetallic nodules under license. That set an operative deadline of 9 July 2023.

At meetings of the ISA Assembly and ISA Council in July 2023, the ISA Council determined that more time was needed to establish processes for prospecting, exploring, and exploiting mineral resources, and a new target was set for finalising the rules: July 2025.

The expiration of the two-year rule in July 2023 does allow mining companies to submit a mining license application at any time. However, the above extension gives the ISA Council direct input into the approval process, which will make approval of any application difficult.

NORWAY’S DEEP-SEA MINING PLAN

State legislation regulates deep-sea mining in different EEZs. Norway is one of the only countries that has its own legislation (the Norway Seabed Minerals Act of 2019) regulating the exploration and extraction of deep-sea minerals.

In December 2023, Norway agreed to allow seabed mineral exploration off the coast of Norway, ahead of a formal parliamentary decision. The proposal was voted 80-20 in favour by the Storting on 9 January 2024.

The proposal will permit exploratory mining across a large section of the Norwegian seabed, after which the Storting can decide whether to issue commercial permits.

The decision initially applies to Norwegian waters and exposes an area larger than Great Britain to potential sea-bed mining, although the Norwegian government has noted that it will only issue licenses after more environmental research has been done.

The Norwegian government has defended the plan as a way to seize an economic opportunity and shore up the security of critical supply chains. However, there is concern that this will pave the way towards deep-sea mining around the world. Green activists, scientists, fishermen, and investors have called upon Oslo to reconsider its position. They cite the lack of scientific data about the effects of deep-sea mining on the marine environment, as well as the potential impact on Arctic ecosystems. In November 2023, 120 European Union lawmakers wrote an open letter to Norwegian members of the Storting, urging them unsuccessfully to reject the project, and in February 2024, the European Parliament voted in favour of a resolution that raised concerns about Norway’s deep-sea mining regulations. This resolution carries no legal power, but it does send a strong signal to Norway that the European Union does not support its plans.

In May 2024, WWF-Norway announced it will sue the Norwegian government for opening its seabed to deep-sea mining. WWF-Norway claim that the government has failed to properly investigate the consequences of its decision, has acted against the counsel of its own advisors, and has breached Norwegian law.

METHODS OF POLYMETALLIC NODULE EXTRACTION

Should Norway, or any other nation, initiate commercial deep-seabed mining, one of the following methods of mineral extraction may be employed:

Continuous Line Bucket System

This system utilises a surface vessel, a loop of cable to which dredge buckets are attached at 20–25 meter intervals, and a traction machine on the surface vessel, which circulates the cable. Operating much like a conveyor belt, ascending and descending lines complete runs to the ocean floor, gathering and then carrying the nodules to a ship or station for processing.

Hydraulic Suction System

A riser pipe attached to a surface vessel “vacuums” the seabed, for example, by lifting the nodules on compressed air or by using a centrifugal pump. A separate pipe returns tailings to the area of the mining site.

Remotely Operated Vehicles (ROVs)

Large ROVs traverse the ocean floor collecting nodules in a variety of ways. This might involve blasting the seafloor with water jets or collection by vacuuming.

Recent progress has been made in the development of these vehicles; a pre-prototype polymetallic nodule collector was successfully trialed in 2021 at a water depth of 4,500 metres, and in December 2022, the first successful recovery of polymetallic nodules from the abyssal plain was completed, using an integrated collector, riser, and lift system on an ROV. A glimpse of the future of deep-sea ROVs perhaps comes in the form of the development of robotic nodule-collection devices, equipped with artificial intelligence that allows them to distinguish between nodules and aquatic life.

Key to all three methods of mineral extraction is the production support vessel, the main facility for collecting, gathering, filtering, and storing polymetallic nodules. Dynamically positioned drillships, formerly utilised in the oil and gas sector, have been identified/converted for this purpose, and market-leading companies active in deep-water operations, including drilling and subsea construction, are investing in this area. It will be interesting to see how the approach to the inherent engineering and technological challenges will continue to develop.

THE RISKS OF DEEP-SEA MINING

As a nascent industry, deep-sea mining presents risks to both the environment and the stakeholders involved:

Environmental Risks

ISA’s delayed operative deadline for finalising regulations has been welcomed by parties who are concerned about the environmental impact that deep-sea mining may have.

Scientists warn that mining the deep could cause an irreversible loss of biodiversity to deep-sea ecosystems; sediment plumes, wastewater, and noise and light pollution all have the potential to seriously impact the species that exist within and beyond the mining sites. The deep-ocean floor supports thousands of unique species, despite being dark and nutrient-poor, including microbes, worms, sponges, and other invertebrates. There are also concerns that mining will impact the ocean’s ability to function as a carbon sink, resulting in a potentially wider environmental impact.

Stakeholder and Investor Risks

While deep-sea mining doesn’t involve the recovery and handling of combustible oil or gas, which is often associated with offshore operations, commercial risks associated with the deployment of sophisticated (and expensive) equipment in water depths of 2,000 metres or greater are significant. In April 2021, a specialist deep-sea mining subsidiary lost a mining robot prototype that had uncoupled from a 5-kilometer-long cable connecting it to the surface. The robot was recovered after initial attempts failed, but this illustrates the potentially expensive problems that deep-sea mining poses. Any companies wishing to become involved in deep-sea mining will also need to be careful to protect their reputation. Involvement in a deep-sea mining project that causes (or is perceived to cause) environmental damage or that experiences serious problems could attract strong negative publicity.

INVESTOR CONSIDERATIONS

Regulations have not kept up with the increased interest in deep-sea mining, and there are no clear guidelines on how to structure potential deep-sea investments. This is especially true in international waters, where a relationship with a sponsoring state is necessary. Exploitative investments have not been covered by ISA, and it is unclear how much control investors will have over the mining process. It is also unclear how investors might be able to apportion responsibility for loss/damage and what level of due diligence needs to be conducted ahead of operations. Any involvement carries with it significant risk, and stakeholders will do well to manage their rights and obligations as matters evolve.

Copyright 2024 K & L Gates
For more news on Deep Sea Mining, visit the NLR Environmental, Energy & Resources section.

Using an LLC to Protect the Family Vacation Home

Vacation homes offer a retreat from daily life, providing a sanctuary to relax and create cherished family memories. Many owners envision passing down their vacation home for future generations to enjoy, but the lack of proper planning can often lead to intra-family disputes. Leaving a vacation home outright to children or other family members may be the easiest option, but the potential for discord over the control and usage of the property only increases as ownership is passed from one generation to the next. A limited liability company (LLC) can mitigate the risk of conflict and provide a tailored solution to the meet the specific needs of a family.

When a vacation home is owned by an LLC, the membership interests in the LLC are passed down to younger generations, which allows for the continued use and enjoyment of the property by the family. The structure also provides a framework for management through an operating agreement, which governs the LLC. An operating agreement allows the original owner to create a plan for how the property will be used and managed as additional owners are added. The agreement can determine who is responsible for property management, how expenses should be proportioned and paid, how decisions should be made and provide guidelines for scheduling family usage. By establishing clear rules and procedures, an LLC can reduce the likelihood of disputes and encourage fairness among different generations.

