ESG+ Newsletter – 02 November

Debate continues as to the merits of ESG or Green investing  

On the back of £2.5 billion in outflows from ESG funds since May, The Daily Telegraph published a long article arguing whether this is the beginning of the end for ESG investing. The article points to a 25% drop in renewable energy investing, a reduction in the number of new sustainable funds that have been launched this year, and an increase in energy index prices over the same period. Some of these trends may reflect the macroeconomic backdrop though. Rising interest rates have increased the cost of capital, while strong demand and price strength for oil has been driven by several factors. Whether ESG has reached its saturation point or not, the rapid growth in demand over the last number of years for ESG funds and products has resulted in ESG investing transitioning from a niche capital deployment opportunity on the fringe to becoming an established part of the capital markets landscape. As a result of this, ESG funds must fight just like every other sector in the capital markets to attract capital. 

Some of the concerns highlighted by the author, such as greenwashing, transparency of where capital is being allocated and market confusion regarding the definition of ‘ESG’, are legitimate questions that ESG investing, or whatever it evolves to, must address. As history has shown though, financial markets are cyclical and are subject to swings and volatility; basing the demise (or the virtues) of ESG investing on the increase in outflows over a short period may not tell the full story. Only time will tell whether the contraction in ESG reflects a broader shift in investors view of ESG or whether ESG investing is just another part of the capital markets top table.  

Are investors moving from ESG to impact? 

Indeed, maybe ESG is dying, but not in the way its critics envisioned. According to Michael Loukas, CEO of TrueMark Investments, “The days of simply gathering AUM based on ESG philosophies seem to be behind us”. Chicago-based ETF provider TrueMark Investments has $195.9m in AUM and is seeing a shift away from ESG investing, towards impact investing. There appears to be a greater interest from individuals in using their investments to make a difference, even where that may mean forgoing a proportion of returns. Financial adviser Darren Lloyd Thomas, managing director of Thomas and Thomas, says he has seen a distinct rise in clients wanting to use their investments to create a positive impact on society and the environment. Globally, impact investing is growing, with the Global Impact Investing Network reporting that impact assets under management had surpassed $1trn for the first time. While this increase in impact investing may be a good thing for society and the environment, will it actually replace ESG investing? ESG and impact investing represent two different approaches, with ESG investing primarily focused on taking ESG factors into account, where impact investing is focused on the outcomes of an investment. As the backdrop of the anti-ESG movement gains traction in the US, and to a more limited extent elsewhere, it is interesting to see movements away from ESG towards both an anti-ESG rhetoric and impact investing, simultaneously. 

Fund market update points to potential misalignment with Taxonomy

There is a lack of alignment between the European ESG fund market and the European Union’s taxonomy, according to research covered by Responsible Investor. Novethic’s publication, which is based on Morningstar data, concludes that of the 2071 Article 8 and Article 9 funds studied, only 7% and 28% respectively reported taxonomy aligned investments information. While the research expressed its disappointment in the data, there may be a key driver underpinning it: the current lack of available company level taxonomy data makes it extremely difficult for funds to report. There are some funds, those classified as Article 9 most frequently, that are more mature; however, it realistically will not be until next year, when companies will be required to disclose taxonomy alignment of activities, when the picture may become clearer. This is covered in Morningstar’s quarterly  SFDR report, which remains the gold standard for detailed insight into ESG investing.  

The more notable of those insights include that 99% of the Article 8 and Article 9 fund universe are acknowledging the Principal Adverse Impact indicators, while 89% and 98%, respectively, have stated they consider the PAIs in investment decisions in one way or another. There have also been 250 SFDR upgrades from Article 6 to Article 8 funds over the quarter, with 280 total reclassifications. This is interesting given the ESG market is proving to be highly exposed to macroeconomic pressures, with significant outflows in the quarter. It shows the underlying demand for the products, with asset managers happy to pursue these strategies – perhaps looking ahead to times that are more friendly to equity markets while acknowledging longer term regulatory and policy tailwinds. 

