ESG+ Newsletter – 12th January 2023

As ESG reporting increases, so too must board oversight

A recent report published by Deloitte and Center for Audit Quality highlighted that there is increased concern amongst audit committee members regarding the potential for the inclusion of fraudulent or inaccurate disclosures in companies’ ESG reporting. As ESG reporting has grown and developed, so too have the risks associated with disclosure. Ultimately, companies must be comfortable that all aspects of reporting were subject to rigorous evaluation so that it can be relied upon by markets and wider stakeholders. One effective measure to ensure robust procedures are in place is to increase the direct role of Board oversight of any ESG disclosure, in the same way that audit committees oversee financial statements prior to their publication. Over half of the companies in the FTSE100 have created an ESG committee at the Board level, reflecting how companies are embedding ESG across their risk infrastructure and the volume of ESG capital companies are seeking to attract.

The challenge for companies remains that, with ESG reporting being in its relative infancy compared to financial reporting, it lacks an industry wide agreed upon reporting framework. Despite this, investor expectations are for companies to report both accurately and transparently their ESG risks and targets. While the creation of ESG or sustainability committees might be the answer, there is also a growing argument that if ESG data is to be viewed as equally important to financial figures, maybe ESG oversight should be integrated into audit committee processes.

Behavioural economist seeks to expand workforce strategy evaluation

Efforts to improve the measurement and reporting of employee motivation have been gathering pace and will likely see increased focus through 2023. Workforce reporting has traditionally been focused on simple measurements, such as gender pay gaps, living wage commitments or ratios of executive pay to the median of the workforce. While those data points remain important, their usefulness may be blunted if evaluations do not review how workers feel about the data points and their work life. To address this gap a behavioural economist, Dan Ariely, has come up with a metric called the “Human Capital Factor” (HCF).  The metric combines internal survey data with public data from services such as Glassdoor to determine employees’ motivation and what they call “psychological safety”. JP Morgan analysts have endorsed the HCF by highlighting how high HCF scores have a positive correlation with companies’ share prices; an annualised return of 6.9 per cent above the MSCI USA index between 2009 and 2020. The HCF has also caught the attention of some fund managers who have developed ETFs comprised of companies with strong HCF scores. With investors showing more engagement in behavioural psychology and clamouring for ways to truly evaluate non-financial factors, it may be time for companies to take a more scientific approach to develop workforce strategies.

ESG litigation to raise bar of accountability

Could 2023 be a “watershed year for climate litigation”? The Guardian believes so, having penned a look ahead for the year through the lens of the significant numbers of climate lawsuits that have been filed across the globe. The article spotlights a particular case whereby a group of young people are facing off against the state of Montana, for failing to protect their constitutional rights – “including the right to a healthy and clean environment, by supporting an energy system driven by fossil fuels”. 

The read across for businesses is two-fold. The first relates to so far unseen levels of accountability on a company-by-company basis via justice system scrutiny, and the second is of real change in the writing and interpretation of relevant laws and regulations. With listed companies continuing to be under the shareholder magnifying glass for all things sustainability; supply chain impacts coming more into focus; and employees focusing on the role their employers play in society, litigation represents the latest traditional tool being used by stakeholders to spur fundamental change in how companies act. While commitments and strong engagement may get companies out of certain binds, there is nowhere to hide if courts start forcing governments and companies to change how they treat stakeholders and the environment. In that sense, 2023 may not only be a watershed year for climate litigation but in genuine responsible business delivery as a whole.

Water is life (and a stewardship priority)

While much of the debate regarding the “E” component of ESG has been focused on climate change, there has been growing awareness of the importance of preserving biodiversity and, recently, water. The United Nations Biodiversity Conference, COP 15, ended with the announcement of the Global Biodiversity Framework which includes ambitions regarding the importance of protecting water as a key enabler of protecting nature. The impacts on water quality and quantity present a significant risk to “corporations whose activities depend on freshwater and the services healthy ecosystems provide”, but also represent a risk to investors, whose ability to generate value for shareholders depends on the functioning of these healthy ecosystems.

To guide investor action, the Valuing Water Finance Initiative was launched in August 2022, and sets out six science-based actionable expectations, that provide investors with the framework to engage with 72 companies with “a high water footprint to value and act on water as a financial risk and drive the necessary large-scale change to better protect water systems”. BlackRock has also published its approach to engagement on natural capital – a discussion which has become increasingly focused on freshwater, oceans, land, and atmosphere – to understand companies’ policies and approach to topics such as water scarcity, waste disposal, and the development of any water-efficiency solutions. Water safety is as important to global health as it is to the creation of a sustainable biodiverse world. Understanding the clear threat that climate change poses to biodiversity, and the important role of biodiversity in the transformation of carbon, failing to address issues is a growing risk for companies and investors.

ICYMI

• A new ESG law has come into force in Germany. From January 1st 2023, the German Supply Chain Due Diligence Act will require any company that supplies German firms to check their supply chains for social and environmental risks. The ramifications of this law are significant not only for the UK but on a global scale, as businesses around the world must get to grips with these latest legal requirements.
• Will heating our homes with hydrogen be the future? As plans are drawn up to inaugurate the UK’s first-ever hydrogen village, some argue that hydrogen will be fundamental to the net zero transition, whilst others are more sceptical of how big a role hydrogen will play in the future of our homes.
• The top seven ESG trends to watch for in 2023. From the escalating energy crisis and new disclosure frameworks to an increasing focus on biodiversity and the ‘E’ in DE&I, the ESG landscape looks set to continue to evolve rapidly, according to Edie.
• ESG credit risks are on the rise. Amid political and economic uncertainty stemming from the COVID-19 pandemic and Russia’s invasion of Ukraine, the credit rating agency Moody’s announced that credit risks are expected to rise across a range of sectors in 2023.

Gain insights and stay informed on ESG, sustainability, building back better or on any industry or topic that interests you here. To be added to the distribution list for our ESG+ Newsletter, please click here to input your details or email [email protected].