EHS Compliance Audit Deconstructing ESG Practice

Authors：ZHU, He; NI, Tianling

Wang, Zhengming and Sun, Jiping

INTRODUCTION

Over the past few years, JunHe has been actively involved in environment, occupational health and safety (EHS) compliance. Our clients' demands have gradually extended from environmental protection investigations and the handling of environmental pollution and safety disputes, to consultations on daily compliance regarding prevention. This has involved the identification of any major changes in construction projects, the identification and disposal of hazardous wastes, and the management of volatile organic compounds, hazardous chemicals, and new chemicals. It also involves areas such as fire-fighting management and the compliance management of supply chains. EHS compliance management is a particularly difficult issue due to its multi-disciplinary nature.

For the manufacturing, energy, R&D and testing enterprises we serve, EHS itself is a major issue in ESG management, and there are substantial overlaps with ESG management.  Due to the different legal and cultural backgrounds in common and civil law teams, as well as the different knowledge systems amongst lawyers and engineers, team members often have a different approach to understanding and solving problems. In addition, there may be some differences in the local regulations and practices in specific areas, resulting in disagreements, which means that EHS compliance management will face unique challenges. Accordingly, an EHS compliance audit is as important in investment and financing M&As, as well as in supply chain management. This article will provide insight from the perspective of an EHS compliance audit, and we hope to stimulate more thoughts and exchanges on EHS compliance management and other ESG issues.

1

Why is an EHS Compliance Audit Important?

EHS compliance management requires legal professionals to have knowledge of EHS management, not only to understand the legal requirements, but also to be able to understand the major standards. In addition, EHS management engineers are required to have legal knowledge. However, it is not easy for both legal professionals and engineers to have this skill, and it requires theoretical and practical accumulation over time. In previous seminars, we have stressed that EHS compliance issues (such as soil or groundwater pollution accidents) may result in civil, administrative and criminal liabilities for an enterprise (and, in some cases, the person (s) responsible may also be prosecuted). Meanwhile, enterprises may also face challenges in terms of contract breach risks, credit risks and the maintenance of business partnerships. EHS compliance audits, as a tool to comprehensively investigate EHS compliance risks, have been adopted by more and more enterprises to improve ESG management.

Taking investment and financing M&A transactions for example, if pre-investment due diligence fails to effectively identify the target company's EHS compliance issues, the target company may bear the unexpected corrective costs, the administrative penalties and the ESG management enhancement costs, which may seriously damage the commercial value of the transaction and make it impossible to achieve the investors' expectations. In the ESG era, EHS compliance issues will also affect the satisfaction of stakeholders, product competitiveness and corporate image, as well as business sustainability. EHS compliance audits or ESG due diligence, as tools to comprehensively investigate EHS and ESG compliance, have been adopted by more and more enterprises to improve ESG management.

2

What are the different areas in an EHS Compliance Audit?

When conducting an EHS compliance audit, enterprises need to pay attention to three areas, namely, E (Environment), H (Occupational Health) and S (Safety). When conducting specific EHS Compliance Audits, there will be many subdivided templates and areas under these three main areas. The audit modules listed in the following table are for reference only, and can be customized according to the industry and business characteristics of the enterprise (in investment and financing M&As and supply chain management, we will determine the specific audit modules and their reach according to the key risk factors, the project timeline, etc.):

No.

Dimension

Audit Module

1.

Environment

Approval and Permit, Environmental Management, Gas Emission, Water Supply Management, Wastewater, Waste Management, Chemicals Management, Noise at Boundary, Ozone-Depleting Substances, Radioactive Substances, Asbestos, Soil and Groundwater, Hazard Identification and Governance, etc. 

2.

Occupational Health

Approval and Permit, Occupational Health Management, Occupational Hazard Factors, Occupational Disease and Occupational Health Management, Chemical Exposure, Occupational Disease Protective Facilities, Health Monitoring, Health Record Management, Hazard Identification and Governance, etc.

3.