Another benefit of an LLC is the ability to prevent unwanted transfers of ownership thus ensuring that the property stays in the family. A well-drafted operating agreement can prohibit membership interests from being transferred to third parties, protecting the family as a whole from an individual’s divorce or creditor problems. The LLC can also hold additional assets, including rental income and deposits of other funds earmarked for property expenditures, which facilitates the proper management and use of resources to cover expenses.

An LLC offers an efficient structure to avoid intra-family turmoil and preserves the spirit of the family vacation home for generations to come.

© 2024 Chuhak & Tecson P.C.
For more news on Protecting Real Estate Ownership, visit the NLR Real Estate section.

Unlocking India’s Space Potential: India Liberalizes Foreign Direct Investment Regime

  1. The foreign investment policy was ambiguous about space activities beyond satellites, leading to different interpretations.
  2. Some companies made investments basis the view that investments in the activities not listed under the FDI policy in this sector could be made up to 100% without prior government approval.
  3. The proposed FDI Space Policy addresses these concerns and allows 100% foreign investments under the automatic and governmental approval route.
  4. Formal notification is awaited which will make this policy effective as law.

Background

India currently is home to more than 200 space start-ups, and the space sector in India has attracted USD 124.7 million investment in the year 2023. The existing foreign investment policy of India (“FDI Policy”) requires foreign investors to obtain prior government approvals for investing in the space sector, particularly for the establishment of satellites.

Considering the growth of this sector, the Indian government has been periodically releasing policies / notifications, establishing organizations, etc. with the intent to allow more private participation in this sector. This has led to the establishment of an organization to promote the sector called the Indian National Space Promotion and Authorization Centre in 2020, as well as the introduction of the National Geospatial Policy, 2022 followed by the Indian Space Policy, 2023.

On February 21, 2024, the Union Cabinet approved amendments to the Foreign Direct Investment (“FDI”) policy and communicated it in a press release (“FDI Space Policy”) which proposes to liberalize investments in the space sector. However, a formal notification from the relevant authorities is still awaited for the amendments to become enforceable as law.

Existing FDI Policy 

Existing foreign investment limits in the space sector are provided under the Schedule I of Foreign Exchange Management Act (Non-Debt Instrument) Rules, 2019 (“NDI Rules”). The current norms do not recognize “space” as a sector in itself. Instead, the space related activities are primarily captured under the head – “satellites – establishment and operation”. 100% foreign investment is allowed in this sector but the same is subject to approval from the government along with compliance of sectoral guidelines from Department of Space / Indian Space Research Organisation. In essence, all foreign investments in companies undertaking the activities of satellites-establishment and operations require government approval.

Reforms – New FDI Space Policy 

The proposed FDI Space Policy allows 100% foreign investment in the space sector and has also created sub-categories, entry route and investment thresholds for various space related activities, which are as follows:

S.no. Activity FDI Thresholds
1. Satellites-manufacturing & operation, satellite data products and ground segment & user segment Up to 74% under automatic route

and beyond 74% (up to 100%) under government route
2. Launch vehicles and associated systems or subsystems, creation of spaceports for launching and receiving spacecraft Up to 49% under automatic route and beyond 49% (up to 100%) under government route
3. Manufacturing of components and systems/ sub-systems for satellites, ground segment and user segment Up to 100% under automatic route

Analysis 

(i) Status of existing investments

The existing FDI policy did not include space sector related activities (other than satellites-establishment and operation) such as launch vehicle business, ground segment, user segment, sub-component / sub-systems manufacturing, data products etc.

Various stakeholders argued that since the existing FDI policy did not specify certain activities such as launch vehicles, data sets, manufacturing of space systems / components etc. under the head of “satellites-establishment and operation”, foreign investments in such cases should be permitted up to 100% under the automatic route. This was based on the interpretation under the FDI policy that sectors / activities not specifically listed or prohibited, are permissible for foreign investment up to 100% under the automatic route, subject to sectoral conditionalities. Relying on the same, foreign investors made investments in space start-ups whose activities were not explicitly listed or regulated under the current FDI regime without obtaining government approval.

Some stakeholders interpreted “satellites” very broadly and took a more conservative view that all space related activities required government approval. Similarly, there were overlaps in activities / interpretation of the FDI policy under the sectors of defence, telecom and manufacturing.

The space liberalization norms under the proposed FDI Space Policy may have actually de-liberalized this sector for certain companies who received investments in allied space activities based on the understanding that sectors / activities not specifically listed or prohibited, should be eligible for foreign investments up to 100% under the automatic route. In such cases where the investment thresholds under the proposed FDI Space Policy may be breached, it would be interesting to see the government’s approach including granting approvals on a post-facto basis.

(ii) Sub- categorizations of activities within the Space Sector

While the government has acknowledged the sub-categories of activities within the space sector, it hasn’t clarified its rationale for providing different foreign investment thresholds for such activities. Relaxed thresholds for satellites (i.e., 74% under the automatic route (up to 100% under government route)) and its sub-components (i.e., 100% under the automatic route) encourage foreign participation in commercial aspects of space activities. In contrast, the 49% cap on foreign investments under the automatic route (up to 100% under government route) on launch vehicles acknowledge their dual-use potential for both civilian and defence purposes. This sensitivity, combined with the launching state’s heightened liability under Article II of the Convention on International Liability for Damage Caused by Space Objects (“Liability Convention”), may be viewed as necessitating greater government oversight.

However, industry players have also criticized the differential treatment provided to launch vehicles vis-a-vis satellites. They believe, in essence, both industries have similar sensitivity issues and hence should be treated at par from a foreign investment perspective. Hence, the difference in foreign investment thresholds require more explanation from the government.

(iii) Satellite Data Products

The term ‘satellite data products’ has not been defined under the proposed FDI Space Policy but investments in such activities would be permitted up to 74% under the automatic route (up to 100% under government route). This may lead to some conflict from a satellite imagery / data perspective read along with the liberalized Geospatial Guidelines, 2021. (“Geospatial Guidelines”).

The Geospatial Guidelines largely permit foreign investments up to 100% under the automatic route with limited foreign investment restrictions especially if the activity is for (i) creation / ownership / storage of geospatial data of a certain accuracy (as defined under the Geospatial Guidelines); (ii) terrestrial mobile survey, street view survey and surveying activities in Indian territorial waters. There seems to be no specific restriction on satellite generated data (other than the above) under the Geospatial Guidelines. Thus, the proposed FDI Space Policy may end up limiting foreign investments for activities relating to Satellite Data Products (which would include geo-spatial data) in which otherwise is viewed to be permissible up to 100% under the automatic route.

The government should also define what constitutes satellite data products and to the extent possible it would be recommended that foreign investment up to 100% should be permitted under the automatic route.

