ESG+ Newsletter – 11 April 2024

The SEC’s thinking on Scope 3 emissions opens this week’s newsletter, as the regulator defends its approach. From there, we review a potentially landmark ruling by the European Court of Human Rights regarding governments’ role in protecting its citizens from the impact of climate change. We also look at the cost of financing the net zero transition and what this might mean for climate reporting for banks; how efforts to tackle greenwashing in the fashion industry are discouraging retailers from pursuing their sustainability initiatives; the continued focus on splitting the role of Chair and CEO; and how the growing adoption of AI is impacting employers and the customer experience.

Further questions prompt SEC to defend Scope 3 approach

As covered in a previous edition of the newsletter, the SEC’s climate rule has been met with criticism from both sides, with some arguing the rule doesn’t do enough to mitigate corporate impacts on climate change, while others are arguing that the SEC is grossly overstepping its remit. Now, according to Environmental Finance, the SEC has been asked whether there is a “back door” requirement to disclose Scope 3 emissions. Erik Gerder, Director of the SEC’s Division of Corporation Finance, has asserted that the disclosure of Scope 3 emissions is “strictly voluntary”. However, given the full extent of the SEC’s climate ruling, there may be instances where companies need to make qualitative disclosures on Scope 3, for example, if the company has adopted a climate transition plan to manage material climate-related risks. The issue of Scope 3 emissions was one of the more contentious topics during the development of the climate rule. Since its publication, a number of lawsuits have been brought against the SEC, forcing them to voluntarily pause the implementation of the rule pending the outcome of judicial proceedings.

The issue of Scope 3 emissions continues to be a hot topic in the climate debate. This week, a prominent investor dropped Scope 3 emissions from a climate proposal at an oil and gas firm, stating instead that only “material” operational emissions sources should be included in the target setting. Scope 3 emissions are challenging to quantify, and similarly challenging to mitigate. However, by encouraging corporates to only disclose material Scope 1 and 2 emissions, the SEC and investors are potentially missing a substantial part of a company’s impact on climate change.

European Court of Human Rights rules that climate inaction violates human rights 

This week the European Court of Human Rights (ECHR) ruled in favour of a group of elderly Swiss women who argued that the Swiss Government had failed to protect its citizens from the severe impacts of climate change, as reported by Reuters. The landmark case sets a precedent for future climate litigation, marking the first time that a European Court ruled on the legal obligations of government in relation to climate change policies. The ruling has cemented the fact that the climate crisis is a human rights crisis, sending a clear message across Europe on the existential threat of climate change. At the same time, the judges dismissed two similar cases, one brought by six young Portuguese people against 32 European governments for failing to avert life-threatening consequences of climate change, and the other brought by a former French mayor which challenged France’s refusal to implement more ambitious climate measures. Despite not reaching the same verdict across all three cases, the outcome could be viewed as a watershed moment for climate justice and human rights; and a win in the fight against climate change.

Financing the climate transition and how to pay for it

Financing the transition to net zero, and the role of the banking sector in doing so, has long been a topic of much discussion. This week, a report was published which highlighted that Europe needs to invest €800 billion in its energy infrastructure to meet 2030 climate targets, with a total of €2.5 trillion required to complete the green transition by 2050. While EU support is needed with this financing, it is widely accepted that a large part of the funding for business will have to come from the capital markets and banking sector. However, while the need for their capital is clear, there appears to be an increasing disconnect across the banking sector. Banks have been facing growing pressure regarding climate-related disclosures on financed activities, particularly the requirement to disclose how their financing and capital markets activities – also known as facilitated emissions – contribute to global warming. A recent Responsible Investor article highlighted that the Basel Committee on Banking Supervision, the primary global standard setter for the prudential regulation of banks, has been unable to find support for the disclosure of facilitated emissions across the three banking groups it represents. Banks have argued that as these emissions do not come from activities directly financed by them, they should be excluded. 

Financing the climate transition and accurately capturing the progress of different sectors are two central pillars to achieving net zero. An unlimited chequebook for financing is irrelevant if progress on emissions is not being transparently monitored – which will be used to judge the pace of decarbonisation. 

