ESG+ Newsletter – 24th February 2022

Dropping CVs can improve diversity

Organisations are rethinking their hiring practices to de-emphasise the importance of academic or professional achievements and are instead shifting focus to assessing individual skills, with evidence emerging that this approach can lead to more diverse hiring. Research from UK recruiter, Applied, found that companies that use a skills-based recruiting process increased the number of women hired into STEM roles by almost 70%. Similarly, when Health Data Research UK, a public-health research non-profit, sought to improve the industry’s track record of recruiting black women by starting a new internship programme, they took the unusual step of asking candidates to complete a short questionnaire in lieu of sending in a CV. What they found was that more female candidates applied than men, resulting in 30 of the 48 positions being filled by female candidates. While skills assessments often occur at the interview stage of the hiring process, applying these assessments at the screening stage is less common, but can help to overcome unintentional biases that may prioritise certain degrees, universities and backgrounds. The non-profit lobbying group, Business Roundtable, has also organised an initiative, signed by 80 of its members, which aims to prioritise skills over formal qualifications and ultimately address inequities in hiring. While organisations often blame poor diversity on a lack of candidates, a rethink of their hiring practices may unearth a more diverse pool of talent.

Growing pressure to link ESG and remuneration as US prevalence grows

Earlier this week, German fund manager, Allianz Global Investors (‘AllianzGI’), announced that it would vote against UK and European large cap companies that fail to link executive remuneration to ESG KPIs. The news came as AllianzGI published its annual analysis of how it voted at 2021 AGMs, while also providing an update to its voting policy for 2022. In addition to demanding companies link ESG KPIs to executive remuneration, AllianzGI also made it clear that it expects UK and US companies to come up with an approach to diversity that looks beyond gender, in line with revised approaches from most of the world’s largest asset managers and index funds. While AllianzGI has put EU companies on notice, we have already seen evidence of environmental and social targets being linked to executive bonuses in the US. A portion of Starbucks CEO’s 2021 bonus was awarded for successfully achieving environmental and workplace targets such as the elimination of the use of plastic straws, reduction in methane emissions from farm operations and the retention of minority workers. Starbucks decision to include environmental and social metrics in its executive remuneration followed on from its failure to win support for its executive bonuses in 2021.

While the pressure on companies to integrate ESG measures into pay is increasing, so too is investors’ evaluation of what constitutes good and bad ESG practice. ESG measures and targets should be clearly defined and detail how they are material to the business and linked to long-term company performance – particularly if they are to appease some shareholders who may be sceptical of replacing typical bonus targets tied to more traditional financial metrics.

Rise in ESG investing puts greenwashing centre stage

Demand for ESG investments has continued to increase with assets using some form of ESG assessment passing the $35 trillion mark across major markets. With the increased demand comes increased scrutiny and assurance requirements to ensure investors or companies are not exaggerating or misrepresenting the benefits of their activities, otherwise known as ‘greenwashing’. To compound the issue, ESG auditing is still in its infancy, with no single global standard and only limited assurance possible. The EU is driving ESG regulation and is only mandating limited assurance, but in three years’ time will look at whether ESG reporting should be audited to the same level as financial statements. To ramp up assurance and give investors’ confidence that the ESG data is accurate, the race is on for globally accepted audit rules and consolidation of ESG reporting frameworks. While consolidation aims to ensure comparability and reliability of data, the debate over what should be included – i.e. what is the most accurate means of incorporating ESG and sustainability criteria – continues.

Could ESG be the new PPI?

According to the Investment Association, last year in the UK, one out of every three pounds in net sales of retail funds went to ethically labelled products. Some of the bolder green claims, along with the lack of clarity, inconsistency, and vagueness around the disclosures of these increasingly popular products, has left many industry insiders fearful of a potential mis-selling scandal – similar to those that have taken place in the past around diesel cars and protection insurance.  The London-based law firm, Bates Wells, argues that ESG fund disclosures should be reviewed in line with the 2015 Paris Climate Agreement; while the climate think-tank, InfluenceMap notes in a recent study that 72 out of 130 climate-themed funds were not aligned with the Paris goals. As the number of ESG funds has continued to grow over the past number of years, financial regulators have been slow to keep up. However, as covered in last week’s ESG+ newsletter, regulatory action seems imminent with the European Securities and Markets Authority setting its legislative agenda sights on ‘greenwashing’.

We wonder whether, without sufficient information to assess the impact of the EU’s Sustainable Finance Disclosure Regulation, would the binding nature of the Paris agreement on nations suffice for legal action to be taken against funds on the mismatch between their rhetoric and their allocation strategies?

