ESG+ Newsletter – 08 June 2023

EU eyes conflicts of interest crackdown in ESG ratings rules

ESG ratings agencies may face fines for conflicts of interest under new EU rules set to be proposed by the European Commission next week amid wider efforts to regulate the industry and reduce greenwashing. Any ratings provider that operates within the EU, including those based outside the bloc, will be required to certify with the financial regulator and divest from any activities that may be conflicting, including consulting or insurance services provided to businesses that they rate. Failure to comply with these rules could result in penalties of up to 10% of annual turnover. The EU expects that 59 ratings agencies will fall within its regulatory scope.

Efforts to regulate the ratings industry follow the International Organisation of Securities Commissions call on global regulators to focus on data providers in 2021. Alongside proposed EU regulation, action has already been taken in other markets with the Securities and Exchange Board of India proposing a regulatory framework in February this year, while the UK Treasury is considering giving more formal power to the UK regulator which is currently drafting a voluntary code of conduct. It remains unclear how ratings agencies within the EU will respond in anticipation of these new rules, though the Commission’s wider efforts to combat greenwashing are triggering many agencies and other corporates to re-examine their practices.

CSDDD moves forward as CSRD gets scaled back

The Corporate Sustainability Due Diligence Directive (CSDDD) has taken a step forward as MEPs voted in favour of the directive in the European Parliament. Under the directive EU companies will be accountable for human rights and environmental violations along their value chains. While several MEPs had been opposing key parts of the report, most of these amendments were rejected by Parliament. There was one notable victory for the opposers, however, as a proposal to give directors responsibility for the implementation and oversight of due diligence obligations was dropped from the draft.

A key battle may have been won but the war isn’t over yet, as the directive will now need to be negotiated at member state level. A point of contention will likely be the financial sector. Under the directive asset managers and other financial institutions will be required to conduct ongoing environmental and human rights due diligence on the companies they invest in. While they won’t be held legally responsible for the behaviour of investee companies, asset managers will need to demonstrate efforts made to prevent issues such as pollution or human rights violations. According to Ignites there has already been pushback from the funds industry with the German funds trade body stating that asset managers as investors only have limited influence over companies.

CSDDD may be moving forward but rules regarding another directive – the Corporate Sustainability Reporting Directive (CSRD) – look likely to be scaled back, according to Reuters. Much discussion has taken place regarding whether disclosures should be mandatory or based on materiality with the latest indications that materiality-based disclosures are likely to be the chosen path. EU companies’ ESG obligations are obviously increasing, however clarity on what exactly will be required still seems some way off.

Asset managers again targeted by ShareAction

Continuing with a focus of pressure on asset managers, earlier this week, ShareAction, an NGO that sees the value of stewardship in addressing key societal issues, published a report criticising the world’s largest asset managers stating that they have a lack of ambition in supporting the transition to net-zero, and many key climate issues, including biodiversity and deforestation. The report argues that asset managers are not aligned with world’s leading scientists and the UN when it comes to emissions and net-zero, detailing that they had set “inadequate targets to reduce emissions” and continue to “invest in companies that are expanding their oil & gas production”. This is not the first time that asset managers have come in for criticism from ShareAction for not doing enough to mitigate the impact of the climate crisis. Earlier this year, ShareAction published a report which detailed that large asset managers were failing to invest in a manner that will protect the climate, biodiversity and people. The report highlighted that two-thirds of the 77 asset managers surveyed, who control $60 trillion of assets, had “serious gaps in their responsible investment policies and practices” and lacked an ambition to drive serious change across the world. While the report does commend some asset managers for various responsible investment policies they have implemented, it is clear that, as a sector, asset managers need to use their influence to do more – both in terms of influencing real change and supporting the climate transition with sustainable investment decisions.

Biodiversity under stress

While climate change remains front and centre for companies, biodiversity continues to be highlighted as a key environmental issue that can no longer be left off businesses’ agendas. The Financial Times this week reports that biodiversity is declining faster than previously thought. According to research from Queen’s University Belfast, 48% of more than 71,000 species are undergoing decline, and 33% of species deemed “non-threatened” are also declining. Alarming figures by any measure.

Businesses continue to face pressure to provide greater disclosure regarding their impact on biodiversity. The Taskforce on Nature-related Financial Disclosure is creating a reporting framework expected to be released in September of this year. The Science Based Targets Network has also recently published tools and guidance for companies to set goals related to nature; and is conducting a pilot with 17 companies to help set, implement and track progress on targets for freshwater, land, biodiversity and ocean, as well as climate.

Progress is being made but perhaps the pace is too slow. According to Daniel Pincheira-Donoso, a co-author of the Queen’s study:  “The scientific community has been sending warnings for a while and I feel that everybody’s listening a bit more… But we need to have commitments from politicians and companies.”

Pigs do fly – but that may not be sustainable

Sustainable fuels have been a notable topic of discussion in the media this week, with the conversation catalysed by research published by NGO Transport & Environment that has questioned the use of biofuels as a truly feasible alternative. The campaign group’s new study has ultimately concluded that, within Europe especially, the current usage of animal fat within biodiesel is increasingly unsustainable, having doubled in the past decade to the point of almost half going into biodiesel as it stands. Other companies are similarly dependent on animal fats including pet food, soap, and cosmetics. If there is an unscalable increase in biofuels, states T&E, these industries may need to rely on damaging alternatives such as palm oil. The alternative is increased livestock farming, which is of course a suboptimal environmental outcome too.

