ESG+ Newsletter – 09 November

Your weekly updates on ESG and more

The past months have included growing scrutiny on ESG and its impact which, as detailed below, has engulfed ESG rating agencies in several jurisdictions. Keeping with that theme, we also look at whether there are externalities to boycotting firms who implement ESG strategies, and whether a reversion to values and the decoupling of E, S and G might produce superior outcomes. We also look at regulatory efforts in China and France, governance developments in the UK and a report from the UN that argues that a 1.5C degree scenario will be unachievable, based on the aggregated plans for fossil fuel production from leading economies. 

UK confirms plans to increase oversight of ESG ratings 

As the focus on ESG has risen, so has the scrutiny on third parties who offer ratings of individual companies. The latest developments were detailed this week in the Financial Times, where it was confirmed that UK regulators intend to publish formal proposals on regulating the ESG rating industry as soon as January 2024. While UK ministers are still analysing the responses to their previous consultation on the topic, regulation – in some form or another – will be finalised shortly. The general arguments for and against the regulation have focused on traditional battlegrounds: on the one hand, critics note concerns around conflicts of interest, methodology, transparency and process; on the other, advocates point to the important role the industry can play in the evaluation of ESG risks and opportunities. The UK’s approach follows on the back of a similar push in the EU (currently under consultation), which may look to the separation of consultancy businesses from ratings and require formal registration with authorities. While the continued push for oversight of the industry looks a formality, how extensive the regulatory regime in the UK is remains to be seen and could range from lighter rules on codes of conduct and transparency, to more forceful steps to tackle conflicts of interest and fundamentally shift approaches to research. Either way, in several jurisdictions globally, the role of ESG rating agencies – and indeed ESG as an approach generally – remains firmly under the microscope. 

FRC rolls back on certain proposed changes to corporate governance 

The Financial Reporting Council (FRC) announced on Tuesday that it would be dropping “over half ” of the 18 changes it had proposed in the consultation on the UK Corporate Governance Code in May of this year. Some of the scrapped changes include those related to increased expectations for diversity reporting, the allocation of ESG reporting responsibilities to the audit committee, and greater engagement expectations for committee chairs. The need for reforms in audit and corporate governance standards was identified in three government-backed reviews, following high-profile corporate failures in the UK in recent years. However, concerns around the competitiveness of the UK market appear to have played a role in reducing the level of change in the proposed regulation. Critics have argued that “toughening up its corporate governance code would knock the hub’s post-Brexit competitiveness as it vies with New York for listings”, as noted in a recent Reuters article. The FRC announced that it would publish an updated version of the Code in January 2024, with changes seeking to support “UK economic growth and its international competitiveness”. 

Unbundling ESG to improve its impact and image 

Recently, ESG’s composition, objective and intentions have been the centre of much debate and discussion in the US. While some of the commentary and opinions may have been opportunistic, it does feel as if we are at an important juncture for ESG and its role in the investment landscape. This week, the NYU Stern Center for Business and Human Rights published a report on that topic, Making ESG Real: A Return to Values-Driven Investing, which articulates a vision for ESG investing in the US that dissembles E, S and G from each other and moves away from composite ESG scores, which the report argues makes it a “bundle of contradictions”. Instead, the report advocates for a return to a “common-sense” understanding of ESG investing that focuses on limiting the negative impact of business on the environment and society. Funds could reduce their scope and narrow their objectives, customising ESG portfolios to meet clients’ values. For example, a fund that is focused solely on carbon emission reductions or increasing renewable energy production would be easier to label and measure, while also providing enhanced transparency for investors.  

Moving away from the moniker of ESG in the US may be required if this form of investing is to escape the politicisation and scrutiny that it has been subject to this year. A potential shift towards ethical investing or thematic and value-based investment – similar to the EU’s taxonomy aligned funds – could potentially yield greater impact while also quietly rehabilitating ESG’s image in the US, perhaps under a different name.

States’ anti-ESG laws may produce additional costs 

Recently, many US state policymakers have put forth anti-ESG legislation, aimed at boycotting financial services companies that use ESG in their investment decisions. In response, an article in Bloomberg raises an interesting point: “Ironically, [anti-ESG] policies will have the same effect as the heavy-handed federal government regulations they’re rebelling against: micromanaging US businesses and adding significant, unnecessary costs to achieve ideological aims”. The potential impacts of these stances are delved into in greater detail by the Oklahoman, setting out a recent example where state taxpayers were forced to take on a higher interest rate loan for new street lights and water infrastructure aimed at addressing rising energy costs, due to the exclusion of certain banks. As increased regulation of banks and financial firms hit home in certain states, it appears the exclusion of options for loans and investments may have the knock-on effect of less choice – and potentially more cost – for taxpayers seeking to invest in infrastructure.