Additionally, the rationale for capping investments for satellite data products under the proposed FDI Space Policy seems unclear as these are data sets which could be regulated under the Geospatial Guidelines and the new Indian privacy law.

(iv) Where are sub-components for launch vehicles covered?

The proposed FDI Space Policy explicitly covers the manufacturing of components and systems / sub-systems for the satellite sector, ground & user segment, and permits 100% FDI under automatic route for the same. With the absence of similar language for components in launch vehicles, it could imply its inclusion under the broader launch vehicle category, hence falling under the 49% automatic route (up to 100% under government route). Alternatively, it could also be argued since it is not expressly specified, the same could be covered under the 100% automatic route category. However, considering the critical role of such components in the sector’s development, clarification from the government would provide much-needed comfort especially if the components are dual use (satellite and launch vehicle usage).

(v) What about ground segment and user segment for launch vehicles?

Following the pattern observed with the satellite and ground segment categories, the absence of specific mention for the “ground segment & user segment” in the launch vehicle section raises further questions. This omission could be an oversight or intentional, but the lack of clarity hinders transparency and predictability for potential investors. Further clarity on the inclusion from an industry perspective in the official amendment notification would ensure a comprehensive and consistent policy framework for the entire launch vehicle sector.

(vi) Were any sub-categories / activities missed?

As space activities may expand to include space mining, exploration, international space station construction, space tourism etc., India needs to proactively address these areas. Especially, if these should be interpreted for foreign investments up to 100% under the automatic route, as this would have a bearing on India’s ability to attract foreign investment while safeguarding national interests, technological competitiveness, and responsible stewardship of India in space.

Conclusion

While the proposed FDI Space Policy provides substantial liberalization, further clarity is awaited based on the formal notification which will make this effective as law. Ideally, the Government should provide definitions / explanations for the proposed categorization and sub-categorizations, and further clarity on the inclusions and omissions of activities which may be related to most space sector functions such as user and ground segments.

While the move towards liberalization significantly reduces government control over the space sector, its inherent interconnectedness with other regulated domains like telecommunications / geospatial cannot be ignored. Despite these challenges, the government’s willingness to open the space sector to foreign investments is a positive step offering greater confidence to foreign investors. Relaxation in the existing norms also signifies a supportive stance towards the industry, encouraging both domestic and international participation. Notably, India successfully attracted substantial foreign investment even during the era of full government control. Therefore, with the current reforms, a significant increase in foreign investments is expected.

Footnotes
[1] Rajya Sabha Questions, Department of Space, available at
https://sansad.in/getFile/annex/262/AU621.pdf?source=pqars
[2] Notification, Department of Space, available at https://pib.gov.in/PressReleasePage.aspx?PRID=1988864
[3] Notification, Ministry of Commerce & Industry, available at
https://pib.gov.in/PressReleaseIframePage.aspx?PRID=2007876
[4] Article II of the Liability Convention provides that a launching State shall be absolutely liable to pay compensation for damage caused by its space object on the surface of the earth or to aircraft flight.

Nishith Desai Associates 2024. All rights reserved.
For more news on Foreign Direct Investments, visit the NLR Financial Institutions & Banking section.

740,000 Reasons to Think Twice Before Putting a Company in Bankruptcy

A recent decision from a bankruptcy court in Delaware provides a cautionary tale about the risks of involuntary bankruptcy.

In the Delaware case, the debtor managed a group of investment funds. The business was all but defunct when several investors, dissatisfied with the debtor’s management, filed an involuntary Chapter 7 petition.  They obtained an order for relief from the bankruptcy court, then removed the debtor as manager of the funds and inserted their hand-picked manager.  So far, so good.

The debtor, who was not properly served with the involuntary petition and did not give the petition the attention it required, struck back and convinced the bankruptcy court to set aside the order for relief. The debtor then went after the involuntary petitioners for damages.  After 8 years of litigation, the Delaware court awarded the debtor $740,000 in damages – all of it attributable to attorneys’ fees and costs.

If you file an involuntary petition and the bankruptcy court dismisses it, then a debtor can recover costs and reasonable attorneys’ fees.  The legal fees include the amount necessary to defeat the involuntary filing.  In addition, if the court finds that the petition was filed in bad faith, then the court also can enter judgment for all damages proximately caused by the filing and punitive damages.  The Delaware court awarded the debtor $75,000 for defeating the involuntary petition.

The debtor also sought a judgment for attorneys’ fees in pursuit of damages for violating the automatic stay.  The involuntary petitioners had replaced the debtor as manager without first obtaining leave from the court to do so.  The investment fund was barely operating and had little income to support a claim for actual damages.  Nevertheless, the Delaware court awarded $665,000 in attorneys’ fees related to litigating the automatic stay violation.

Because the debtor had no “actual” damages from the stay violation, the involuntary petitioners contended that the debtor was not entitled to recovery of attorneys’ fees.  The Delaware court pointed out that “actual” damages (e.g., loss of business income) are not a prerequisite to the recovery of attorneys’ fees, much to the chagrin of the defendants.  The court held that attorneys’ fees and costs are always “actual damages” in the context of a willful violation of the automatic stay.

The Delaware court also rejected defendants’ argument that the fee amount was “unreasonable” since there was no monetary injury to the business.  In other words, the debtor should not have spent so much money on legal fees because it lost on its claim.  The court held that defendants’ argument was made “with the benefit of hindsight” – at the end of litigation when the court had ruled, after an evidentiary trial, that debtor suffered no actual injury.  The court pointed out that the debtor sought millions in damages for the loss of management’s fees, and even though the court rejected the claim after trial, it was not an unreasonable argument for the debtor to make.  The court concluded that “the reasonableness of one’s conduct must be assessed at the time of the conduct and based on the information that was known or knowable at the time.”

The involuntary petitioners likely had sound reasons to want the debtor removed as fund manager.  But by pursuing involuntary bankruptcy and losing, they ended up having to stroke a check to the debtor for over $700,000.  Talk about adding insult to injury.  The upshot is that involuntary bankruptcy is an extreme and risky action that should be a last-resort option undertaken with extreme caution.

© 2024 Ward and Smith, P.A.. All Rights Reserved.

by: Lance P. Martin of Ward and Smith, P.A.

For more news on Bankruptcy Litigation, visit the National Law Review’s Bankruptcy & Restructuring section.

2024 Regulatory Update for Investment Advisers

In 2023, the Securities and Exchange Commission issued various proposed rules on regulatory changes that will affect SEC-registered investment advisers (RIAs). Since these rules are likely to be put into effect, RIAs should consider taking preliminary steps to start integrating the new requirements into their compliance policies and procedures.