The research’s most hard-hitting headline is that a flight from Paris to New York requires 8,800 dead pigs – and with major low budget airlines recently striking large deals to secure animal fat heavy “Sustainable Aviation Fuels” going forward, the group believes it is imperative to raise awareness on the broader consequences of unsustainable upscaling – particularly on the palm oil front where there is strong public understanding already. That is not to say there is no solution to be found – as covered by Reuters this week, soybean and canola oil are increasingly serving the sector. Watch this space!

Solar power spending surpasses oil in the US as concerns grow about the impact

Global spending on solar power and other clean-energy projects is not slowing. A WSJ article indicates that solar investments are expected to surpass $1 billion a day in 2023. This number is well above expectations for spending on upstream oil projects. The spending isn’t growing as fast in developing countries due to the upfront cost of technologies. (Although this substantial spending is a sign that renewables are becoming a central focus for spending, concerns over solar waste are growing.) A BBC article indicates that although it is positive that more solar panels are being produced, billions of panels will need to be disposed of and ultimately replaced. A solar recycling factory, the first of its kind, is expected to open in France by the end of June. Recycling solar panels will be key to managing and sustaining the increased demand, or non-solar renewable options might be necessary to fill energy needs.

UAE Companies pledge to reduce carbon emissions

An initiative led by the Ministry of Climate Change and Environment, the UAE recently hosed the 10th National Climate Ambition Dialogue under the theme “Accelerating the Pace of Transition to Low Carbon Green Industry” as reported by Zawya. The dialogue aims to encourage organisations across the UAE to pledge reduction in carbon emissions as the UAE prepares to host COP28 later this year in Dubai. During the event, 28 companies operating in the industrial sector pledged to adopt sustainable ways to manage their operations bringing the total number of pledged companies up to 90 from various sectors in the country. The event aims to foster collaboration among strategic partners, private organisation and government entities. The event also included several discussions and workshops on pertinent topics enabling the industrial sector to reduce carbon emissions and implement sustainable and innovative methods to promote green financing, the circular economy amongst others.

Scope 3 emissions reporting challenges stalling UK company progress

Remaining on the theme of carbon emissions, a recent survey conducted by Mobilityways and reported by ESG Clarity, highlighted that just 1.5% of 400 UK firms surveyed (the sample included companies with more than 1,000 employees in the healthcare, financial services education sectors) consider they are on top of Scope 1, 2 and 3 emissions reporting. The survey found that while 65% of companies have started Scope 3 reporting most are not comfortable with their current systems and processes. The survey also revealed 55% of companies have studied the impacts of their products and 53% have audited their supplier emissions, both of which are key steps in understanding Scope 3 emissions. In addition, 47% have begun Scope 3 reporting under the GHG protocol. However, low confidence in the emissions reporting process was principally attributed to the lack of standardisation for weighting and measuring emissions performance, especially on Scope 3. These challenges are nothing new in the ESG space and calls for standardisation have a long-standing history in our ESG + newsletter. The solution will be standardised reporting frameworks – such as the ISSB – which are in development.

Universal sustainability disclosures

Finally, sticking with reporting frameworks, The UK Sustainable Investment and Finance Association (UKSIF) has emphasized the need for the UK government’s consultation on non-financial reporting requirements to align with the International Sustainability Standards Board (ISSB). UKSIF believes that the government should clearly outline its approach to implementing the ISSB’s standards and ensure they complement existing reporting initiatives like the Task Force for Climate-related Financial Disclosures (TCFD). The UKSIF supports a phased approach to disclosure, especially for smaller businesses, and believes that ISSB’s common baseline of reporting standards will minimise costs and reduce the regulatory burden associated with multiple reports, as noted in this recent article. Additionally, there is a call to prioritise quantitative over qualitative disclosures in the new UK non-financial reporting framework to encourage adoption and address climate change effectively. The UKSIF hopes for swift adoption of the ISSB’s standards across the UK’s economy, highlighting the country’s role as a leader in climate action.

Furthermore, there is a need for cooperation between standard-setting bodies and authorities to consider environmental and social impacts in corporate reporting. The government’s review is part of its effort to reduce regulatory burdens and promote economic growth post-Brexit. The Financial Conduct Authority (FCA) is also working on Sustainability Disclosure Requirements (SDRs) to enhance transparency and trust in sustainable investments while addressing greenwashing concerns.

ICYMI

• Activist shareholders threaten Japan’s AGM season. Ahead of this year’s AGM season in Japan, with most companies’ annual meetings taking place in June, there are increasingly expectations that there will be more shareholder proposals than ever before. Proposals are expected to go beyond share buybacks and asset sales and instead push for transparency, climate policy and changes in capital allocation.
• Top ESG Funds in Asia Boost Returns In Once Unloved Market. Though the Japanese market has largely been ignored by money managers focused on sustainability, some of Asia’s top ESG funds are reaping the rewards of investing in Japan. Four of the five best performers in the region this year are focused on investing in Japan stocks and have generated total returns of over 17%. Fund managers have generally avoided the market on account of its relatively low returns and subpar ESG practices. However, many have seen progress in Japan on areas such as corporate governance, indicating that the market’s relevance to ESG investing may be on the rise.
• Energy efficiency revolution would create 12 million new jobs. The International Energy Agency (IEA) states the global rate of energy efficiency improvements must double this decade for international climate goals to be met, despite the significant progress made in 2022. Achieving this could create millions of jobs and improve energy access for almost a billion people. While the IEA has welcomed that nations with high levels of energy consumption have introduced new and improved energy efficiency policies since the price crisis began, it has also warned that many markets have relied on subsidising bills, meaning that longer-term efforts on efficiency are still needed.

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