ESG+ Newsletter – 24th March 2022

SEC draft proposal ups the ante on emission disclosures

On Monday, the Securities and Exchange Commission issued its long-awaited draft rule for climate disclosures that, after years of speculation and deliberation, proposes all publicly traded companies in the U.S. be required to meet set disclosure standards. As outlined by FTI Consulting earlier this week, the proposal is not final but does “cement several realities”, including that companies now must have a climate strategy in place and have an executive governance body to oversee execution of said strategy. On the disclosure front specifically, should the rule be passed into law, public companies’ direct greenhouse gas emissions will need to be verified by a third party in order to be validated for reporting. This area of the regulation ultimately brings the U.S. into alignment with the U.K., as the Financial Times notes, where “more than 1,300 large companies and financial institutions face new climate disclosure rules from next month”. The more controversial aspect, having been both criticised and lauded by policy makers and activists, is the requirement to provide information on Scope 3 emissions “if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.” While US companies were already required to provide all information that was “material”, the rule challenges those making proactive commitments on Scope 3 to back it up with evidence. Whether this results in less commitments being made or a rapid increase in transparency on all emissions remains to be seen. Nonetheless, by accepting there is a role for Scope 3, investors who have been struggling to compare corporate climate efforts on a company-by-company basis stand to gain through increased transparency and comparability.

The ESG boom has far-reaching implications

This week the FT reported that the race for ratings agencies to carve out market share in the ESG space is causing confusion with inconsistent approaches, differing methods, and engrained theoretical biases which vary from provider to provider. What should investors do in scenarios where a company scores well on one ESG ranking but poorly on another? Arguments have been made that inconsistency between agencies is at best causing confusion and at worst is discouraging companies from acting to improve their ESG performance due to the mixed signals they receive. Others argue a variety of opinions can provide a more rounded picture of company practice.

Despite the concerns around the inconsistency of ESG ratings, according to Amundi, the ESG boom is here to stay. We have previously covered mumblings of an ESG bubble, however, Amundi this week argued that ESG assets do not face a bubble, instead are subject to ‘crowding risk’ due to investor demand outstripping the supply of ESG assets. Amundi argues that ESG investing represents a paradigm shift, not a trend, making it difficult for investors to return to business-as-usual. For this structural change in financial markets to hold true, investment decisions must be made on transparent, consistent ESG data. Regulators are beginning to mandate consistency through regulations such as the EU Taxonomy. Regulation and the integration of existing reporting standards will be vital to ensure ESG funds create real impact by making investment decisions on the basis of transparent, comparable data.

GRI and IFRS to commit to collaboration

Just this morning, the Global Reporting Initiative (GRI) announced a memorandum of understanding with the International Financial Reporting Standards (IFRS) Foundation, which commits to coordinate work on standard-setting activities. As ESG and sustainability have boomed, so have – genuine and opportunistic – complaints about lack of consistency in reporting standards. In the gap of regulation, two prominent reporting frameworks with decidedly different approaches sprung up, GRI and the Sustainable Accounting Standards Board (SASB). Recently, however, and most significantly since the creation of ISSB at COP26, there have been growing efforts to converge frameworks. Companies, investors and wider stakeholders will get a good understanding of how effective those efforts have been throughout 2022. Next week, ISSB intends to publish its proposed Climate and General Sustainability-related Disclosure requirements along similar lines to SASB’s approach; and then later this year, the EU will publish its Corporate Sustainability Reporting Directive, which will be heavily informed by the GRI.

Where cybersecurity fits within ESG

As the risk of cyber-attacks continues to be front of mind for organisations there has been an increased reflection on where cybersecurity falls, or should fall, within ESG. The broad implications of cybersecurity, and an actual cybersecurity incident, means that it can fall under of the ESG pillars. The increasing reliance on cloud infrastructure and its associated data centres has led to increased energy consumption. On the social side, companies’ use and processing of data has come under growing scrutiny, both from regulators and legislators, and also consumers and employees who are increasingly concerned about data privacy. ESG investors will also look for greater transparency and evidence of the compliant treatment of personal data. A cybersecurity incident can also cause societal instability when an incident impacts on critical infrastructure and services. Cybersecurity is most commonly addressed under the governance pillar and this newsletter has previously discussed the governance structures which need to be in place to appropriately assess cyber risk, and the importance of having leaders who understand cybersecurity enough to implement appropriate protection measures. Being able to demonstrate good cybersecurity governance is key to inspiring confidence in investors. However, cybersecurity faces a challenge that is familiar to many ESG matters – the lack of a standardised measurement framework. Without a framework, cyber risk disclosures are likely to be inconsistent and make it difficult for stakeholders to truly assess a company’s approach to cybersecurity.