1. Updates to the Custody Rule

The purpose of the custody rule, rule 206(4)-2 of the Investment Advisers Act of 1940 (Advisers Act), is to protect client funds and securities from potential loss and misappropriation by custodians. The SEC’s recommended updates to the custody rule would:

  • Expand the scope of the rule to not only include client funds and securities but all of a client’s assets over which an RIA has custody
  • Expand the definition of custody to include discretionary authority
  • Require RIAs to enter into written agreements with qualified custodians, including certain reasonable assurances regarding protections of client assets

2. Internet Adviser Exemption

The SEC also proposed to modernize rule 203A-2(e) of the Advisers Act, whose purpose is to permit internet investment advisers to register with the SEC even if such advisers do not meet the other statutory requirements for SEC registration. Under the proposed rule:

  • Advisers relying on this exemption would at all times be required to have an operational interactive website through which the adviser provides investment advisory services
  • The de minimis exception would be eliminated, hence requiring advisers relying on rule 203A-2(e) to provide advice to all of their clients exclusively through an operational interactive website

3. Conflicts of Interest Related to Predictive Data Analytics and Similar Technologies

The SEC proposes new rules under the Adviser’s Act to regulate RIAs’ use of technologies that optimize for, predict, guide, forecast or direct investment-related behaviors or outcomes. Specifically, the new rules aim to minimize the risk that RIAs could prioritize their own interest over the interests of their clients when designing or using such technology. The new rules would require RIAs:

  • To evaluate their use of such technologies and identify and eliminate, or neutralize the effect of, any potential conflicts of interest
  • To adopt written policies and procedures to prevent violations of the rule and maintain books and records relating to their compliance with the new rules

4. Cybersecurity Risk Management and Outsourcing to Third Parties

The SEC has yet to issue a final rule on the 2022 proposed new rule 206(4)-9 to the Adviser’s Act which would require RIAs to adequately address cybersecurity risks and incidents. Similarly, the SEC still has to issue the final language for new rule 206(4)-11 that would establish oversight obligations for RIAs that outsource certain functions to third parties. A summary of the proposed rules can be found here: 2023 Regulatory Update for Investment Advisers: Miller Canfield

© 2023 Miller, Canfield, Paddock and Stone PLC
For more news on 2024 Updates for Investment Advisers, visit the NLR Securities & SEC section.

2023 Foreign Direct Investment Year End Update: Continued Expansion of FDI Regulations

As previously reported, regulations and restrictions on Foreign Direct Investment (“FDI”) have expanded quickly in the United States and in many of its trading partner countries around the world. FDI has been further complicated in the U.S. by the passage of individual State laws – often focused the acquisition of “agricultural land,” and in Europe by the passage of screening regimes by the individual Member States of the European Union (E.U.).

In 2023, fifteen U.S. States enacted some form of FDI restrictions on real estate. Some States elected to incorporate U.S. Federal regulations regarding who is prohibited from acquiring certain real estate, while other States have focused on broadly protecting agricultural lands. State laws also vary from those that prevent foreign ownership, to those that only require reporting foreign ownership.

Thus far Alabama, Arkansas, Florida, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Maine, Minnesota, Mississippi, Missouri, Montana, Nebraska, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, and Wisconsin have passed laws related to FDI in real estate.

Alabama, Arkansas, Florida, Illinois, Iowa, Kansas, Maine, Missouri, Ohio and Texas all currently require foreign investors to disclose acquisitions of certain real estate, much like the U.S. Federal Agricultural Foreign Investment Disclosure Act of 1978 (AFIDA). Arkansas, Illinois, Maine, and Wisconsin, actually allow acquirers to fulfill their reporting requirements by simply submitting a copy of applicable federal AFIDA reports. Texas currently only limits Direct Foreign Investment in certain “critical infrastructure.”

Ohio, Pennsylvania, South Carolina, South Dakota, and Wisconsin limit foreign investment in real estate based on the number of acres; while Iowa, Minnesota, Missouri, Nebraska, North Dakota, and Oklahoma ban foreign ownership of certain land completely.

The Alabama Property Protection Act (“APPA”), which went into effect in 2023, is one of the most expansive of the U.S. State laws, and which also incorporates U.S. Federal law. The APPA restricts FDI by a “foreign principal” in real estate related to agriculture, critical infrastructure, or proximate to military installations.

The APPA broadly covers acquiring “title” or a “controlling interest.” The APPA also broadly defines “foreign principal” as a political party and its members, a government, and any government official of China, Iran, North Korea, and Russia, as well as countries or governments that are subject to any sanction list of the U.S. Office of Foreign Assets Control (“OFAC”). The APPA defines “agricultural and forest property” as “real property used for raising, harvesting, and selling crops or for the feeding, breeding, management, raising, sale of, or the production of livestock, or for the growing and sale of timber and forest products”; and it defines covered “critical infrastructure” as a chemical manufacturing facility, refinery, electric production facility, water treatment facility, LNG terminal, telecommunications switching facility, gas processing plant, seaport, airport, aerospace and spaceport infrastructure. The APPA also covers land that is located within 10 miles of a “military installation” (of at least 10 contiguous acres) or “critical infrastructure.”

Notably, APPA does not specifically address whether leases are considered a “controlling interest,” nor does it specify enforcement procedures.

U.S. Federal Real Estate FDI

Businesses involved in the U.S. defense industrial base have been historically protected from FDI by the Committee on Foreign Investment in the United States (“CFIUS”). The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) expanded those historic protections to include certain Critical Technologies, Critical Infrastructure, and Sensitive Data – collectively referred to as covered “TID.”

FIRRMA specifically expanded CFIUS to address national security concerns arising from FDI impacting critical infrastructure and sensitive government installations. Part 802 of FIRRMA established CFIUS jurisdiction and review for certain covered real estate, including real estate in proximity to specified airports, maritime ports, military installations, and other critical infrastructure. Later in 2022, Executive Order 14083 further expanded CFIUS coverage for certain agricultural related real estate.

Covered installations are listed by name and location in appendixes to the CFIUS regulations. Early this year, CFIUS added eight additional government installations to the 100-mile “extended range” proximity coverage of Part 802. The update necessarily captured substantially more covered real estate. Unlike covered Section 1758 technologies that can trigger a mandatory CFIUS filing, CFIUS jurisdiction for covered real estate currently remains only a voluntary filing. Regardless, early diligence remains critical to any transaction in the United States that may result in foreign ownership or control of real estate.

U.S. Trading Partners FDI Regimes

The U.S. is not alone in regulating FDI, or the acquisition of real estate by foreign investors. Canada, United Kingdom and the European Union have legislative frameworks governing foreign investment in business sectors, technology, and real estate. Almost all European Union Member States have some similar form of FDI screening.

Key U.S. trading partners that have adopted FDI regimes include, Australia, Austria, Belgium, China, Germany, France, Hungary, Ireland, Italy, Japan, Luxembourg, Netherlands, Poland, Singapore, Spain, and Sweden. What foreign parties, economic sectors, or technologies are covered vary from country to country. They also vary as to the notification and approval requirements.