Safety

Approval and Permit, Production Safety Management, Hazardous Materials Management, Major Hazard Sources Management, Confined Space Operation Safety, Electricity Safety, Accident Investigation, Hazard Identification and Governance, etc. 

(Note: The above mentioned "Management" usually refers to targets and policies, organizations, personnel, systems and procedure documents, finance and supporting resource guarantees, publicity, training and education, emergency plans and drills, records management, performance assessments, rewards and punishments, self-evaluation and continuous improvement, information disclosure and reporting, etc.).

3

How does an Enterprise/Investor conduct an EHS Compliance Audit?

An enterprise's EHS compliance audit requires the coordination of multiple departments such as EHS, infrastructure, procurement, legal and finance. It is  critical to have an internal auditor who is knowledgeable in the applicable laws and EHS management practices of the specific industries, and if this is not available, EHS attorneys or third-party legal advisors can be engaged as external auditors. Typically, an auditor completes the audit by: (1) identifying the EHS - related risk factors, the legal and compliance requirements (not only the laws and regulations, but also the national, local and industrial standards and the key regulatory documents) and compiles an audit checklist based thereon; then they identify EHS compliance issues by reviewing materials, conducting interviews and conducting on- site inspections; (2) drafting a compliance audit report based on the identified issues (including factual descriptions, legal risk analysis and practical corrective recommendations); (3) reporting to the management and recommending corrective actions based on the compliance audit report. Enterprises engaged in production, energy, R&D and testing may consider conducting EHS or ESG internal audits on a regular basis. In addition, given that the relevant laws, regulations and standards are frequently updated, regardless of whether an enterprise has an internal auditor, enterprises may consider conducting a periodical (e.g., one year) external audit of the enterprise and its key suppliers' EHS or ESG compliance (please contact EHS attorneys or third-party legal advisors for assistance if necessary). Such efforts will help enterprises to lower their EHS and/or ESG compliance risk.

Accordingly, in M&A transactions involving target production, energy, R&D and testing companies, in addition to the conduction of customary legal due diligence, an investor may also communicate with an EHS attorney about the scope and range of an EHS compliance audit or an ESG due diligence depending on the target company, the amount of the subject matter and any other factors (an EHS compliance audit or an ESG due diligence is not a new topic in itself, and it is consistent with the duty of due diligence performed by the investor in the investment process). As an incremental service to our traditional M&A business, we have extended legal due diligence in M&A transactions to bespoke EHS compliance audits and ESG due diligence and incorporate the findings of these into the transactional documents.

We believe that continuous efforts in the areas of EHS and ESG compliance will enable us to assist our valued clients (whether funds, investors or enterprises) to success.

About JunHe’s ESG Team

JunHe is one of the largest full-service law firms in the PRC, employing a team of nearly 900 professionals to provide high quality legal services to clients. JunHe is one of the pioneers in the field of ESG legal services in China and has one of the largest teams of EHS lawyers to provide clients with legal services in these areas. JunHe provides EHS compliance audits to companies in different industries, sometimes in cooperation with third-party agencies, based on the needs of our clients. In addition, JunHe provides services which include ESG, EHS, labor and personnel, intellectual property, trade and data, finance and taxation, and commercial and criminal compliance, in supply chain management and M&As. JunHe also provides ESG due diligence services either alone or in cooperation with third-party agencies. In addition, JunHe assists companies and/or third-party agencies in drafting ESG reports. Based on our experience serving clients in different industries, JunHe can provide services including specific legal and compliance diagnostics relating to ESG in the daily operations of companies, the drafting and reviewing of ESG clauses in contracts with business partners and the construction and improvement of ESG systems.

ZHU, He

zhuh@junhe.com

Practice Area

Corporate and M&A

Infrastructure and Project Finance

Environmental, Health and Safety Compliance

NI, Tianling

Partner

nitl@junhe.com

Practice Area

Environmental, Health and Safety Compliance

Corporate and M&A

WANG, Zhengming

wangzhm@junhe.com

SUN，Jiping  

sunjp@junhe.com

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