Hedge funds seek clarity on their role in ESG investing

As the $40 trillion ESG market continues to grow, hedge funds looking to participate hesitate to get involved in the face of what they claim are unclear legal frameworks around short-selling. Hedge funds are advocating for clearer disclosure rules that explain how they should account for short-selling and consulting lawyers as a means to circumvent legal consequences. The Sustainable Finance Disclosure Regulation, the EU’s anti-greenwashing rulebook, aims to cover all corners of the asset management industry. However, hedge funds and their lawyers argue that the rules aren’t clear enough. On the one hand, sceptics claim that short-selling and sustainable investing cannot be reconciled; on the other, there is the argument that shorting unsustainable companies has a real material impact. Adding this onto the aforementioned problem of inconsistent ESG ratings causing confusion about what is and isn’t sustainable, and it seems that the role of hedge funds in the sustainable investing landscape remains murky for now.

Improving board diversity can improve climate action

This week the FT reported that 94 FTSE 100 companies had at least one director from a minority ethnic background, hitting a target set by the UK government in 2015 to encourage greater boardroom diversity. This represents a rapid rise in diversity from five years ago where only half of FTSE 100 boards had representation from minority ethnic backgrounds. This rapid improvement appears to be a direct response to increased pressure from investors and customers to improve diversity. As stakeholder pressure increases, so does the data that points to the cost of inaction and the benefits of increasing diversity. Last week this newsletter covered a study on the costs of a lack of diversity. This week, Arabesque released a study showing that companies with more women on boards are more likely to be on track to meet the climate goal of limiting global warming to 1.5°C. The study also found that the converse is true, with the least diverse 20% of companies heading towards a worst-case 2.7°C warming trajectory or above. This study demonstrates how the components of E, S and G are inherently linked, and how improving diversity on boards can support companies to deliver across the ESG agenda.

Fierce fight for ESG and sustainability experts

Happy days for ESG practitioners. Recent sustainable investing and ESG growth has resulted in a battle to retain and employ ESG experts. Efforts to align climate goals, social good and strong governance have been building for a decade but has really ramped up the last 18 months. Covered in the piece, Morningstar data suggests assets in sustainable funds grew by 53% year-on-year to $2.74tn in 2021. In order to meet these demands and manage the funds, head-hunters are actively looking for ESG hires. It is so intense, that candidates are often fielding multiple job offers, while their employer also battles to keep them. Some candidates are seeing 50% increases in salaries as firms desperately look to hire. The demand currently far outweighs the availability of skills and as such fund managers are not only poaching staff from rivals but also unusually hiring from outside the industry. Some asset managers are acquiring the skills through mergers and acquisitions. With continued growth in ESG, this trend is unlikely to come to an end and investment in ESG education should be considered to further increase the pool of skills and support the growing demand.

As cryptocurrencies tries to change its image, old issues persist

A little over a year ago, the ESG+ Newsletter looked at how cryptocurrencies’ energy consumption had come under increasing investor scrutiny, with many in the ESG investment community viewing it as being at odds with the principles of impact investing due to its carbon footprint. Since then, we have seen regulators crackdown on cryptocurrencies and, at one point its most ardent supporter, Elon Musk, distancing himself from the industry due to its use of fossil fuels. Fast forward to today, and it would appear that the cryptocurrency mining industry is trying to reposition itself and shift the narrative regarding its climate impact. Earlier this week, The New York Times did a deep dive into the efforts that the industry is undertaking to change its image, via re-purposing old coal plants to renewable energy plants focused on mining and the formation of an industry forum – Bitcoin Mining Council – which is focused on coordinating an environmental strategy for cryptocurrencies.

However, despite the progress being made, cryptocurrencies are still extremely energy-intensive and have a large carbon and environmental footprint. Research shows that a single Bitcoin transaction now requires more than 2,100 kilowatt-hours of electricity or enough energy to power the average American household for 75 days. Additionally, as demand for the digital assets continues to grow, so too will the power required to generate Bitcoin and, unless cryptocurrencies can fundamentally change both its source of energy usage and perceptions about its poor sustainable credentials, then there will likely remain scepticism regarding its viability as an ESG investment.

In Case You Missed It

• Unilever is trialling SAP’s blockchain technology to track its supply chain. Unilever is committed to having a deforestation-free supply chain by 2023. The first trial project covered the entire supply chain journey of 188,000 tonnes of palm oil fruit. Unilever aims to be forest-positive by 2030 and blockchain solutions could help the company ensures its products are sourced responsibly and in line with this ambition.
• The EU Member States have reached an agreement on Carbon Tax. The new tax will be imposed on products imported to the EU that are produced by less stringent climate standards. The main goal of this new measure is to avoid “carbon leakage” and encourage industries with production in non-EU countries to adopt stricter sustainability standards. The tax will be fully introduced in 2026.

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