Shareholders request split of CEO and Chair roles 

This week, Bloomberg and Reuters have both reported two distinct cases of shareholders filing proposals to split CEO and Chair roles at major US financial institutions. The crux of the argument is that the combination of the functions creates a conflict of interest with the CEO and Chair being seen as a case of ‘marking their own homework’, and that the appointment of an independent Chair provides better oversight. Joint CEO and Chair roles are frequently observed in the US and in other markets around the world, including France. Most of the time, they get routinely re-elected by shareholders, provided reasonable counterpowers are put in place such as a sufficiently independent Board composition and the appointment of a senior independent director. However, the combination of the two positions gets more difficult to justify when the company’s performance deteriorates. 

Greenwashing claims in the fast fashion industry under investigation

The British Retail Consortium, a retail lobby, has warned that the Competition and Markets Authority’s (CMA) stringent stance on greenwashing could discourage businesses from pursuing their sustainability initiatives. In a recent article, the CMA acknowledged the necessity of transparency but fears businesses might retreat from promoting their positive efforts. Over the last two years, the CMA has intensified scrutiny on companies suspected of overstating their environmental commitments to attract environmentally conscious consumers. A number of British retailers have been under investigation by the CMA over alleged misleading green claims. The CMA’s recent focus on fashion retailers, set out in its open letter to the fashion retail sector, highlights its commitment to ensuring eco-friendly claims are substantiated, and that companies “understand and comply with their legal responsibilities when making environmental claims”. To clarify expectations for businesses and facilitate compliance, it has developed a Green Code, where it sets out six principles that businesses must adhere to in order to ensure that their environmental claims are not misleading.

Efforts to tackle greenwashing, covered in previous editions of this newsletter, have become a top priority for regulators around the globe.  Concerns persist about the potential chilling effect on businesses’ sustainability initiatives and also the impact on consumer confidence that misleading green claims may cause. While companies may be concerned about the levels of scrutiny of their products and campaigns, in light of the growing focus on environmental and social concerns from consumers, it is a key responsibility of the regulator to ensure consumers’ interests are being protected.

When adopting AI, don’t neglect the ‘S’

This week, the Times reported on how Klarna, a fintech who developed the “buy now, pay later” approach, is leveraging AI to bolster operations and revenue without additional hires. With 700 customer service roles out of its 3,000 replaced by a virtual assistant, the company could potentially save $40 million a year in operating costs. That is alongside notable customer benefits which include a reduction in both wait and problem resolution times. Yet, amid this efficiency surge, the ‘S’ in ESG cannot be forgotten and stakeholders are widely impacted. For instance, customer satisfaction remains unchanged, prompting reflection on the AI vs. human experience. Despite efficiencies, AI ushers in substantial risks, spanning legal and reputational implications from erroneous chatbot interactions. Employee morale may also be impacted, underscoring the necessity for strategic implementation and risk mitigation. A recent FTI whitepaper delves into these risks and offers actionable steps for robust governance frameworks to ensure AI is adopted responsibly.

ICYMI 

• More action needed on companies’ plastic data, says CDP. Thousands of companies are behind on key steps to tackle plastic pollution in their value chains, according to landmark data released by CDP. Major gaps in corporate plastic data reveal the extent of companies’ awareness of their contribution to the plastic crisis and highlight the need for mandatory plastic-related disclosure rules. 
• Aon chief calls for better models for ‘stressed’ property insurance market. Greg Case, Chief Executive of Aon, has called for more forward-looking analytic models that better understand climate risks and improve the supply of insurance, saying conditions in the market were “stressed” after a surge in claims from extreme weather.  
• ESG Pioneer, Mary Jane McQuillen, says ESG funds held to ‘different standard’. Recent scepticism around ESG has put its supporters on the defence, including nearly 30-year ESG veteran Mary Jane McQuillen. In an interview with Bloomberg, she argues that non-ESG actively managed funds have equally suffered in the market, and that too frequently ESG investments are held to a different standard than other active funds.