ESG+ Newsletter – 12 October

Your weekly updates on ESG and more

This week’s newsletter begins with looking at the UK’s launch of Transition Plan Taskforce Disclosure Framework, which outlines the mandatory disclosure of net zero transition plans for financial institutions and listed companies. From there, we look at France’s decision to roll back on its plans for mandatory say-on climate votes; the growing role of ESG analysis in M&A due diligence; what impact ‘E’ and ‘S’ considerations have on pay; and, how ESG investors are increasing their exposure to investment grade bonds. The newsletter looks at how working is impacting the office sector – both from and ‘E’ and ‘S’ perspective. 

Transition Plan Taskforce launches disclosure framework

On Monday, the Financial Conduct Authority (FCA) welcomed the launch of the Transition Plan Taskforce (TPT) Disclosure Framework. All the way back at COP26, Rishi Sunak, in his former role as UK Chancellor, announced that the UK would introduce mandatory disclosure of net zero transition plans from financial institutions and listed companies. The TPT framework provides a set of recommendations to help large public and private companies across the economy make high quality, consistent and comparable transition plan disclosures. The TPT recommends that entities publish a standalone transition plan at least every three years, with updates reported annually in financial reporting. Companies will be expected to use the framework to disclose their transition plans for 2025 and onwards. This means that the first reporting would be in 2026. Both the Chair of the FCA and their Director for ESG  recommend that businesses get ahead of the regulation, rather than wait for 2026. The development of the TPT framework and mandatory transition plan disclosure reflect the growing view that net zero ambitions are no longer enough, actions and accountability are now crucial in demonstrating the credibility of these targets. 

France is stepping back on mandatory Say-on-Climate votes

In a July edition of the ESG+, we detailed reports that members of the French National Assembly had tabled a proposal to amend the Commercial Code and make Say-on-Climate votes mandatory for listed companies. Under this proposal, shareholders would have had the opportunity to vote on the company’s climate and sustainability strategy every three years, or earlier, if a material amendment to the strategy was made. They would also have the opportunity to vote on the implementation of the strategy every year. This framework resembled that of UK votes on directors’ remuneration policies and remuneration reports, though under the French proposal both votes would have remained advisory.

As reported by Responsible Investor this week though, this proposal was initially rejected by the commission, but was then approved in a second vote. This proposal, which was part of France’s green industry bill, has again been removed from the bill at the last minute ahead of a debate and vote by the joint committee. Parliament member, Alexandre Holroyd, shared his disappointment and commented that the most ambitious part of the bill had been removed. He added that this could delay important discussions on corporate transition plans, but that he remained hopeful the proposal could be further discussed as part of other bills. For opponents of Say-on-Climate votes, this might only be a temporary relief.

ESG regulation helping to drive more stringent M&A processes

ESG Investor published an analysis of the growing role ESG is playing in M&A earlier this week. The report highlights that the sectors currently seeing the highest rate of dealmaking are those broadly aligned with ESG megatrends, such as energy transition. The article also refences the upcoming EU’s Corporate Sustainability Due Diligence Directive (CSDDD) as regulation that has been influential in the increased attention on non-financial performance when examining targets. 

The regulatory obligation, per CSDDD, for large companies to ultimately assume responsibility for environmental and human rights impacts across the value chain emphasises the need for M&A targets to be fully understood from an ESG perspective. When combined with the EU’s Corporate Sustainability Reporting Directive, which requires an unprecedented understanding of materiality and sustainability reporting, it is clear than ESG can no longer be viewed as a fringe subject, but rather fundamental. More regulation can protect and create responsible supply chains, while ensuring the overall responsible stewardship of a new owner. It also helps to row back the likelihood of market failures, and all the impacts of this, stemming from potential areas such as overinflated valuation through a more stringent checks and balances system.

ESG metrics improving alignment or increasing pay 

Executive remuneration has always been a sensitive topic, given its important role in talent retention and development. In recent years, investors have been pushing companies to include ESG measures in their executive remuneration structures as a means of spurring performance on a wider range of areas. A recent article notes that more than three quarters of publicly traded companies in the US and Europe have included ESG metrics when determining executive bonuses. Although these metrics, much like any financial metric, are included in remuneration plans to incentivise performance, there seems to be a concern about the “risk of executives manipulating performance metrics to gain bonuses.” The article finds that, although the majority of executives are not receiving higher compensation under ESG measures, some are. Although pay constitutes an important tool to improve the alignment between executive performance and the strategic objectives of a company, these findings – and the difficulties in defining robust and quantifiable ESG metrics – may suggest that implementing additional oversight in the monitoring and management of these and targets, or a review of the approach by which ESG metrics more effectively drive performance is needed. Indeed, one other question might be that if material ESG issues are effectively managed, performance against traditional financial measures – most regularly used under incentive plans – will end up being stronger.