Human rights performance impacts bond pricing

Verisk Maplecroft, the risk consulting firm, recently released a report which detailed how ESG factors impact sovereign debt. The study, which was based on six years of ESG data, found that the best-performing countries on human and labour rights have significantly lower bond market spreads compared to the worst, even when taking economic factors into account. Narrowing bond spreads are often used as an indicator of positive economic performance, with tighter bond spreads reflecting investor perceptions that there is a lower default or downgrade risk. The findings of the report suggest that social risks are increasingly feeding into sovereign bond pricing, reflecting a recent phenomenon of the integration of social and environmental issues into market pricing. Social risks are under increasing global scrutiny, including from investors. The report is the first to demonstrate a strong correlation between sovereign debt and social risk, reflecting the growing scrutiny from investors on the ‘S’ of ESG. There is a lesson here for companies. As the focus on human and labour rights grows, as well as that of sustainable supply chain management, companies could do well to notice the growing impact of these factors on traditional financial mechanisms.

SEC deliberates the inclusion of Scope 3 emissions in its climate disclosure requirements

As the SEC continues to consider climate disclosure requirements for public companies, the inclusion of Scope 3 emissions has come to the fore. While unveiling these requirements is a stated priority for SEC Chairman Gary Gensler, there have been significant delays due to ongoing deliberations, such as those surrounding the inclusion of Scope 3 emissions. Proponents for its inclusion, such as investors evaluating company risk, argue that Scope 3 emissions are needed to offer a complete picture of a company’s environmental impact and prevent greenwashing. CDP notes that, according to its company database, supply chain emissions alone were 11.4 times greater than operational emissions on average. Opponents claim that Scope 3 data is unreasonably burdensome to collect and measure, and is sometimes unreliable, as elements of the calculation rely on third-party information.

This news comes at a time when policymakers are growing impatient with the slow rollout of climate disclosure regulations. As we detailed in last week’s ESG+ Newsletter, the slow rollout has forced some state governments to take matters into their own hands, with the California Senate recently passing a bill requiring large companies operating in the state to disclose Scope 1, 2, and 3 emissions. In addition, guidance from the Science-Based Targets Initiative, which aids companies in targeting reduced emissions, in October, mandated the inclusion of Scope 3 emissions in any target-setting process. With investors demanding targets underpinned by science, it seems a matter of time before regulators and catch up by incorporating the details of the GHG Protocol.

EU ups the ante on due diligence in the value chain

The European Commission has adopted a proposal for new rules aimed at boosting sustainable and responsible corporate behaviour throughout global value chains. Under the proposed directive on corporate sustainability due diligence, companies will be required to identify and prevent adverse impacts of their activities such as child labour, the exploitation of workers, pollution and biodiversity loss. These new due diligence rules will apply to all large, limited liability companies, both from within and outside the European Union – SMEs, however, are not currently inside the scope. Interestingly, the proposal applies not just to companies’ operations, but also to their subsidiaries and their value chains, much like expectations on Scope 3 emission reporting. The largest European limited liability companies will also need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 °C in line with the Paris Agreement. A key element of the proposal to ensure its enforcement is the introduction of what the European Commission calls ‘directors’ duties’ to set up and implement due diligence and to integrate it into their company’s business strategy. However, as the obligations are limited in nature and left to Member States to implement, it remains unclear how this will look in practice. The proposal will now be presented to the European Parliament and the 27 Member States for approval. Once adopted, Member States will have two years to transpose the Directive into national law. Whether updating director duties to have regard for more than the company or shareholders will have the desired effect remains to be seen, particularly given the length of time from approval to implementation.

In Case You Missed It

• Billionaire activist investor, Carl Icahn, launched a proxy fight with McDonald’s over the welfare of the pigs sourced for its pork supply. In 2012, the fast-food leader boldly pledged to end the use of gestation stalls in its production chain by 2022. Well, 2022 has come and the commitment has yet to be fulfilled. Icahn, a longstanding animal cruelty activist and McDonald’s shareholder, has nominated two individuals for election to their board.
• The water services regulator, Ofwat, has stated that Britain’s privatised water companies should link executive pay to performance. In a letter written to the Chairs of Remuneration Committees at company boards, the regulator states that water providers must ensure that chief executives are not given pay packages that “reward poor performance”. The warning comes following increased public outcry regarding the enriching of investors and senior executives, despite poor investment in infrastructure.

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