The UK National Security and Investment Act (NSI Act) came into effect on 4 January 2022, giving the UK government powers to intervene in transactions where assets or entities are acquired in a manner which may give rise to a national security risk. There were over 800 notifications under the NSI during the previous 12-month reporting period. In November 2023 the Deputy Prime Minister Oliver Dowden published a call for evidence on the legislation which aims to narrow and refine the scope of powers to be more ‘business friendly’, given that very few notified transactions have not been cleared within 30 working days. We will revisit developments on this in 2024.

The UK has continued to implement other reforms to improve transparency of foreign ownership of UK property. Part of the UK Economic Crime (Transparency and Enforcement) Act 2022 requires the register of overseas entities. The register is maintained by Companies House and requires overseas entities which own land in the UK to disclose details of their beneficial owners. Failure to comply with the new legislation will impact any registration of ownership details at the UK Land Registry (and thus the relevant legal and equitable ownership rights in any relevant property) and officers of any entity in breach will also be liable to criminal proceedings.

Recommendations

Whether a buyer or a seller, all transactions involving FDI should include an analysis of the citizenship of the interested parties, the nature of the business, land and products, and the applicability of laws and regulations that can impact the parties, timing, or transaction.

Copyright © 2023 Womble Bond Dickinson (US) LLP All Rights Reserved.
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European Commission Action on Climate Taxonomy and ESG Rating Provider Regulation

On June 13, 2023, the European Commission published “a new package of measures to build on and strengthen the foundations of the EU sustainable finance framework.” The aim is to ensure that the EU sustainable finance framework continues to support companies and the financial sector in connection with climate transition, including making the framework “easier to use” and providing guidance on climate-related disclosure, while encouraging the private funding of transition projects and technologies. These measures are summarized in a publication, “A sustainable finance framework that works on the ground.” Overall, according to the Commission, the package “is another step towards a globally leading legal framework facilitating the financing of the transition.”

The sustainable finance package includes the following measures:

  • EU Taxonomy Climate Delegated Act: amendments include (i) new criteria for economic activities that make a substantial contribution to one or more non-climate environmental objectives, namely, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems; and (ii) changes expanding on economic activities that contribute to climate change mitigation and adaptation “not included so far – in particular in the manufacturing and transport sectors.” The EU Taxonomy Climate Delegated Act has been operative since January 2022 and includes 107 economic activities that are responsible for 64% of greenhouse gas emissions in the EU. In addition, “new economic sectors and activities will be added, and existing ones refined and updated, where needed in line with regulatory and technological developments.” “For large non-financial undertakings, disclosure of the degree of taxonomy alignment regarding climate objectives began in 2023. Disclosures will be phased-in over the coming years for other actors and environmental objectives.”
  • Proposed Regulation of ESG Rating Providers: the Commission adopted a proposed regulation, which was based on 2021 recommendations from the International Organization of Securities Commissioners, aimed at promoting operational integrity and increased transparency in the ESG ratings market through organizational principles and clear rules addressing conflicts of interest. Ratings providers would be authorized and supervised by the European Securities and Markets Authority. The regulation “provides requirements on disclosures around” ratings methodologies and objectives, and “introduces principle-based organizational requirements on” ratings providers activities. The Commission is also seeking advice from ESMA on the presentation of credit ratings, with the aim being to address shortcomings related to “how ESG factors are incorporated into methodologies and disclosures of how ESG factors impact credit ratings.”
  • Enhancing Usability: the Commission set out an overview of the measures and tools aimed at enhancing the usability of relevant rules and providing implementation guidance to stakeholders. The Commission Staff Working Document “Enhancing the usability of the EU Taxonomy and the overall EU sustainable finance framework” summarizes the Commission’s most recent initiatives and measures. The Commission also published a new FAQ document that provides guidance on the interpretation and implementation of certain legal provisions of the EU Taxonomy Regulation and on the interactions between the concepts of “taxonomy-aligned investment” and “sustainable investment” under the SFDR.

Taking the Temperature: As previously discussed, the Commission is increasingly taking steps to achieve the goal of reducing net greenhouse gas emissions by at least 55% by 2030, known as Fit for 55. Recent initiatives include the adoption of a carbon sinks goal, the launch of the greenwashing-focused Green Claims Directive, and now, the sustainable finance package.

Another objective of these regulatory initiatives is to provide increased transparency for investors as they assess sustainability and transition-related claims made by issuers. In this regard, the legislative proposal relating to the regulation of ESG rating agencies is significant. As noted in our longer survey, there is little consistency among ESG ratings providers and few established industry norms relating to disclosure, measurement methodologies, transparency and quality of underlying data. That has led to a number of jurisdictions proposing regulation, including (in addition to the EU) the UK, as well as to government inquiries to ratings providers in the U.S.

© Copyright 2023 Cadwalader, Wickersham & Taft LLP

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CFIUS Determines it Lacks Jurisdiction to Review Chinese Land Acquisition

In 2022, Fufeng USA, a subsidiary of Chinese company Fufeng Group, purchased 370 acres near Grand Forks, North Dakota, with the intention of developing the land to build a plant for wet corn milling and biofermentation,[1] prompting opposition from federal and state politicians.[2] North Dakota Senators, North Dakota’s Governor, and Senator Marco Rubio urged the Committee on Foreign Investment in the United States (CFIUS) to review the acquisition as a potential national security risk for being located within 12 miles from the Grand Forks Air Force Base, which is home to military drone technology and a space networking center.[3] Following CFIUS’ review of Fufeng’s notice submission, CFIUS determined that it lacked jurisdiction over the transaction. This post summarizes the public information about that CFIUS case and provides observations about the responses by North Dakota and CFIUS in the wake of Fufeng’s proposed investment.

CFIUS Review and Determination

1. Procedural History

In conjunction with rising public opposition to its land acquisition, public reports show that Fufeng USA submitted a declaration to CFIUS on July 27, 2022.[4] North Dakota local news outlet Valley News Live obtained a copy of the CFIUS closing letter to that declaration filing, which stated that CFIUS determined on August 31, 2022 that it lacked sufficient information to assess the transaction and requested that the parties file a full notice.[5] (CFIUS has the option under the regulations to request a full notice filing at the conclusion of the abbreviated 30-day review of a declaration filing.) Based on the CFIUS closing letter to that subsequent notice filing, which was likewise obtained and published by Valley News Live, Fufeng USA submitted a notice on October 17, 2022, and CFIUS subsequently concluded that it lacked jurisdiction to review the transaction in December 2022.[6]

2. Why CFIUS did not Review under its Part 802 Covered Real Estate Authority

According the CFIUS Letter released by Fufeng to Valley News Live, Fufeng submitted its notice pursuant to 31 C.F.R. Part 800 (“Part 800”), which pertains to covered transaction involving existing U.S. businesses.[7] The closing letter made no reference to the transaction being reviewed as a “covered real estate transaction” under 31 C.F.R. Part 802 (“Part 802”).[8] A reason for this could be that, at the time the case was before CFIUS, the land acquisition by Fufeng USA was not within any of the requisite proximity thresholds and, thus, did not fall within Part 802 authority. Under Part 802, CFIUS has authority over certain real estate transactions involving property in specific maritime ports or airports, or within defined proximity thresholds to identified “military installations” listed in Appendix A to Part 802. Grand Forks Air Force Base was not included in Appendix A at that time, nor was the acquired land within the defined proximity of any other listed military installation. Accordingly, the only way for CFIUS to extend authority would be under its Part 800 authority relating to certain acquisitions of U.S. businesses.

