ESG+ Newsletter – 2nd June 2022

As ESG becomes politicized, World Economic Forum calls for greater ESG integration

In a recent letter to US President Joe Biden and the SEC, sixteen Republican Governors expressed their disapproval of the SEC’s proposed climate disclosure mandate. The Governors called the move an “unprecedented level of federal overreach” and said that it would “harm businesses and investors in our states by increasing compliance costs and by larding disclosure statements with uncertain and immaterial information that the federal government – let alone the SEC – is not equipped to judge.” The letter follows on from recent high-profile politicians and business leaders – such as Mike Pence and Elon Musk – who have publicly politicized ESG trends and written them off as part of the left-wing agenda. However, a recent article published by the World Economic Forum (WEF) argues that ESG issues and related stakeholder interests cannot be dismissed as mere public relations or politics, but rather that ESG is a critical considerations for long-term enterprise value preservation and creation. The article argues that ‘S’ and ‘G’ considerations appear more often in a company’s intangible assets – such as human capital and intellectual property – and “are increasingly important drivers of business value creation.”

Proponents of ESG often assert that disclosures results in better information for investors and are not grounded in political objectives, with support for the industry – particularly in the US – appears to be falling along party lines. While the WEF article offers a non-partisan advocation for ESG integration, it would seem that ESG advocates could face significant hurdles in the US – particularly if there is a Republican Senate following the November elections.

Could proxy voting be changing?

The proliferation of index funds has led to the seismic power shift to their passive funds’ investment managers. The Big Three investment managers, BlackRock, Vanguard and State Street, have a joint AUM of c. $20 trillion, and, for 90% of public companies, one of them is their largest shareholder. A recent WSJ article criticised the role of the big three asset managers, for using their economic power to “push their political agendas” rather than promoting long-term shareholder value.

In recent weeks, legislation was proposed calling for voting choices to be made available to those investing in passive funds, highlighted in our previous newsletter. While the driver of the proposed bill has been related to environmental and social proposals at large US companies, there has also been significant criticism around the Big Three’s approach to siding with management on more governance focused topics such as remuneration and board composition, particularly when the ‘E’ and the ‘S’ are aligned with their priorities. The Head of iShares and Index Investing at BlackRock responded to the criticism and highlighted the role of BlackRock and peers in pushing towards greater disclosure with proxy votes being cast solely in line with long-term shareholder interests. He further notes that, while BlackRock is working towards ensuring its clients are able to direct how their proxy votes are cast, the decision on where to invest rests with its clients.

As ESG ratings remain in the spotlight, confusion leads to trust issues for investors

As another week passes in the ESG sphere, the sector is once again faced with concerns over ESG ratings. A recent Financial Times article outlined how governments, respective treasury departments and central banks, are looking at ways of regulating ESG ratings – focusing on increasing transparency and validity of ratings. As detailed in a number of editions of the newsletter, there has been growing momentum towards regulating ESG ratings; however, the current impetus seems to arise out of the fact that trust amongst the investment community is fast becoming a priority issue for the ESG industry. Sacha Sadan, Head of ESG at the UK’s Financial Conduct Authority, believes these concerns become augmented when investors see stocks from certain sectors, such as oil and gas, in ESG funds or with a  high ESG rating.

This divergence amongst ESG rating agencies is highlighted in a recent academic paper, titled ‘Aggregate Confusion’, which examines the difference between ESG ratings by the leading rating agencies and explores what causes the divergence amongst them. One major factor cited was the different measures that they use, which accounts for 56% of the confusion. Undoubtably this confusion in the market can lead to distrust amongst to investors as they try to deploy their capital in financial products that are aligned with ESG objectives and use ESG ratings as a basis.

Fund managers step closer towards achieving net-zero target

The Net Zero Asset Managers initiative issued a statement this week from a group of members agreeing to manage 39% of their assets in line with an overall goal of achieving net-zero emissions by 2050 across their entire portfolio. This is the latest commitment by the initiative which includes 236 members, representing a total of $57 trillion in funds under management. The initiative was established in 2020, with members agreeing to limit global warming to 1.5°C by setting interim targets to achieve an end goal of net-zero emissions across their entire portfolios. A total of 43 fund managers have now set these interim targets, including Allianz Global Investors, BlackRock Inc, and Royal London Asset Management. The latest statement follows on from an earlier round of commitments last year from a group that included Aviva Investors and DWS. Another member, State Street Global Advisors, provided insights on their rationale for committing to this initiative, stating that the transition to net zero “will secure economic benefits, which will be reflected in the risk-adjusted returns of long-term investments”. They also set out their stall in the engagement versus divestment debate, asserting that “constructive engagement and stewardship with the companies that we invest in will enable greater adoption of effective energy transition plans”. In a month that has seen significant doubt cast on sustainable investing, these commitments will be welcome news for its advocates.

