ESG & Sustainability

ESG+ Newsletter – 16th December 2021

Your weekly updates on ESG and more

In our final ESG+ newsletter for 2021, we look at the growing scrutiny on Wall Street and the parallel growth in regulation which is likely to convert increased scrutiny into enhanced reporting. In addition, an interesting story on the ‘ESG Mirage’ asks the question as to what is really driving ESG ratings and whether they are really tracking (or incentivising) improved behaviour. On the issue of investor action, we look at the scrutiny on pay practices and how that may continue to translate to ESG; and the pressure on investors to be responsible stewards of capital. We also cover new EU climate legislation; further scrutiny on auditors; and Norges’ continuing agenda to migrate from perceived ‘higher risk’ ESG companies.

We would like to thank all our readers for their interest during 2021 and wish everyone peace and happiness for the holidays and New Year.

The ESG Mirage

Earlier this week, Bloomberg released a long read called The ESG Mirage. The article points to the shortcomings of ESG ratings, and the common misconception that ESG ratings measure the impact of an organisation on the planet and society. Instead, the authors argue that ESG ratings do not measure a company’s impact, instead measuring the potential impact of the world on the company. This means that rather than guiding investment into companies that are improving their impact on the planet and society, ESG ratings direct investment into companies that are less exposed to the risks associated with environmental and social changes. Bloomberg investigated 155 of the rating upgrades for S&P 500 companies awarded by MSCI, the world’s most prominent ESG ratings agency. Many of these upgrades were made based on changes in methodologies, with only one upgrade made based on reduced greenhouse emissions. In fact, some of the organisations analysed that received rating upgrades actually increased emissions year on year.

Whilst ESG ratings have supported an increase in ESG investment, it is incredibly important that investment decisions are made based on transparent information. Without transparent ESG ratings that reflect the impacts of an organisation on the planet and society, global capital will not be directed into investments that support this transition. Without improved, transparent rating systems and increased scrutiny of ESG investing, the “ESG Mirage” will continue.

Growing scrutiny on Wall Street as greater disclosure and regulation looms

Earlier this week, a study published by the Sierra Club and the Center for American Progress argued that we are heading towards a climate bubble and the potential collapse of the financial system unless regulators address Wall Street’s contribution to the climate crisis. The report highlighted that eight of the biggest US banks and 10 of its largest asset managers, combine to finance an estimated 2 billion tonnes of carbon dioxide emissions, which would represent the fifth largest contribution of any nation in the world. The report also detailed that disclosure, appropriate oversight, and regulation are key steps in mitigating the climate related financial risks.

But how close are we to the introduction of climate disclosure and regulation frameworks?  In the US, the SEC is currently working towards finalizing their proposal for additional ESG disclosure, with some indications that a climate reporting framework may come in Q1 2022. However, it is also expected that companies will not have to start providing the information immediately, with the expectation that there will be a 9-12 month timeline for its introduction. Europe’s position at the forefront of introducing sustainability targets and ESG disclosures for companies over the past year was further strengthened this week with the passing of the EU green taxonomy into law. The new rules, which will come into effect on 1 January 2022, and are viewed as crucial in assisting the region to meet its ambitious climate targets, will provide a labelling system for green investment and outline the sustainable criteria for a variety of sectors, including renewable energy, car manufacturing, shipping, forestry and bioenergy. The long-awaited uptick in regulatory focus will be welcome across the investment community, particularly as investors clamour for greater transparency in relation to companies ESG disclosures.

The importance of proxy voting in ESG

Well before the scrutiny on ESG came to the fore, spats over pay had been commonplace. Often seen as a window into Board practices, most companies have – at least once – faced pressure from investors on pay practices and incentive structures. Lex’s opinion piece in the Financial Times argues that investors have been ineffective in addressing concerns over pay, with the gap between the top and bottom of companies growing despite rhetoric from market participants. While we’ve seen significant growth in ESG measures in pay, one wonders whether pay itself may become a more prominent ESG metric.

On a similar note, in its report ‘Voting Matters 2021’, ShareAction took aim at the voting records of some institutions on both ‘E’ and ‘S’ related proposals. The report, which includes interesting statistics on how often asset managers voted in line with the two major proxy advisors, asks institutions to not only increase support through proxy voting but also in co-sponsoring shareholder proposals where progress is not fast enough. The increasing traction ShareAction is getting speaks to the pressure on companies to change from a host of stakeholders, as well as the focus on whether asset managers are being proactive (and responsible) stewards of capital.

FTI Perspective: Human rights and growing supply chain risk

Following world Human Rights Day, which took place on December 10, our own Nick Wood penned a piece on the growing importance of protecting human rights in the supply chain. The article, reported on by the South China Morning Post, discusses how the growing focus on ESG across the globe means that supply chain risks are becoming increasingly pronounced. While human rights risks are meaningful in every jurisdiction, Nick points to the factors making it a particularly prevalent risk for businesses in the Asia Pacific as well as those with operations there, including migrant labour issues and the heightened focus from US authorities on “forced labour.”

Lack of investor trust in ESG ratings

A new survey by PWC echoes concerns around ESG ratings – indicating that around 60% of investors do not trust the ESG information coming out of ESG rating agencies, leaving only a third of investors believing the quality of the information is good. The results come at a time when several thought leaders are criticising ESG rating frameworks, including EY’s global vice-chair for sustainability Steve Varley who called the current landscape an “alphabet soup”, and where corporates see reporting as a compliance-based activity.

PWC’s research also revealed 74% of investors have an issue with ESG rating agencies all using different metrics – creating difficulties in comparison. Investors believe decision making would be better informed with a single ESG reporting standard, a theme which continues to dominate the ESG landscape.