3. CFIUS Determined It Lacked Jurisdiction Under its Part 800 Covered Transaction Authority

CFIUS’ closing letter to Fufeng stated that “CFIUS has concluded that the Transaction is not a covered transaction and therefore CFIUS does not have jurisdiction under 31 C.F.R. Part 800.”[9] Part 800 provides CFIUS with authority to review covered control transactions (i.e., those transactions that could result in control of a U.S. business by a foreign person) or covered investment transactions (i.e., certain non-controlling investments directly or indirectly by a foreign person in U.S. businesses involved with critical technology, critical infrastructure, or the collection and maintaining of US citizen personal data). Greenfield investments, however, inherently do not involve an existing U.S. business. As such, greenfield investments would be outside of CFIUS’ jurisdiction under Part 800. Although the justification underlying CFIUS’ determination regarding Fufeng’s acquisition is not publicly available, CFIUS might have determined that it lacked authority under Part 800 because Fufeng’s purchase of undeveloped land was not an acquisition of a U.S. business, but more likely a greenfield investment.

State and Federal Response

Under state and federal pressure, the City of Grand Forks, which initially approved Fufeng’s development of the corn milling facility, “officially decided to terminate the development agreement between the city and Fufeng USA Inc.” on April 20, 2023.[10] This decision was largely impacted by the U.S. Air Force’s determination that “the proposed project presents a significant threat to national security with both near- and long-term risks of significant impacts to our operations in the area.”[11] As of today, the land appears to still be under the ownership of Fufeng USA.[12]

CFIUS’ determination that it lacked authority drew sharp criticism from state and federal politicians. North Dakota Senator Cramer purported that CFIUS may have determined the jurisdictional question too narrowly and indicated that the determination may prompt federal legislative action.[13] Senator Marco Rubio (R-Florida) concurred, issuing a statement that permitting the transaction was “dangerous and dumb.”[14] In response to the determination, the Governor of South Dakota announced plans for “legislation potentially limiting foreign purchases of agricultural land” by investigating “proposed purchases of ag land by foreign interests and recommend either approval or denial to the Governor.”[15]

On April 29, 2023, North Dakota Governor Doug Burgum signed Senate Bill No. 2371 into law, which prohibits local development and ownership of real property by foreign adversaries and related entities, effective August 1, 2023. Notably, these entities include businesses with a principal executive offices located in China, as well as businesses with a controlling Chinese interest or certain non-controlling Chinese interest.

On May 5, 2023, the U.S. Department of Treasury, the agency tasked with administering CFIUS, also took steps to expand its authority to cover more real property acquisitions. It published a Proposed Rule that would expand CFIUS covered real estate transaction authority over real restate located with 99 miles of the Grand Forks Air Force Base and seven other facilities located in Arizona, California, Iowa, and North Dakota. See a summary of that Proposed Rule and related implications at this TradePractition.com blog post.

FOOTNOTES

[1] See, Alix Larsen, CFIUS requesting Fufeng USA give more information on corn mill development, Valley News Live (Sep. 1, 2022), https://www.valleynewslive.com/2022/09/01/cfius-requesting-fufeng-usa-give-more-information-corn-mill-development/.

[2] See Letter from Gov. Doug Burgum to Secretaries Janet Yellen and Lloyd Austin (Jul. 25, 2022), https://www.governor.nd.gov/sites/www/files/documents/Gov.%20Burgum%20letter%20urging%20expedited%20CFIUS%20review%2007.25.2022.pdf; Letter from Senators Marco rubio, John Hoeven, and Kevin Cramer to Secretaries Janet Yellen and Lloyd Austin (Jul. 14, 2022), https://senatorkevincramer.app.box.com/s/2462nafbszk2u6yosy77chz9rpojlwtl.

[3] See id; Eamon Javers, Chinese Company’s Purchase of North Dakota Farmland Raises National Security Concerns in Washington, CNBC, July 1, 2022, https://www.cnbc.com/2022/07/01/chinese-purchase-of-north-dakota-farmland-raises-national-security-concerns-in-washington.html.

[4] See, Alix Larsen, CFIUS requesting Fufeng USA give more information on corn mill development (Sep. 1, 2022), https://www.valleynewslive.com/2022/09/01/cfius-requesting-fufeng-usa-give-more-information-corn-mill-development/.

[5] See id.

[6] See Stacie Van Dyke, Fufeng moving forward with corn milling plant in Grand Forks (Dec. 13, 2022), https://www.valleynewslive.com/2022/12/14/fufeng-moving-forward-with-corn-milling-plant-grand-forks/.

[7] See id.

[8] Id.

[9] See id.

[10] Bobby Falat, Grand Forks officially terminates Fufeng Deal (Apr. 20, 2023), https://www.valleynewslive.com/2023/04/20/grand-forks-officially-terminates-fufeng-deal/.

[11] News Release, Senator John Hoeven, Hoeven, Cramer: Air Force Provides Official Position on Fufeng Project in Grand Forks, (Jan. 31, 2023), https://www.hoeven.senate.gov/news/news-releases/hoeven-cramer-air-force-provides-official-position-on-fufeng-project-in-grand-forks.

[12] See, Meghan Arbegast, Fufeng Group owes Grand Forks County more than $2,000 in taxes for first half of 2022 (Apr. 5, 2023), https://www.grandforksherald.com/news/local/fufeng-group-owes-grand-forks-county-more-than-2-000-in-taxes-for-first-half-of-2022.

[13] See Josh Meny, Senator Cramer discusses latest on Fufeng in Grand Forks (Dec. 27, 2022), https://www.kxnet.com/news/kx-conversation/senator-cramer-discusses-latest-on-fufeng-in-grand-forks/.

[14] Press Release, Senator Marco Rubio, Rubio Slams CFIUS’s Refusal to Take Action Regarding Fufeng Farmland Purchase (Dec. 14, 2022) https://www.rubio.senate.gov/public/index.cfm/2022/12/rubio-slams-cfius-s-refusal-to-take-action-regarding-fufeng-farmland-purchase.

[15] Jason Harward, Gov. Kristi Noem takes aim at potential Chinese land purchases in South Dakota (Dec. 13, 2022),https://www.grandforksherald.com/news/south-dakota/gov-kristi-noem-takes-aim-at-potential-chinese-land-purchases-in-south-dakota.

