ESG+ Newsletter – 14th July 2022

ESG tested in uphill bear market

ESG funds in Europe are rebalancing portfolios to include rallying defence and energy stocks, despite the continent’s historical status as being the leading light of ESG investing. The shift in focus is reflective of increasingly bearish market conditions, and a consequence of the sector’s first real period of underperformance – evidenced by outflows for the second quarter in a row. As covered by the Financial Times, the inclusion of defence and energy stocks may not be a sustainable strategy in the long-term as new reporting requirements are introduced, notwithstanding the ammunition it provides for critics of the sector.

The impact of a bear market on ESG was covered in detail by Reuters this week, in a thematic article which framed it as the industry’s first big test. It noted two specific headwinds facing sustainability (and similar) labelled funds – the struggles faced by tech stocks, viewed widely as an environmentally-friendly sector, and how the Ukrainian war has prompted oil and gas boom. The tone of the piece was positive, however, with numerous sector experts cited in saying that ESG is poised for an upswing, and this period of difficulty was predicted and prepared for.

The news this week that “sustainable bond issuance continues to break new ground as it reaches a landmark $3 trillion total” could well be one area which is contributing to the viewpoints of those who are viewing ESG more positively. With criticism and scrutiny of corporate progress on ESG not being few and far between of late, the development that record numbers of loans are dependent on ESG KPIs, is surely a positive indicator of the direction of travel.

Investor spotlight on workforce pay

Last week, Sainsbury’s, one of the UK’s largest supermarket chains, won a battle at its AGM against a group of shareholders who wanted them to adopt a voluntary standard for employers to raise low-paid workers’ wages. The proposal, which received nearly 17% support at the AGM, would have forced Sainsbury’s to commit to wage levels calculated by the Living Wage Foundation. In advance of the AGM, Sainsbury’s urged investors to vote against the proposal, arguing that it gave too much control to a third party to dictate its wage structure, and would require the company to have a plan in to pay all of their third-party contractors the living wage as well.

As detailed in our AGM season recap in last week’s newsletter, shareholders are becoming increasingly vocal in advocating for ‘S’ issues – particularly around employee and workforce-related matters. In the past, how companies have approached these issues has been based on how they view wages in a business context – principally whether it is a net cost or an investment. As the world faces into a cost-of-living crisis, it will be interesting to see how this dynamic plays out moving forward – particularly as it is unlikely that public conversations and investor scrutiny around employee compensation will go away.

‘H’ thrown in the ESG mix for major food companies

We’ve all heard of carbon footprints, but what about salt and sugar footprints? This is a growing focus for shareholders who are pushing companies for greater disclosure on the health credentials of their products. Responsible investment lobby group, ShareAction, has asked major multinational food brands to increase their disclosure on the health credentials of their products. Unhealthy portfolios carry financial risk as many countries impose regulation to tax sugary products, with the UK set to ban the advertising of high fat, salt, and sugar products before 9pm. As with many ESG topics, a key challenge is standardised data. Many food companies use their own metrics for good nutrition, which not only lack standardisation but also lack methodological transparency. Standardising reporting will not be straightforward – food products are complex, and this complexity will need to be accounted for. For example, products that contain high levels of nutritious fibre may also be packed full of sugar. However, so far it seems health is not driving company valuations, with one major food company that has a higher proportion of healthy foods than its three closest competitors, valued at the second lowest forward earnings multiple of this peer group. As shareholders push for increased disclosure on health, and as the financial impact of new regulation becomes clear, we may see health credentials beginning to impact company valuations.

FRC updates UK corporate governance code to increase board accountability

The UK’s Financial Reporting Council (FRC) this week unveiled new rules that will strengthen board accountability for fraud and company finances. A position paper published on Tuesday sets out several updates to the UK corporate governance code, including a new framework for reporting on the effectiveness of internal controls, and updating the code to reflect wider board and audit committee responsibility for expanded sustainability and ESG reporting. New guidance on fraud reporting is expected to recommend the inclusion of minimum clawback conditions on pay for directors’ remuneration, which would lead to greater accountability for directors in the event of fraud or other financial failings. These proposed reforms will require the government to pass primary legislation for them to become legally binging. In the meantime, the FRC will be pressing ahead with making with making changes to their standards and codes. They will also be providing guidance to allow companies to lay the groundwork ahead of the imminent statutory changes and a tougher regulatory environment.

UN report suggests the value of nature must be integrated into decision making

According to a new report from scientists at the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES), understanding the true value of nature is key to addressing the global biodiversity crisis. The study details the different values of nature and how to integrate them into decision making. Co-chair of IPBES, Professor Patricia Balvanera, said, “shifting decision-making towards the multiple values of nature is a really important part of the system-wide transformative change needed to address the current global biodiversity crisis.” The report also calls for the integration of science-based valuation of nature in decision making. A related study by the Environment Agency warned 41% of England’s native flora and fauna species have significantly decreased since 1970, with 15% at serious risk of extinction. These latest studies will add significant weight to the UN convention on biodiversity which is due to be held in Montreal in December.

ECB warns that Eurozone banks are underestimating the hit from climate change

The European Central Bank’s (ECB) debut climate stress test has found that Eurozone banks are poorly equipped to measure the risks of global warming on their loan books and are underestimating the losses they are likely to suffer. According to the stress test, an estimate of €70 billion of losses from the short-term impact of higher carbon emission prices and extreme weather events that was provided by 41 banks involved in the test “significantly understates the actual climate-related risk”. Overall, two-thirds of the 104 assessed banks scored poorly in their capabilities for assessing the risk of global warming. However, campaigners criticised the central bank for not being tough enough, stating that the stress tests failed to account for the higher cost of energy triggered by the war in Ukraine, and that the ECB should consider changing the rules for future climate stress tests, including potentially adding a severe economic downturn. The exercise also revealed that many banks lack the data and models needed to effectively measure climate-related risk. Given a similar exercise by the Bank of England in May showed that banks and insurers who fail to manage climate risk could see a 15% hit to their annual profits, there may be a high price to pay for banks who fail to address this gap.

In Case You Missed It

• “Companies should prepare themselves for the inevitable ISSB standards” warns KMPG China and CLP Holdings. With the ISSB’s new international standards for ESG reporting expected to be introduced next year, the process of corporate climate risk and sustainability reporting will become more standardised. With only 17% of companies in Hong Kong currently conducting a climate change risk and opportunities analysis, and 86% of companies not currently setting a climate-related business transition, Hong Kong business will likely be required to enhance their current sustainability reporting framework.
• India introduces single-use plastic ban to manage pollution generated from unmanaged waste. With estimated annual plastic waste production levels at 3.5 million tonnes per year and per capita waste generation almost doubling over the past 5 years, the Government of India have now banned single-use plastics and, by the end of the year, will ban plastic bags below a certain thickness. This ban has come into effect immediately and the government has also stated their intention to set-up enforcement teams, ensuring implementation and compliance.
• A recent report from Janus Henderson Investors has analysed the diverse range of decarbonisation efforts across Asian nations. While they concluded that 75% of Asian countries has set net zero targets, their respective timeframes spanned significantly from 2030 (Maldives) to 2070 (India). Additionally, the regional decarbonisation rate at 0.9% currently sits notably behind the global average of 2.5%. However, with China, India and South Korea dominating Asia’s decarbonisation movement, there is hope they can pave the way for more progressive decarbonisation efforts across the rest of the continent and other emerging economies.

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