ESG & Sustainability

ESG+ Newsletter – 9th December 2021

Your weekly updates on ESG and more

This week’s ESG+ again highlights the market’s emphasis on driving change within companies – to place greater focus on environmental and social responsibility – overseen by an ever-stronger governance framework. This is undeniable and has been a thread through almost every newsletter this year. That said, as things slowly evolve, investors still see opportunities in ‘fuzzy’ ESG data to identify potential out-performers; or in ‘gender-lens’ investing. We also take a look at the increased pressure that will be applied on company gender practices, banks funding the energy transition, auditing ESG and how the SEC is facilitating more shareholder proposals at companies.

Norges CEO lays down an ESG marker

Nicolai Tangen, CEO of Norges Bank Investment Management, which has $1.4 trillion of assets under management, this week warned that companies who fail to adapt to the new ESG landscape will be hit hard – facing significantly increased scrutiny. In fact, Bloomberg quotes Tangen as saying that “Firms that don’t adapt face a world in which financing will dry up, insurance companies will walk away, employees will defect, social-media shaming will intensify and customers will disappear”.

Tangen outlines that he intends to apply more pressure on bigger companies with poor ESG scores who are failing to meet their ESG responsibilities and, if that fails, then shareholder voting dissent awaits those laggards. It is clear from Norges’ perspective that they plan on using their sizeable voting rights as a tool to influence change. This form of activism – more commonly referred to as ESG activism – is becoming more popular with investors and we have looked at this new phenomenon in a previous newsletter. What is clear is that more investors are willing to engage companies (and in a more public way) across a variety of ESG-related campaigns – working to entice, if not force, companies to address their environmental and social impact.

Opportunities, Fuzzy Data and Telling the Truth

Against a backdrop of diverse but evolving ESG reporting standards; and as regulators fine tune their reporting requirements for issuers’ emissions and workforce demographics, sustainability-focused investors believe that there remains a great opportunity for those who do their research. A Reuters article notes that “disparate reports from many companies give portfolio managers the chance to dig deeper” – providing potential for identifying rewarding investment opportunities. This offers the opportunity for companies who have strong reporting to differentiate themselves. As companies become subject to increased scrutiny, and information becomes more widespread, issuers will need to continue to place significant focus on reporting and disclosure, as well as engagement with shareholders, to ensure that the right information is being fed to the market. However, there is an opportunity to steal a march and differentiate from peers – in what Reuters describes as a world of “fuzzy data”. For those that do not put their ‘best-foot-forward’ in their reporting, there is a warning from Julie Gorte of Impax Asset Management:  “For companies the watchword is, look, people are going to find out stuff about you, whether you tell them or not. If you want them to know what the truth is, tell them.” 

Funding the energy transition

Large global banks have helped fossil-fuel companies issue almost $250 billion in bonds so far in 2021, a figure which matches the average annual fundraising for the industry in 2016. This is despite the fact that the International Energy Agency suggested the need to cut all funding for new oil and gas to avoid the worst impacts of climate change. The banks argue that legacy energy needs support to transition to new sources of energy. How quickly the world transitions and how fast lenders can assist in financing the transition, will play a major role in determining how bad the climate catastrophe might be. The world is still on track for a 2.4-degree Celsius warming by the end of the century, which is further adding to the pressure the banks face. Striking the balance between earnings and climate goals will become a key issue in how successful we are in the fight against climate change.

The growth of gender-lens investing

A growing number of investors are homing in on ‘gender-lens’ investing which prioritises companies with greater female representation on boards and in senior positions, and whose pay and work policies are equitable to women. Advocates for these funds point to evidence that greater gender diversity is linked to higher share price, better risk management and reduced fraud. CNBC reports that approximately $3.6 billion is currently invested in funds that are focused on this strategy. While this represents a small fraction of the $330 billion invested in ESG in the US, it has been growing in the past five years with eleven new gender-lens funds emerging since 2018 and four of those in the past year.

Performance of gender-lens funds is mixed but there are some successes such as the Pax Ellevate Women’s Leadership Fund which was established in 1993 and whose assets have doubled from $500 million to $1 billion in the past 20 months.  For many funds, their purpose is not financial return but to advocate for greater gender representation. For example, Fidelity Women’s Leadership Fund only tracks companies where at least one-third of the board is female. While investment strategies may bring greater scrutiny of gender representation, they are just one part of the solution – imminent legislation will likely bring more significant changes.