France makes climate impact a key principle of labelling 

France’s Minister of Economy, Finance and Recovery Bruno Le Maire announced this week an update to the French Social Responsible Investment (SRI) labelling standard, ESG today reports. The SRI label was launched in 2016 with the objective of allowing the public to make investments in alignment with certain ESG principles. The label, which is only awarded following a strict compliance process conducted by an independent body, is currently used by nearly 1,200 funds, representing more than €770 billion of assets under management. The new requirements will make the label stricter and is intended to focus on spurring greater progress on the country’s efforts to combat climate change. 

Under the new requirements, labelled funds will not be allowed to invest in companies that exploit coal or unconventional hydrocarbons, or those that launch new oil and gas exploration projects, production or refining projects. Investee companies will also be required to have a Paris Agreement-aligned transition plan, which is compatible with a 1.5 degrees Celsius scenario. The new rules will be published later this month and become effective in March 2024. The latest update on fund labelling is part of wider trends that seek to ensure investment products are subject to stricter criteria than previously, where concerns as to the genuine credentials of sustainable investment strategies have come under scrutiny from regulators, including through the EU’s SFDR.

Climate crisis set to continue as countries double-down on fossil fuel production  

In a similar space to French efforts to clamp down of investment labelling, climate targets look to be in doubt, according to a new report from the UN that profiled 20 fossil fuel-producing nations. The report used publicly available data to assess the expansion plans of the largest fossil-fuel producers and found that their plans would result in 46% more coal, 83% more gas, and 29% more oil in 2030 than is compatible with keeping to a 1.5C global temperature rise. The data revealed that the countries that would produce the largest carbon emissions according to their fossil fuel production plans are India (coal), Saudi Arabia (oil) and Russia (coal, oil and gas), with the US and Canada next in the list based on their plans to become major oil producers. These plans seem out of sync with the countries’ climate policies, with 17 of the 20 countries having pledged to achieve net zero emissions. The report has caused alarm among environmentalists with the executive director of the UN environment programme stating that “these plans throw humanity’s future into question.” There was similar concern among responsible investment campaigners ShareAction, who condemned the UK’s government’s plans to approve new licenses for North Sea oil and gas drilling. The group described the plans as “reckless” and called upon investors to avoid fossil fuel solutions and instead support cleaner energy options. With the phasing out of fossils fuels likely to once again be a key topic of COP28, the range of reports are likely to drive difficult discussions at the conference. 

China announces methane action plan  

China has announced a plan to control methane emissions as part of its efforts to address climate change ahead of the COP28 climate summit as reported by Argus Media. Methane is the second-largest contributor to global warming after CO2 emissions, and China is the world’s largest emitter of methane from fossil fuel operations. The plan acknowledges issues like weak data collection, insufficient regulatory standards, and technical and management challenges. In response, the report calls for the establishment of a methane emissions supervision system to effectively control emissions. The plan outlines a timeline for improvement, aiming to establish control policies and standardized technological systems by 2025. It also sets targets for reducing flaring in oil and gas extraction, increasing the use of coal mine gas, and capturing manure emissions from livestock and poultry. The initiative, which will look to enhance laws, regulations, technological innovation, monitoring, and supervision to reduce methane emissions, represents the latest effort to align with China’s broader climate goals and addresses emissions from sectors including fossil fuels, waste, and agriculture, which are major sources of methane emissions globally. 

ICYMI 

• As the 2023 Cricket World Cup heads into the knockout stage, a recent Bloomberg article has reported players unhappiness about the air quality, as certain cities in India battle worsening smog. Several large cities continue to see “unhealthy” to “very unhealthy” air quality levels, New Delhi, Mumbai, and Kolkata are currently among the world’s top 10 cities in air pollution. India’s air pollution problems could ultimately impact its bid to host the Olympic Games. 
• Sustainable Bond Issuance on Track to Grow to $950 Billion in 2023, Despite Q3 Pullback: Moody’s (US) A new report from Moody’s Investors Service shows Issuance volumes of green, social, sustainability and sustainability-linked (GSSS) bonds pulled back sharply in Q3 2023. This represents a fall of 26% year-over-year to $198 billion, slightly underperforming the global bond market’s 22% decline, after significantly outperforming the market in the first half of the year. By bond type, green bonds accounted for most of the drop in GSSS issuance in Q3, falling 37% in the quarter to $100 billion, after a record setting first half of the year. 
• US invests $2 billion for lower-carbon construction at federal buildings (US): On 6 November 2023, the Biden administration said it will invest $2 billion in 150 federal building projects across 39 states that use materials that minimize carbon emissions. This is the latest effort to tackle climate change through government purchasing power in the U.S. and will help create a market for low- and zero-carbon materials.
• Less than 1% of businesses have adequate transition plans in place for long-term climate goals – New research by the Transition Pathway Initiative Centre (TPI Centre) at the London School of Economics and Political Science (LSE) has revealed that only 20 out of over 1,000 assessed companies, mainly in high-emitting sectors like oil and gas, steel, and coal mining, have quantified transition plans to achieve their long-term decarbonization targets. Despite 84% of these companies disclosing emissions targets and 98% having climate policy commitments, just 52% have conducted climate scenario planning, and only 48% have integrated climate risks and opportunities into their long-term strategies.