© Copyright 2023 Squire Patton Boggs (US) LLP

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Is Biodiversity Emerging As A Unifying Concept That Can Help Ease The Political Polarization Surrounding ESG?

Highlights

    • In addition to global initiatives by the United Nations, G7, and the U.S., the need for protection against biodiversity loss has become a central focus of the business and investment communities
    • Biodiversity protection is emerging worldwide as a unifying concept that can mitigate the political polarization surrounding ESG and promote constructive dialogue about sustainability
    • A number of steps can be taken to capitalize on the unique attributes and appeal of biodiversity and leverage its potential to serve as a unifying concept

International Biodiversity Day, May 22, 2023, with its theme “From Agreement to Action: Build Back Biodiversity” was a powerful reminder that momentum for biodiversity conservation is accelerating globally. Biodiversity is increasingly being recognized as a potential unifying concept that can help alleviate some of the extreme political divergence over the term ESG.

ESG, which encompasses a broad range of environmental, social, and governance factors, has become politically charged and the subject of intense debate and varying interpretations. Biodiversity, on the other hand, is widely recognized as a critical aspect of environmental sustainability and it is increasingly acknowledged as a pressing issue by virtually all stakeholders, including scientists, policymakers, businesses, and communities.

Biodiversity represents the variety of life on Earth, including ecosystems, species, and genetic diversity. It is a tangible and universally valued concept that resonates with people from various backgrounds and ideologies. The preservation, protection and conservation of biodiversity are essential for the health and resilience of ecosystems, as well as for addressing climate change and ensuring the well-being of future generations.

By emphasizing biodiversity within sustainability discussions, stakeholders can find common ground and rally around a shared objective: protecting and restoring the Earth’s natural diversity. Biodiversity provides a unifying language and focus that transcends political divisions, as it highlights the interconnectedness of all life forms. It allows for a more tangible and universally valued point of reference, which can facilitate collaboration and drive collective action towards conservation efforts.

In addition to global initiatives by the United Nations, the Group of Seven (G7), and the U.S., the need for protection against biodiversity loss has also become a central focus of business and investment communities, and appears to be receiving a more favorable reception in the U.S. than the broader concepts associated with and motives attributed to ESG investing. This increased attention has, in turn, opened up a number of practical opportunities for action to leverage the potential of biodiversity as a unifying concept.

International Support for Biodiversity Protection

The United Nations formed the Convention on Biological Diversity (CBD) to promote nature and human well-being. The first draft was proposed on May 22, 1992, which was then designated as International Biodiversity Day. Since the Rio Earth Summit in 1992, nearly 200 countries have signed onto this treaty, which is a legally binding commitment to conserve biological diversity, to sustainably use its components and to share equitably the benefits arising from the use of genetic resources.

In December 2022, at the 15th UN Biodiversity Conference (COP15), the CBD adopted the Kunming-Montreal Global Biodiversity Framework that calls for protecting 30 percent of the planet’s land, ocean, and inland waters and includes 23 other targets to help restore and protect ecosystems and endangered species worldwide, and ensure that big businesses disclose biodiversity risks and impacts from their operations. The Kunming-Montreal framework also focused on increasing funding for biodiversity by at least $200 billion per year (with at least $30 billion per year to developing countries by 2030).

The U.S. is one of just a few countries worldwide that has not yet formally approved the CBD. While President Clinton signed the CBD in 1993, the Senate did not ratify it. Although the U.S. was on the sidelines at COP15 in late 2022, in parallel with the CBD approval of the Kunming-Montreal framework, the U.S. reiterated its support for an ambitious and transformative Global Diversity Framework, outlined in this State Department press release.

In addition to committing to conserve at least 30 percent of U.S. lands and waters by 2030, other U.S. leadership initiatives to mainstream and conserve nature that were announced or reaffirmed at that time include:

    • Conserving forests and combatting global deforestation
    • Prioritizing nature-based solutions to address climate change, nature loss, and inequity
    • Incorporating nature into national economic statistics and accounts to support decision-making
    • Recognizing and including indigenous knowledge in federal research, policy, and decision-making, including protections for the knowledge holder
    • Knowing nature with a national nature assessment that will build on the wealth of existing data, scientific evidence, and Indigenous Knowledge to create a holistic picture of America’s lands, waters, wildlife, ecosystems and the benefits they provide
    • Strengthening action for nature deprived communities by expanding access to local parks, tree canopy cover, conservation areas, open space and water-based recreation, public gardens, beaches, and waterways
    • Conserving arctic ecosystems through increased research on marine ecosystems, fisheries, and wildlife, including through co-production and co-management with Indigenous Peoples

The U.S. also spearheaded efforts to reverse the decline in biodiversity globally by advancing land and water conservation, combating drivers of nature loss, protecting species, and supporting sustainable use, while also enabling healthy and prosperous communities through sustainable development. The U.S. also affirmed its financial commitment to and support for international development assistance to protect biodiversity. Additionally, the U.S. made major policy and financial commitments to protect oceans and advance marine conservation and a sustainable ocean economy.

Of particular importance, the U.S. reaffirmed its commitment to advancing science-based decision making and its support for the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services.

Most recently, the G7 Hiroshima Leaders’ Communique issued at the close of their meeting on May 20 on the cusp of International Biodiversity Day, affirmed that G7 leadership (including the U.S.) welcomed “the adoption of the historic Kunming-Montreal Global Biodiversity Framework (GBF) to halt and reverse biodiversity loss by 2030, which is fundamental to human well-being, a healthy planet and economic prosperity, and commit to its swift and full implementation and to achievement of each of its goals and targets.”
G7 leadership also reaffirmed their commitment “to substantially increase our national and international funding for nature by 2025,” and “to supporting and advancing a transition to nature positive economies.” Notably, they also pressed companies to do so as well while at the same time voicing support for TNFD’s market framework for corporate nature related disclosures:

“We call on businesses to progressively reduce negative and increase positive impacts on biodiversity. We look forward to the publication of the Taskforce on Nature-related Financial Disclosures’ (TNFD’s) market framework and urge market participants, governments and regulators to support its development.”

Similarly, multilateral development banks (MDBs) were urged by the leaders of G7 to increase their support for biodiversity by leveraging financial resources from all sources and “deploying a full suite of instruments.”

Increasing Focus On Biodiversity By The Financial Sector

The financial sector has taken note of the growing international support for biodiversity conservation and protection. A 2023 study by PwC found that “55% of global GDP—equivalent to about US $58 trillion—is moderately or highly dependent on nature.” In its report The Economic Case for Nature, the World Bank found that a partial collapse of ecosystem services would cost 2.3 percent of global GDP ($2.7 trillion) in 2030. Conversely, the report found that implementing policies beneficial to nature and biodiversity conservation (including achieving the “30×30” goal subsequently approved by the CBD in the Kunming-Montreal framework and by Executive Order in the U.S.) could result in a substantial increase in global real GDP by 2030.