Goldman Sachs details new Board ethnic and gender expectations

Sticking with the issue of gender and diversity, last week Goldman Sachs Asset Management (GSAM) announced that it has updated its proxy voting policies to increase diversity expectations for public company boards. Beginning in March 2022, GSAM will require S&P 500 and FTSE 100 companies to have at least two women on any board with more than 10 directors and to have at least one diverse director from an underrepresented ethnic minority group on their board. For companies that do not have the minimum number of female and minority board members, GSAM will vote against members of the board’s nominating committee. Commenting on the decision, Heather Miner, GSAM Chief Operating Officer, said that “the latest enhancements to our voting policy will keep Goldman Sachs Asset Management at the forefront of driving greater diversity and inclusion on boards around the world.” This decision taken by GSAM sees them join other global asset managers and countries who are trying to force companies to move away from their all-male boards. It is clear that companies that don’t diversify their boards will be increasingly marginalised and it is likely to seriously impact their licence to operate.

The task of Auditing ESG

This week the Journal of Accountancy outlines that, since they must take into account ESG factors when they have a material effect on financial statements, preparers and auditors of those statements must remain fully apprised on evolving ESG requirements. With the formation of the International Sustainability Standards Board, and the SEC planning to unveil a mandatory climate risk disclosure rule proposal early next year, auditors are advised to be proactive in improving their ability to identify the risk of material misstatements when it comes to “ESG issues”. This requires both understanding ESG factors within a company as well as the broader regulatory and business landscape. In this context, the Association of International Certified Professional Accountants has published an ESG practice aid that addresses the auditor’s consideration of climate-related matters in audits of financial statements. The document highlights what auditors must know about management’s policies and procedures and sheds light on how they may consider and evaluate management’s response to climate-related matters in an audit of financial statements conducted in accordance with auditing standards generally accepted in the United States (GAAS). What is clear is that as companies evolve ESG reporting to match the expectations of regulators and investors, auditors will equally have to be better equipped to scrutinise and validate that reporting – effectively becoming the scrutineers of ‘greenwashing’.

Artificial intelligence, data governance, and human rights

The use of artificial intelligence (AI) and machine learning for decision-making and problem-solving has led to greater efficiencies, new insights, and the potential for solving major global problems such as climate change and pandemics. However, a significant risk with AI is that it can contribute to, and reinforce racial, gender, and ableist inequalities by building biases into its algorithms or by being based on non-diverse datasets and there is a lack of regulatory or governance frameworks to address these issues.

While there are regulations in place to protect personal data and privacy, most notably GDPR, they are focused on the privacy rights of the individual. They do not take into account how algorithms make decisions or how datasets are built. There are several movements underway that aim to advance AI but in a way that respects human rights and democratic values. 42 countries have signed up to the 2019 OECD principles on Trustworthy AI, while more recently the UNESCO 41st General Assembly adopted its ‘Recommendation on Ethics in AI’. While there are no firm regulations in place, the potential harms of AI are becoming clear and organisations should ensure they are developing and using AI in a responsible and ethical manner.

New SEC Guidance Will Accelerate E&S Shareholder Proposals

On November 3, 2021, the Division of Corporation Finance at the US SEC, issued new guidance that shifted the SEC’s traditional interpretation to no-action requests, which is a request submitted by companies to try to exclude certain environmental and social shareholder proposals. Previously, the SEC allowed a company to exclude a shareholder proposal if the company demonstrated that it did not have social or ethical significance “for the company”. Under the new guidance, a company will need to show that the proposal in question does not raise significant social or ethical issues “with broad societal impact”. The big implication is that the higher threshold to exclude proposals will result in far more E&S shareholder proposals making it onto the agenda of a company’s shareholder meeting. The development largely follows actions at the Democratic-leaning SEC, chaired by Gary Gensler, to involve itself in more sustainable initiatives. Similarly, the SEC is preparing a proposed rule to be released early next year that will likely mandate some form of company climate change disclosure. However, unlike the climate rule, the new guidance from the SEC on no-action letters is just that—guidance—which means that any subsequent SEC administration can reverse the new threshold as they choose, whereas reversing a codified rule would require a more laborious process of initiating a new rulemaking. For now, however, we expect E&S proposals to accelerate during the 2022 proxy season, in line with the new guidance and a more sustainably-minded SEC.

In Case You Missed It

  • COP26 drives a record £1.5 billion (US$2bn) in inflows in ESG funds in November, Reuters reported. According to fund network Calastone, COP26 climate talks spurred investor interest in sustainability, with investors particularly interested in companies who have committed to COP26 climate agreements.
  • Newmont, one of the world’s largest gold miners, is the first mining industry company to issue sustainability-linked bonds.   Bloomberg reported that Newmont sold US$1 billion of bonds giving it a financial incentive to cut emissions and improve corporate governance.
  • AB InBev announced its commitment to achieving net-zero emissions across its value chain by 2040. The company approach to achieving its goals includes working with suppliers, retailers, and start-ups, as well as engaging with farmers in its supply chain.

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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.

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