ESG+ Newsletter – 12th May 2022

UK Government calls for ESG rating oversight as net zero transition looms large

Another week in the ESG universe saw fresh calls by a government body for oversight of ESG ratings. Adam Lyons, head of the UK Finance Ministry’s Green Finance Unit, said that the financial markets are facing growing risks of greenwashing due to the “totally unregulated” nature of ESG rating agencies. These comments follow a similar trend to the EU, whose securities watchdog is looking at introducing regulatory oversight for the ESG ratings market, and also follows calls from both the global securities regulatory body IOSCO and the Financial Conduct Authority for enhanced regulation for ESG ratings. While the UK Finance Ministry’s current focus may be on ESG rating oversight, the Worldwide Fund for Nature (WWF) and Aviva recently published a paper which called on the UK Government to formulate an economy wide plan to transition to net zero –  including aligning policy by embedding net zero into core economic and financial decision-making processes. The paper makes a similar argument to that made by Tariq Fancy last year – that the government needs to set the direction with a policy that requires action, rather than setting businesses a target.

As we have detailed across numerous ESG+ newsletters, there is growing consensus from Governments that ESG ratings need some form of regulatory oversight. However, as highlighted by the WWF and Aviva in their paper, Government’s role in the transition to net zero has to extend beyond oversight and setting business a target, and that their policymaking must be the catalyst for change.

Tesla challenges ESG ratings

A Bloomberg article this week also highlights Tesla’s recent criticisms of ESG reporting and scoring. The introduction in Tesla’s 2021 impact report highlights their concerns about ESG ratings focusing solely on investment risk while ignoring company impact. Their concerns are almost solely centred around the automotive industry and call out ESG funds that include companies that exacerbate the effects of climate change. Tesla’s concerns are indicative of widespread push back on ESG ratings. MSCI, one of the most popular rating agencies, has awarded Tesla an A rating. This indicates Tesla is average for their industry, MSCI also indicates that Tesla is misaligned with climate goals, mostly due to not having a decarbonization target. Tesla has fallen short of scrutinising the S & G components of ESG ratings and funds, however its public pushback against ESG ratings being based purely on risk is part of a wider trend that has been bubbling away for some time. Facing calls from the UK Government for ESG ratings oversight, the ratings agencies will need to ensure they present an accurate view of the ESG profile of a company. If ratings are not fixed and cannot present value to investors, Musk argues that the entire ratings system should be deleted.

The cybersecurity data gap

Previous newsletters have explored the position that cybersecurity holds within ESG but a recent article looks at how, despite increased focus on cybersecurity, investors are still dealing with a lack of information. Cybersecurity has moved up the investment agenda as a result of increased volumes of incidents and the digital transformation of more traditional industries which leaves them more exposed to cybersecurity risk. However, despite this increased focus, investors struggle to get meaningful cybersecurity data with many companies reluctant to disclose incidents or unwilling to provide detailed information on their cybersecurity posture. This is either due to fears they will draw attention from attackers or because of a perceived lack of preparedness or maturity. Where data is provided it is often high-level and qualitative. Some businesses take a different approach – for example, by establishing governance structures that demonstrate that cybersecurity is a priority. This can be achieved by including cybersecurity expertise and accountability at the board or senior management level and ensuring cybersecurity features in any risk mapping. However, even when these structures are in place, many companies who reported incidents to their boards did not take any subsequent action. With the SEC proposing new rules that would introduce requirements for the disclosure of security incidents and policies, companies may soon be forced into establishing reporting processes.

Roe V Wade and the implications for ESG

The recent leak of the draft Supreme Court opinion on Roe v Wade has sparked significant debate not only in the US but across the wider world. It poses big societal questions in the US and, as part of the response, has brought the question of corporate responsibility and ESG to the fore. In a short time-frame, there has been a response from major companies to move to protect the rights of their employees from any impending change. Andrew Behar of AsYouSow outlines in a CNBC article that this response which is now a “ripple” will grow to a “wave” and, pending Supreme Court action, will “become a tsunami”. According to Carla Bevins, of Carnegie Mellon University’s Tepper School of Business  “Public companies, whether they like it or not, are in the spotlight for this debate”. Those companies already standing up to protect the reproductive rights of employees have taken the stance that this is no different to providing other important health covers. In time, however, it will be interesting to see the extent to which companies are prepared to be transparent or have a clear public position in what is an issue which can draw polarising views; and most companies have not yet set out any position.