ESG investors turn to investment grade corporate bonds

One prevailing sentiment around ESG investing was that ESG investors found it harder to deploy capital across the fixed income market due lack of options, making it more difficult to integrate fixed income options into portfolios. However, a review of ESG portfolios by FT Adviser revealed that ESG portfolios currently have, on average, higher fixed income exposure than non-ESG portfolios (31% to 29%). The driver of this trend has been investment grade corporate bonds, with ESG allocators having an average exposure of more than 12%, while non-ESG allocators have an exposure of 9.6%. How can non-ESG bonds be part of an ESG portfolio? Well, if the same principle around Green Bonds is used – that positive green change is as much social impact as environmental – when use of the proceeds by investment grade issuers is deployed towards projects that may be supporting its stated net zero transition or will have a positive impact on the environment and, in turn, wider society. The difficulty for investors is identifying the appropriate fixed income opportunities that support their investment criteria and conducting a thorough due diligence process to ensure that they are comfortable with including the investment grade corporate bond in its ESG portfolio – with the obvious caveat that some sectors would be completely off the table.

ESG regulations and weak demand spur innovation from UK office landlords

The pandemic has induced a seismic shift in office demand, which is impacting landlords with outdated assets ripe for reinvention. Even with some companies turning up the pressure on requirements to fulfil ‘in office’ day mandates, occupancy has plateaued as hybrid work becomes the norm and some larger tenants have looked to exit expensive leases for space now excess to their needs. This trend has driven vacancy rates to 30-year highs of over 10% in parts of London, with rent prices in decline. Mike Prew, a property analyst at Jefferies, is forecasting around 5-15% declines in 2024. 

However, rather than signalling the end of the office building, focus appears to be shifting on the race to win hearts, minds and money for the office of the future. Prime sustainable buildings remain resilient, with rents still rising based on scarcity. Large tenant preferences are focused around zero emission buildings, as companies grapple with their commitments around emission reductions. Quality and location are now king, as tenants consolidate into higher-amenity offices near transport hubs. ESG regulations like minimum EPC ratings are also having their impact, with around 50% of UK offices holding EPC ratings of D or below, requiring extensive capex for upgrades. With construction costs high, this is difficult to justify if rental growth is uncertain. A PWC report estimates that £65 billion is required to refurbish UK offices to meet ESG standards. Enter stage left, the reinvention of our urban landscape.  Landlords with older properties face plunging demand and many are stepping up to reinvent and repurpose dated offices into laboratories or residential buildings, reinventing whole swathes of cities and the districts within them.  If the office landscape is fundamentally reconfigured, then these savvy strategies could be just the agile step needed as the future – and present – of work continues to evolve. 

ICYMI 

• Climate change the ‘most common’ reason for portfolio exclusion, according to research by coalition of non-profit environmental and sustainability groups. The research indicates that financial groups continue to factor ESG questions into decisions, even as Republican politicians and state treasurers in the US lead a backlash against what they call “woke” capitalism, arguing it is not up to the financial industry to police companies. The tracker “shows that fossil fuels are becoming a ‘sin’ industry, with a clear need from oil and gas companies to speed up their energy transition efforts.
• India looks to boost domestic green bond market with longer-dated deal. After debuting in the sovereign green bond market with two $1 billion Indian Rupees deals at the start of this year, India has announced plans to raise another $2.2 billion. Aiming to become a net zero economy by 2070, the bond sales are part of a broader push by India to develop a domestic ESG and green bond market.
• A Fair Day’s Wage for a Fair Day’s Work. Investors focused on executive remuneration are looking to close the CEO-to-worker pay ratio. In a time of a cost-of-living crisis, extreme pay inequalities are completely destabilising; research has highlighted that the average US CEO compensation has increased by 940% since 1978, yet only 12% for worker compensation, a pay ratio approaching 5,000:1. A cap on executive remuneration is a potential solution that governments could put forward, but this wouldn’t be simple in practice.