SEC chair speaks on emissions reporting and investor interests  

Last Thursday, the SEC chair Gary Gensler sat down with an executive vice president from the U.S. Chamber to discuss the SEC’s climate proposal rules and the implications of those rules. In addition to discussions on California’s climate disclosure law and the EU’s impending regulations, Gensler focussed his responses on emissions disclosure as a means of standardising reporting. Gensler reiterated the value of consistency and comparability in public companies’ disclosures for investors. ESG Today highlights that Gensler discusses the disclosures rules comment period, and that the SEC received indication from investors that there is value in understanding emissions that come from supply chains. These emissions would be considered scope 3, and although there has been major push back, with critics citing difficulty in measurement and factors outside of their control, the latest discussions indicate that the SEC does not intend to remove scope 3 requirements from the disclosure rule. Regardless of where the SECs final rule lands, many companies will have to disclose their scope 3 emissions because of requirements in California ruling or from the CSRD in Europe.

IESG tool to reduce investment gap in emerging markets 

The Future Investment Initiative (FII) Institute has introduced an “Inclusive ESG Tool” and an accompanying “Inclusive ESG Score” to enhance ESG data quality in emerging markets and enable companies to attract financial investments as reported by Yahoo Finance. While global sustainable investments have surged, emerging markets receive less than 10% of ESG capital flows, despite contributing 58% to the global GDP. The tool aims to reduce the $5.4 trillion ESG investment gap in emerging markets. It provides metrics tailored to the unique challenges of these markets, emphasizing industry risk and promoting transparency and accuracy in evaluation. The initiative was unveiled at the FII flagship conference, FII7, in Riyadh, last week and aims to direct ESG funds toward emerging markets where they can make a significant impact while ensuring market vitality.  

Brazil has announced mandatory sustainability reporting in line with the ISSB 

Public companies in Brazil will be required to provide annual sustainability and climate-related disclosures, starting in 2026, following the announcement from Brazil’s Securities and Exchange Commission (CVM), as reported by ESG Today. The announcement unveiled plans to incorporate the International Sustainability Standards Boards’ (ISSB) requirements into Brazil’s regulatory framework, first on a voluntary basis in 2024, before becoming mandatory in 2026. The move comes less than four months after the launch of the requirements globally, with Brazil now joining “the ranks of Latin American nations that have mandated sustainability-related financial disclosures”, such as Chile and Colombia, and represents the latest salvo of support for ISSB standards. 

The new reporting requirements form part of Brazil’s green transition plan, announced in July this year, with initiatives including “carbon trading, the bioeconomy and infrastructure adaptation across six policy areas.”  These steps are expected to improve the overall governance and reporting environment in Brazil, through greater transparency and focus on sustainability and ultimately “attracting global investment and fortifying the nation’s capital markets”. 

The business case for gender diversity in the workplace 

A recent BlackRock study of around 1,250 large global companies found that those with more gender-balanced workforces performed better financially than less balanced peers over the period from 2013-2022. Companies with mid-range gender parity saw average 7.7% return on assets versus 5.6% for male-dominant firms and 6.1% for female-dominant ones. The study suggests gender diversity, especially in key roles, can create a strong company culture and policies that support women, translating into higher employee retention and better decision-making. The large-scale research bolsters the argument that pursuing gender equity is consistent with fiduciary duty to maximise returns. This study supporting gender diversity’s positive impact on returns is timely amid criticism of ESG investing by those who claim it strays from the duty to maximize returns. 

ICYMI 

• World Benchmarking Alliance to launch nature engagement initiative in 2024:  The collective Impact Coalition (CIC) is focused on engaging firms on nature. Target companies will be drawn from the 769 companies assessed so far, with many others to choose from. These companies include metals and mining, food and agriculture, pharma, and chemicals. This is a fundamental step in terms of credible action, and it will liaise with NA100 to avoid duplication.   
• South Pole walks away from voluntary carbon project: South Pole registered the Kariba project aiming to reduce emissions from deforestation and forest degradation while offering biodiversity and local community benefits (REDD+) – in 2021. However, early 2023 South Pole suspended sale of credits from the project following reports that the number of emission savings it generated may have been overstated. South Pole now said it was “disappointed with aspects of how the project was managed on the ground by the project owner”. 
• Ireland has potential to be a global leader in developing sustainable aviation fuel: Ireland faces a significant opportunity in the aviation industry. Sustainable aviation fuel (SAF), with its potential to drastically reduce emissions, holds the key. A study indicates that by 2050, Ireland could generate over €2.5 billion in revenues and 1,000 high-skilled jobs through SAF. Achieving this potential requires substantial investment in renewable energy, government-industry collaboration, and legislative support. SAF is a crucial element in aviation’s journey to sustainability, and Ireland can be at the forefront of this change with the right policies and investment.