Fund managers want clearer regulatory standards for climate-friendly products

Over the past years, asset managers could easily convince their clients that choosing ESG investments such as green energy and tech companies with a low carbon footprint was good for both the planet and for their financial returns. However, since Russia’s invasion of Ukraine, the dynamics have changed due to the rising valuation of fossil fuel stocks. There are three main strategies for ESG investing which can lead to different results – ESG-influenced, exclusion and impact investing. It is important that clients understand the difference between the three approaches as this will have an impact on short and medium-term performance. However, there are diverging views across the Atlantic, with European and US fund managers expressing opposite concerns over client expectations. In Europe, clients are pressuring fund managers to do more to ensure climate targets are met; while US securities law focuses on the financial best interest of clients, leaving some fund managers conflicted about their ESG investments against the current backdrop. Could fund managers be sued if they excluded a company due to their non-alignment with the Paris goals and the client was unhappy with the resulting performance? Greater clarity and clearer regulatory standards of ESG products would help investors when assessing ESG investments for their clients.

Slow progress but growing understanding of why mental health issues matter in UK businesses

CCLA, the UK’s largest charity fund manager, this week published its Mental Health Benchmark UK 100. The report aims to “provide a window on how 100 of the UK’s largest companies approach and manage workplace mental health” based on public disclosures. The report comes at a time when companies are facing growing scrutiny on the ‘S’ as investors seek material indicators driving the retention and attraction of top talent against the backdrop of a buoyant labour market. The report highlights that COVID-19 was a clear catalyst for placing mental health and well-being of staff at the forefront of executive’s agenda, and ultimately concludes that further work is needed to formalise approaches, and improve disclosures, regarding companies’ ‘S’ policies. This is further reflected in the fact that “while 93% acknowledge workplace mental health as an important business issue, only 34% of companies publish formal objectives and targets.”

The findings reflect the notably unbalanced emphasis on environmental and governance factors, as opposed to social factors, which has partially defined ESG investing to date. Social progress has been more synonymous with corporate social responsibility and stakeholder capitalism, but recent macroeconomic pressures have illustrated how material the ‘S’ is becoming, and it is clearly rising up investor’s agenda. Looking ahead, while considering the behavioural tendencies of Generation Z and Millennial workers, it is a development only likely to grow in sophistication and nuance in the years ahead.

Human rights emerging as a centrepiece on ESG agenda for businesses

Last October at the Human Rights Council in Geneva, the United Nations body for human rights passed a historic resolution which recognises access to a clean, healthy, and sustainable environment as a universal right. The resolution signals to governments and businesses that it is imperative to put human rights at the centre of the sustainability agenda. Mandatory human rights laws are gaining traction, particularly in Europe, and thus the time is now for boards to fully understand the impacts of their operations on all stakeholders, ensuring the protection of both human rights and the surrounding environment. We have seen an increasing amount of human rights climate litigations against both governments and businesses, further highlighting the growing focus on climate as a human right. A key component to understanding human rights and mitigating potential impacts starts with stakeholder engagement. Viewing your groups not as opponents but rather as partners is key and, in doing so, will also highlight the importance of diversity and inclusion, another topic which has risen up the corporate agenda over recent years.

Report finds fashion industry still not doing enough on climate

According to a new report from Business of Fashion, the 30 largest listed fashion firms must do more if they are to achieve their Paris Agreement targets and UN Sustainable Development Goals – even though some have made strides in improving their social and environmental credentials. Fashion brands are facing growing pressure from consumers and governments to show they are doing better on environmental issues. The Business of Fashion Sustainability Index 2022 analysed publicly-disclosed information on environmental targets and policies, including workers’ rights, across three categories – luxury, sportswear and high street fashion. Overall, the report finds that industry performance worsened this year as incremental progress among the original cohort assessed last year was unable to make up for the inaction among many of the newly added companies. The report concludes that the sector is at risk of losing cultural relevance and that failure to act decisively will likely destroy long-term value.

In Case You Missed It

• The U.S. Securities and Exchange Commission (SEC) has proposed two new ESG disclosure rules for funds in an effort to eliminate greenwashing. The ‘Fund Names’ rule would require ESG funds to invest at least 80% of their assets in line with ESG investment policies. The funds will not be allowed to use ESG labels if ESG is not central to their investment decisions, increasing specific disclosure requirements for different types of ESG strategies.
• Integrum ESG, an ESG data-focused SaaS company, is now offering a new SFDR Compliance solution to portfolio managers. From January 2023, the EU Sustainable Finance Disclosure Regulation (SFDR) will require funds to be labelled as Article 6, 8 or 9 depending on how sustainability factors are integrated into their investment decisions. Integrum’s new solution will help portfolio managers determine which category their portfolios fall into and assess each holding against 14 Principal Adverse Indicators.
• Following an April report by the European Securities and Markets Authority (ESMA) which revealed that ESG funds performed better, with lower costs than non-ESG funds in 2019 and 2020, ESMA conducted a study to determine the potential drivers behind this trend. It highlights several differences between ESG and non-ESG funds, such as the focus on large-cap stocks and developed economies of ESG funds and the different sectoral exposures of the two fund categories.
• Billionaire activist Nelson Peltz will join Unilever’s board and compensation committee, effective July 20. Mr Peltz also disclosed the $1.6 billion investment made by his fund, Trian Fund Management LP, making it one of Unilever’s largest shareholders. Mr Peltz said he believed the consumer goods company had “significant potential” and stressed his interest in helping the board continue the company’s sustainability work.

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