At this early stage, according to Responsible Investor, even the ESG ratings agencies are reluctant to publicly comment. One rating agency source did anonymously comment, however, that “access to abortion and reproductive health sits under the umbrella of human rights” and “from an ESG ratings perspective, the issue could lead to lower sub-scores for human rights when taking into account social factors and their impact.” From an ESG perspective – and perhaps from a wider reputational perspective – the challenge is this. How will investors and other stakeholders expect companies to act and what degree of transparency will be required? When facing climate change issues, diversity concerns or mental health considerations, there is general consensus on the direction of travel and the action required. Whether we can or will see broad based consensus on the Roe v Wade issue is another matter and this may be the first real test of how willing companies are to take a stand on a divisive issue.

Investor sentiment has evolved for the 2022 proxy season

A case-by-case approach underpinned by more sophisticated nuance in analysis than in previous years is becoming a dominant theme of the 2022 proxy season. Accentuated by an uncertain and increasingly bearish macroeconomic environment, investor sentiment on corporate climate change action has been varied – with stewardship focus swinging back onto shareholder returns and balance as businesses struggle with difficult conditions. BlackRock’s adapted strategy, which this year accounts for the Russian invasion of Ukraine for instance, is one which has received particular media attention. As noted by the Financial Times, “the group last year voted in favour of 47 per cent of shareholder resolutions” on climate change, but now has made clear that the need for energy security may require more fossil fuel investment in the short term.

More widely, there continues to be support for improved disclosures and net-zero plans, with a level of new nuance applied reflecting the more mature understanding of key issues such as the energy transition. The result has been resistance to some proposals which in 2021 would have likely gained more support. Perhaps the most significant example so far has been activist investor Engine No1 voting against proposals at Citi, Bank of America, and Well Fargo to align their fossil fuel financing policies with achieving net-zero emissions by 2050. In explanation, Engine No1 commented: “People still need fossil fuel. We want to see a fast and as-clean-as-possible transition to net-zero, but in getting there banks need flexibility to finance that transition.” This development has been signposted since the European Commission opted to include both gas and nuclear in the EU Taxonomy in February – outlining the role non-renewable fuels have to play in the energy transition. Discussion of investor positioning as a whole will no doubt continue; perhaps these conversations reflect nuance and increased understanding, catalysed by market conditions, rather than a decreased focus on ESG issues.

Focus on climate reporting is no substitute for action

This newsletter recently covered how investors, NGOs and consumers are beginning to demand action on climate, rather than just promises. Some are beginning to call out corporate climate reporting as a distraction from actual emissions reductions. NYU Stern School of Business’s Alison Taylor, shared a metaphor comparing corporate climate reporting to a calorie labelling law for restaurant menus in the US which has only resulted in customers eating eight fewer calories per day. Taylor argues that disclosing on corporate emissions has a similarly negligible effect on encouraging actual emissions reductions. An additional challenge is the wide variety of climate reporting rules, metrics and frameworks. The ISSB hopes to solve this issue, by streamlining reporting requirements, and in turn increasing comparability between corporate disclosures. Many investors welcome these efforts to tighten up climate reporting, however others worry that more stringent requirements will discourage some from reporting at all. Other investors argue that now is the time for governments to establish the economic and regulatory incentives required to drive decarbonisation, rather than relying on market pressures. As we have seen in the article on ESG rating oversight, there is growing consensus that stakeholder pressure and market forces may not be enough to generate the pace of change required to decarbonise the economy.

In Case You Missed It

• A PWC survey revealed that most CFOs wish to increase their issuance of green, social and sustainability (GSS) bonds. Most issuers will increase issuance in the next two years. The most ambitious are planning to increase issuance by 21% or more. To a lesser extent, the survey showed that investors are also expected to increase their allocation.
• Japan has submitted a carbon tax proposal to tackle emissions from maritime transport. Under this proposal, the sector, which represents just under 3% of global GHG emissions, could face charges of more than $50bn per year, paying $56 per tonne of CO₂ by 2025. The price per tonne would increase every five years and reaching $135 in 2030.
• The plastic-free plan of the UK supermarket, Iceland, has been disrupted by the Covid-19 pandemic and the war in Ukraine. The supermarket’s plan is focused on eliminating plastic instead of recycling, with the target to remove plastic from the brand’s own packaging by the end of the year. However, current crises have delayed the company’s progress.

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