According to a 2020 report by the World Economic Forum, protecting nature and increasing biodiversity could generate business opportunities of $10 trillion a year and create nearly 400 million new jobs by 2030. Given this economic potential, it comes as no surprise that a growing number of investors are focusing on deploying capital for nature-based opportunities, and trying to assess whether and to what extent companies are susceptible to biodiversity related risks.

Toward those ends, the financial sector has been monitoring and supporting the development of TNFD’s market framework for nature related disclosures that was most recently endorsed by G7. That private global effort was launched in 2021 in response to the growing need to factor nature into financial and business decisions. The fourth and final beta version was issued in March 2023:

“The TNFD is a market-led, science-based and government supported initiative to help respond to this imperative. The Taskforce is nearing the end of its two-year framework design and development phase to provide market participants with a risk management and disclosure framework to identify, assess, respond and, where appropriate, disclose their nature-related issues. The TNFD framework, including TCFD-aligned recommended disclosures, will be published in September 2023 ready for market adoption.”

While the TNFD framework is not legally binding, the final version will be coming on line just in time for use as a guide for compliance with the EU’s Corporate Sustainability Reporting Directive (CSRD), which was effective in April 2023. It will require a substantial number of European companies and others operating in the EU, to start making disclosures regarding biodiversity and nature in coming years.

One of the more significant catalysts for investment in the protection of biodiversity and nature was the establishment of the Natural Capital Investment Alliance as part of the United Kingdom’s Sustainable Markets Initiative announced in 2020 and the Terra Carta sustainability charter launched by King Charles a year later. The Alliance is a public/private venture that aims to invest $10 billion in natural capital assets. Speaking at the One Planet Summit on biodiversity where the Alliance was announced in January 2021, King Charles stated “… I have created a Natural Capital Investment Alliance to help us arrive at a common language on Natural Capital Investment so that we can start putting money to work and improve the flow of capital.”

According to research by Environmental Finance, total assets held in thematic biodiversity funds more than tripled in 2022, and it is anticipated that momentum and growth will accelerate in response to COP 15 in December 2023, and approval of the Kunming-Montreal framework.

Positioning Biodiversity As A Unifying Concept

While biodiversity is not replacing ESG, it is gaining more attention within the broader ESG framework. Biodiversity conservation is supported by a vast body of scientific research and has a broad consensus among stakeholders. Many companies are incorporating biodiversity considerations into their sustainability strategies, and setting goals for conservation, habitat restoration, and responsible land use. Investors are also factoring biodiversity into their decision-making processes, looking for companies that demonstrate strong biodiversity conservation efforts.

Given the universal importance of biodiversity, it can serve as a focal point for mutual understanding for stakeholders with varying perspectives. Biodiversity conservation provides a unifying language that encourages collaborative efforts towards shared goals of environmental stewardship and the preservation of natural resources. Protection against biodiversity loss is not an ideological issue. To the contrary, it is fundamental, practical, and existential: the need to preserve the natural systems that support life on Earth. Emphasizing the importance of biodiversity shifts the focus to concrete and tangible actions required globally and locally, such as species preservation, and ecosystem protection, which can garner broader support and participation and help bridge political divides.

While biodiversity protection is by no means a panacea, there are further steps that can be taken to capitalize on its unique attributes and appeal that can improve the potential for biodiversity to serve as a unifying concept that can help reduce the current political polarization in the U.S. over ESG and promote more constructive dialogue around sustainability:

    • Universal concern – Biodiversity loss affects every individual and society, regardless of political affiliation. It is a shared concern that is oblivious to political boundaries, as the preservation of nature’s diversity is vital for the well-being of all life on Earth. By emphasizing biodiversity as a unifying concept, stakeholders can find mutuality and work together towards its conservation.
    • Inclusivity – Biodiversity requires inclusive engagement by diverse stakeholders and technical and scientific support from local communities, indigenous groups, governments, businesses, civil society organizations and the public. Such engagement fosters dialogue, understanding, and collaboration, breaking down political barriers.
    • Tangible and relatable – Biodiversity is a concrete and tangible concept that people can relate to, unlike some of the more complex ESG concepts, like Scope 3 greenhouse gas (GHG) emissions and Net Zero. It encompasses the variety of species, ecosystems, and genetic diversity, which are easily understandable and relatable to everyday experiences. This relatability can bridge political divides and foster broader support for conservation efforts.
    • Interconnectedness – Biodiversity underscores the interconnectedness of ecosystems and species emphasizing that actions in one area can have cascading far-reaching consequences on others, including ecological, social, and economic effects. Recognizing this interconnectedness can encourage stakeholders to collaborate across sectors and ideologies to address biodiversity loss collectively.
    • Co-benefits and shared values – Biodiversity conservation often aligns with other societal values and goals, such as climate change mitigation, sustainable development, and human well-being. By emphasizing the co-benefits that arise from biodiversity conservation, such as ecosystem services and resilience, stakeholders can rally around shared values and work towards a common vision.
    • Economic implications – Biodiversity loss can have significant economic implications for industries like agriculture, tourism, and pharmaceuticals. It can also have impacts on supply chains and market access. Recognizing the economic value of biodiversity and the potential risks associated with its decline can bring together diverse stakeholders, including businesses and investors, who recognize the importance of integrating biodiversity considerations into their strategies and decision-making processes.
    • Science-based approach – Biodiversity conservation relies on scientific knowledge and research. Emphasizing the scientific evidence on the importance of biodiversity helps build consensus and transcends political biases, providing a foundation for constructive discussions.
    • Local and global perspectives – Biodiversity conservation is relevant at both local and global scales. It allows for discussions that incorporate local knowledge, values, and practices, while recognizing the need for global cooperation to address biodiversity loss and protect shared resources.

To leverage biodiversity as a unifying concept, it is crucial to promote open dialogue, knowledge sharing, and collaboration. Stakeholders should engage in inclusive decision-making processes that respect diverse perspectives and prioritize equitable and sustainable outcomes.

Takeaways

Biodiversity is emerging as a potential unifying concept that can help mitigate the political polarization surrounding the term ESG. While ESG has become a politically charged and debated topic, biodiversity is widely recognized as a critical aspect of environmental sustainability and has broad support across different stakeholders.

By focusing on biodiversity, stakeholders can find common ground in recognizing the importance of preserving nature’s diversity and ensuring the long-term sustainability of ecosystems. Biodiversity loss is a global challenge that affects everyone, irrespective of political affiliation, and it is increasingly acknowledged as a pressing issue by scientists, policymakers, businesses, and communities.

It is important to note that while biodiversity can be a unifying concept, there will still be debates and differing opinions on specific approaches and trade-offs involved in biodiversity conservation. Different stakeholders may have differing priorities, perspectives, and proposed means and methods to address biodiversity loss. The complexity of biodiversity issues, such as balancing conservation with economic development or navigating conflicts between different stakeholder interests, requires careful consideration and dialogue.

© 2023 BARNES & THORNBURG LLP

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