Finally, when investors were asked what the most important ESG issue is for companies to prioritise, the overwhelming majority said reducing GHG emissions in line with climate science. This clearly shows the climate agenda has become a top priority (and the emphasis on science-based targets) though does risk some climate ‘tunnel vision’ to the exclusion of other key ESG issues.

Mandatory disclosures are needed to meet SDGs

Sticking with the issue of disclosure and transparency, a new report published by the Impact Taskforce (ITF), an independent body that was created under the UK presidency of the G7, states that the G7 nations must mandate sustainability disclosures in order to deliver on the UN SDGs and meet the goals of the Paris Agreement. The report outlines that making the disclosure mandatory would lead to an increased flow of private capital towards a positive ESG-related impact. Ultimately, the transition to mandatory climate disclosures should be led by the G7 and the private sector. The two groups, along with standard-setters and academia, can work together to improve approaches to impact value. Moreover, the value of private companies should not only be linked to profit but also to environmental and social impact. Mandating disclosures would also aid investors in evaluating the ESG performance of companies. Douglas Peterson, President and CEO of S&PGlobal and Chair of this specific ITF workstream, added: “Transparent and comparable standards will be an essential tool for market participants to evaluate and optimise their impact.”

New EU climate legislation against the backdrop of higher energy costs

Five months on from the publication of the first part of the ‘Fit for 55’ package of legislative proposals, the European Commission this week unveiled several additional proposals aimed at reducing the EU’s emissions. The proposal seeks to amend key pieces of existing energy legislation and include new rules for decarbonised gases, tougher restrictions against methane emissions, a plan to scale up carbon removals and more ambitious building renovation objectives. The proposals also aim to transform aspects of the European transport sector, including supporting the development of rail and boosting sustainable urban mobility. Although they are meant to complement the initiatives published in July, these new proposals are unveiled amidst a different political context, defined by a renewed focus following COP26 and the arrival of a new German government but also by the unprecedented increase in the Emissions Trading System’s carbon price. European policymakers are therefore treading a thin line between a clear political push for greater climate ambitions and the political sensitivities linked to the consumer and social effects of higher energy prices.

Auditors risk possible legal challenge on lack of climate reporting

Following last week’s story on ESG and trying to audit the impact on financial statements, this week, ClientEarth, a non-profit focused on environmental law, said that ‘big four’ auditors may face legal challenges for failing to consider climate risk in their audits. In a letter to the big four, they outline that auditors are continuing to ignore the financial impact of emissions reduction targets, regulatory changes, and reduced product demand. They cite research from Carbon Tracker that found that 80% of auditors did not disclose whether they consider climate risk. In addition to breaching legal requirements, ClientEarth claims auditors are also failing to meet investor expectations and may threaten the integrity of the market as they are eroding trust in corporate reporting. They also point out that all four audit firms publicly claim to have extensive awareness of climate-related risks. ClientEarth is calling on the big four to address material climate risk in financial audits from 2022 onwards and to alert companies that they intend to apply stricter standards. This is not the first time that ClientEarth has faced down auditors – earlier this year they put two of the big four on notice for failing to call out the omission of climate risk in their clients’ accounts. It remains to be seen whether they will take any further action.

Norges ratchets up divestments based on ESG risk

Last week we highlighted that Norges Bank CEO, Nicolai Tangen had laid down an ESG marker for companies. This week, Bloomberg reports that Norges has offloaded almost 370 stocks since 2012 as a result of the potential ESG risks these stocks represented. Norges has recently put in place a new ESG pre-screening process on which it will base its investment decisions. It has since blacklisted nine companies that would have otherwise been automatically added to its portfolio based on the benchmark it follows. The fund screens for a range of ESG risks including climate change, ocean sustainability, children’s rights, human rights, tax and transparency, anti-corruption, water management and lately also biodiversity. Last year, the fund was divested from over 30 companies, following their ESG risk assessment, though the names of these companies were not disclosed. The new ESG filter is based on the principles of Norges’ risk-based divestment policy, in place since 2012, which the Chief Risk Officer has described as a strategy that has “traditionally been profitable”.

In Case You Missed It

  • The total number of climate disclosures at CDP are up 38% in 2021, Reuters reported. The data also shows that, since the Paris Agreement of 2015, the number of companies filing with CDP has more than doubled to 13,132 from 5,532. The principal driver of disclosure is investor and policymaker pressure being placed on boards.   
  • Goldman Sachs has teamed up with the Queen Mary University of London to train apprentices on its trading floor to boost diversity in the financial sector. The announcement comes nearly a year after the UK Treasury and the Department for Business, Energy and Industrial Strategy launched an independent task force to address a lack of socioeconomic diversity across financial and professional services.
  • Oil and gas majors are struggling, and competing, to recruit talent as the world shifts to a greener future, the Financial Times reported. Fossil fuel companies have faced scrutiny in their university recruitment strategies, with students demanding that such companies should be banned from “advertising” their job positions. These incidents show an enduring challenge for the sector as they compete to recruit and retain the talent they need to drive their green agenda.
  • COP26 has underlined the crucial role universities have to play in tackling climate change, according to Emily Shuckburgh, director of Cambridge Zero at the University of Cambridge and co-chair at the COP26 Universities Network. In her most recent article, Shuckburgh said that all the goals agreed at Glasgow require researchers to deliver essential technology at scale, which will require universities to be at the forefront of innovation by delivering climate action response in their own campuses and also decarbonisation of their own operations.

 

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The views expressed in this article are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.

©2021 FTI Consulting, Inc. All rights reserved. www.fticonsulting.com

 

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