ESG+ Newsletter – 18 April 2024

This week’s newsletter is a bumper edition, beginning with the hot topic for this year’s proxy season – pay governance. From there, the newsletter looks at how the impact of anti-ESG pushback in the US and UK, covers controversy over the SBTi’s recent decision around the use of carbon offsets, financing mechanisms for nature restoration, and new EU rules on green buildings. We then take a trip around the world, looking at matters such as: the conundrum of who pays for greener air travel, and how AI is driving sustainability improvements.

Pay governance – motivating executives without losing employees 

When executive pay is in the public domain – as is the case in most developed countries – attracting, retaining, and motivating key executives without demotivating and losing your employees can be a challenge. This week, the Financial Times reported that more FTSE 100 companies will be asking their shareholders to back significant pay raises for their executives this year than was the case in 2023 – often arguing that such increases are necessary to compete with their US rivals in the market for talent. In addition to increasing pay, a number of companies are also looking to implement US-style hybrid schemes combining performance share plans with restricted stock. 

While certain shareholders have signaled a degree of openness to higher pay packages and unconventional pay structures, others maintain their focus on pay equality. According to an article from ESG Investor, the Church of England Pensions Board and Brunel Pension Partnership teamed up to develop the ‘Fair Reward Framework’, a dashboard consisting of different indicators of “fair reward, robust pay setting process, and engagement with stakeholders.” In 2024, the new framework will be be applied to FTSE 100 companies, before a potential expansion of its coverage. Other UK managers have indicated that they will continue to scrutinise the alignment between executive remuneration and the experience of employees and workers. In this context, board proposals and shareholder votes regarding executive pay are likely to be closely watched by various groups of stakeholders during the 2024 AGM season. 

The future of the investment stewardship landscape 

The ongoing anti-ESG backlash in the US and the current debate regarding the impact of the UK’s corporate governance environment on the competitiveness of the market have put the role of stewardship under the spotlight. Stewardship tools such as proxy voting and shareholder engagement have allowed institutional investors to clearly set expectations of companies and shift market practice, particularly across environmental and social considerations. However, investor support for E&S proposals has decreased since 2021, as noted in a recent ESG Investor article, with the drop largely attributed to US-based investors, whose ability to effectively carry out their fiduciary duties to clients has been significantly impacted by the anti-ESG backlash. Moreover, this shift in investor sentiment has also blurred companies understanding of their investors’ expectations, leading to instances where companies have started to push back against shareholder pressure on sustainability-related topics, or the tension between company boards and institutional investors that has been debated in the UK.  

While the evolution of stewardship over the last ten years has been impressive, the rapidly changing regulatory environment, its increasingly global scope, and the growing demands for client-reporting and transparency around vote disclosure, have increased the pressure on institutional investors, as noted by the Head of Stewardship at the Financial Reporting Council (FRC) in a recent ESG Investor article. This change in expectations, is also at the core of the FRC’s decision to carry out a review of the Stewardship Code, to ensure it remains fit for the future and maintains its position as a “leading benchmark” for stewardship globally. 

Republican states litigation against Biden and the SEC is building  

Sticking with the anti-ESG pushback, last week Reuters reported that West Virginia added more financial institutions to its list of firms that are barred from participating in state business due to their energy finance policies. As the week continued, more litigation around climate-related issues in the US has emerged, with other conservative States in the US taking legal action against both the SEC and the EPA for proposed or established climate-related rulings. The Financial Times reported that 16 states are pursuing litigation against the SEC on its climate-disclosure ruling and the Attorney Generals in 24 states are suing the EPA. The EPA’s issued rules are in line with President Biden’s climate agenda and are aimed at limiting toxic emissions and cancer-causing chemicals. The states suing the EPA are calling into question the power of the EPA, but the litigation may be perceived as ‘anti-Biden’ and political. The continued polarisation within American politics on ESG and climate-related issues continues to have an impact on regulations in the US.  

SBTi’s offsetting U-turn

The Science Based Targets initiative (SBTi) has itself become a target this week, following the controversial decision of the board to allow companies to use carbon offsets to meet their climate pledges. The move has been met with fury from staff, who have accused the board of undermining SBTi’s governance policy by not consulting the technical council. According to Responsible Investor, members of SBTi’s technical advisory council plan to respond by seeking a retraction from the climate standards body, which is expected to be submitted tomorrow. Meanwhile, SBTi has since published a clarification on its stance, as Environmental Finance reports, stating that “any change to SBTi standards, including use of EACs (Energy Attribute Certificates) for Scope-3, will be conducted according to previously approved SBTi standard operating procedure for developing standards.”  

The controversy has generated just as many headlines as questions about the future of sustainable finance. Peter Cripps, editor at Environmental Finance, argues that although the path for offsetting within transition plans remains unclear, the world ultimately needs carbon markets in some shape or form. On the other hand, critics are seeing this as a golden opportunity to oust carbon emissions as a measure of corporate preparedness for the energy transition, as the Financial Times writes. Their proposed alternative is to focus on developing tools that can translate emissions data into decision-relevant information for executives, thus opening new avenues to encourage investment in decarbonisation. For SBTi and the world of green finance, it seems the road ahead has yet to be determined. 

Novel financing mechanisms emerge for nature restoration 

According to Environmental Finance, the International Institute for Environment and Development (IIED) has issued a report claiming that up to $100bn of debt could be ‘freed up’ through debt-for-nature swaps. The research found that the 49 countries most at risk of defaulting on external debts collectively owe $431bn; however, based on the methodology used in previous debt-reduction transactions, $103.4bn of this could be freed up for swaps. A number of debt-for-nature swaps have already been used through the issuance of blue sovereign bonds in countries including Belize, the Seychelles and Gabon. Finance for nature restoration has been a topic of debate, with novel financing mechanisms for natural capital emerging, including the possibility of natural capital as an independent investable asset class. It seems that those leading action to restore nature are trying to get ahead of financing concerns and avoid a repetition of the woes of the debate on who funds the climate transition. Governments will also play a crucial role in financing the restoration of nature, with the EU this week announcing a commitment to spend €3.5bn to protect the ocean and promote sustainability through a series of initiatives. This week, more than $10bn in funding was announced at an UN Our Ocean conference in Athens. The conference is seeking to ensure the ratification of a UN treaty to protect the world’s oceans from overfishing and other human activities.   

Greening air travel and who should pay for it 

Of all the sectors looking to decarbonize, the aviation sector – rightly or wrongly – is seen by many as having the most distance to travel. The sector is heavily reliant on fossil fuels to operate and, with 2024 global air passenger traffic expected to exceed 2019 levels in all regions, consumers’ demand for travel looks unlikely to abate. This dynamic, coupled with the crucial part tourism plays for economies, puts the sector and policymakers in a challenging position. With large, net zero emission commercial aircraft decades away, the industry has placed its hopes on Sustainable aviation Fuel (SAF) as a near-term solution. SAF has the potential to reduce greenhouse gas emissions by up to 80% compared with fossil jet fuel; however, scaling SAF production and the costs of producing and procuring it remain a significant barrier. Who should pay the cost is also a topic for contention. IATA, the aviation trade association, has urged policymakers to resist the temptation to introduce additional sustainable taxes for that would make travel more expensive, while Ryanair are uncertain if travelers will pay for higher fares associated with SAF. With governments implementing SAF mandates as part of net zero policies, others have called for them to provide support and investment for the costs. As highlighted in last week’s ESG+ Newsletter, financing the climate transition is challenge facing every economy and sector. The cost dynamics associated with the production and procurement of SAF will have to be covered by someone – the question is who? 

EU approves revised Energy Performance of Buildings Directive

European Union member states have two years to incorporate the newly approved Energy Performance of Buildings Directive (EPBD) into national legislation. The revised, and now adopted, version of the EPBD, requires all new residential and non-residential buildings to have zero on-site emissions from fossil fuels by 2030, with publicly owned buildings to reach that milestone by 2028. The European Commission views emissions associated with buildings as a key area in to address, with 40% of all energy consumed in the EU arising from buildings, and 36% of GHG emissions. As such, the legislation also requires countries to set out strategies for fossil-fuel phasing out in the heating and cooling of buildings – 80% of household energy consumption is used for heating, cooling and hot water. Interestingly, given the wider macro environment and struggles within the sector, new buildings must be suitable for solar installation. The directive is set to have a wide-ranging impact, with investors likely to seek out sector and asset level exposure, across the entire energy efficiency supply chain. Companies with both strong and tangential exposure themselves, will likely pivot more swiftly to increase business activity where possible, given the relatively short-term timeline provided by the EU to members. 

AI-Powered packaging driving sustainability

This week, Forbes highlighted Amazon’s AI model, which optimises packaging choices based on data from product descriptions and reviews. This innovation has led to significant savings, with Amazon reporting a reduction of 500,000 tons of packaging annually, equivalent to the weight of 7,750 Boeing 737 airplanes. While AI’s risks are often debated, its role in reducing packaging waste presents a major opportunity for industry and society. Despite some challenges with AI’s ability to understand human nuances, in packaging, Amazon’s AI recognises the sensitivities. For example, it considers the importance of packaging for personal items like adult diapers regardless of the material savings. Beyond environmental gains, the financial benefits of AI-driven packaging are substantial, offering reductions in variable costs. Where sustainability benefits are so clearly achieved through the use of AI, the question will be how learnings will be shared to enable other companies to adopt similar practices.

ICYMI 

• TNFD and GRI have collaborated to ensure clarity on the interoperability between their two reporting frameworks. According to Environmental Finance, the two bodies will publish an ‘interoperability mapping’ document, setting out how the TNFD’s recommended reporting metrics align with the GRI’s biodiversity standard. This document will aim to provide guidance for companies, regulators, and investors on how to effectively report nature-related information using both frameworks.
• Surge in weather damage insurance claims highlights growing challenges caused by climate change. The Financial Times reports that severe storms in the UK last year resulted in home insurers facing a record £573 million in weather damage claims, the highest in seven years. The insurance sector is struggling with the increasing frequency and the severity of extreme weather events worldwide, leading to challenges in underwriting.
• Chinese Stock Exchanges publish sustainability guidelines for listed companies. The sustainability report guidelines encourage each listed company to incorporate sustainability thinking into development of strategies and business and management activities. The guidelines aim to support in strengthening ecological and environmental protection duties as well as the fulfilment of social responsibilities and corporate governance on an ongoing basis.