ESG+ Newsletter – 12th August 2021

FTI View: IPCC Report will intensify pressure; bringing ‘Say on Climate’ into greater focus

The IPCC report this week held a stark warning, describing climate change as “widespread, rapid and intensifying.” The report has been widely covered and is no doubt front of mind for companies, investors and governments around the world. Without playing down the implications for society as a whole, in this forum, we ask what it may mean for issuers.

BreakingViews highlights that, beyond the stated ambition for companies to tackle climate change, financiers are now looking at ways to reduce emissions more meaningfully. One cited example is insurer Prudential who intends to work on accelerating the shut-down of coal-fired power plants in Asia. Going a step further, the article suggests that financiers will need to step up further to invest in solutions to address emissions and climate change – as against merely reducing future emissions. One example is the investment to replenish forests and, while it’s a laudable goal, we have recently highlighted that climate change is itself impacting the very investment in forests that are intended as part of the solution.

In terms of the impact on companies, the IPCC report follows the recent announcement by The Institutional Investors Group on Climate Change (IIGCC) – which represents 53 leading investors, managing more than US$14 trillion of assets – which called for the implementation of new corporate governance measures to ensure that shareholders can hold companies to account in achieving “net zero emissions commitments”. We think this effectively means that a ‘Say on Climate’ is likely to be expected, maybe even required of companies sooner rather than later.

Shareholder proposals on climate issues are increasingly common, particularly in the US market. In many of these cases, it has been at companies where there has been a perceived absence of a clear commitment to emissions reduction and/or net zero, which has fomented shareholder groups to put climate resolutions on AGM ballots.

Taking a different approach, in December 2020, Unilever was the first major global company to voluntarily commit to providing shareholders with an advisory vote on its climate plans at its AGM. Since then, Say on Climate proposals have become more common with other major global companies committing to a climate resolution at their AGM including: Anglo American, Glencore, Nestlé, Rio Tinto, Shell and Total.

The IPCC report and upcoming COP 26 are likely to result in a greater impetus for a requirement for a Say on Climate resolution – tracking the same trajectory as Say on Pay did 10 years ago. However, we think ESG leaders who voluntarily propose a Say on Climate resolution (albeit advisory) without pressure to do so not only shows climate responsibility, but also demonstrates a commitment to transparency and accountability to shareholders – a hallmark of good governance. In the effort to be recognised as a good corporate citizen in having strong ‘E’ and ‘S’ targets, companies often forget the importance of evolving their ‘G’ practice to align with progress across other ESG pillars.

The IPCC reports impact on ESG and sustainable financing?

Looking at the IPCC report itself it has been labelled a “code red for humanity” by U.N. Secretary-General António Guterres. The opening line ensures there is no confusion about who is to blame: “it is unequivocal that human influence has warmed the atmosphere, ocean and land.” The report is a reality check for investors betting the markets can limit the damage. As outlined in the report, there is a need to think longer-term when tackling climate change and a need to move faster in the short term to finance the fight against climate change. There have been calls for temperature alignment metrics to come into play and the latest scientific consensus should speed this process up; however, whether investors will adopt this for sustainability-linked financing is another question. While critics say there is a lack of reliable emissions data to make such computations (as most metrics rely on assumptions), it is clear from the stark warnings in the report that greater scrutiny of company’s emissions and tougher climate targets for both companies and their financing is on the cards. It is likely that the climate crisis will continue to dominate investor discussions, and impact companies’ ability to both raise capital and at what cost.

Nasdaq follows FCA with diversity disclosure requirements

Last week, the US SEC approved Nasdaq’s board diversity disclosure listing rule, which proposes that listed companies compose diverse boards and, in cases where they don’t, to explain why they do not. Specifically, the proposal will require that companies disclose consistent diversity statistics for board directors and to have two diverse directors, including one director who identifies as female and another as an under-represented minority or LGBTQ+. SEC Chair, Gary Gensler, stated that the new rules will allow “investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity while ensuring that those companies have the flexibility to make decisions that best serve their shareholders.” Welcoming SEC support, Nasdaq issued a statement outlining that the new listing rule would “encourage the creation of more diverse boards through a market-led solution.”

This decision follows a similar path taken by the Financial Conduct Authority (FCA), who launched a consultation in late July that focuses on improving transparency on the diversity of listed company boards and their executive management teams. Under their plan, companies would be required to publicly disclose in their Annual Reports their progress towards achieving specific targets for gender and ethnic minority representation on their boards and executive management, on a ‘comply or explain’ basis.

The moves by the FCA and Nasdaq should significantly enhance the quality of information available to investors across both markets, helping them make more informed investment and voting decisions – but ultimately, it is incumbent on companies to embrace change or risk the ire of investors when it comes to voting at the AGM.

Female and ethnic minority leaders declining across the FTSE 100

Despite the pressure to improve boardroom diversity, “corporate sidelining” of women and ethnic minorities is occurring at leading UK companies, according to a report published by Green Park earlier this week. The report revealed that the number of women in the top 40 leadership roles has fallen from 28.9% to 28% between 2019 and 2020; with eight of the fourteen sectors monitored by Green Park registering a fall in the proportion of women in their pipeline since 2019. A similar rate of decline for ethnic minorities was evident, with representation falling across the top 40 leadership roles from 10.7% to 9.3% and representation also falling in ten out of the fourteen sectors surveyed. However, one of the most concerning declines was the proportion of ethnic minority men and women in the top 40 positions in the FTSE 100, which fell from 7.3% to 6.3% and from 3.4% to 3% between 2019 and 2021, respectively – both of which are now below the level recorded in 2018. Accepting 2020 has been a challenging year for everyone, the reduction in diversity is a concern and highlights the need for continued focus on board and management diversity – across a wide range of measures.

Evaluating and rewarding progress on diversity

Sticking with the theme of diversity, Bloomberg this week outlined the challenges of rewarding executives based on the more intangible aspects of ESG. While financial performance and progress on climate can be measured, to some extent, tying pay to progress on diversity is a lot less clear cut. Evaluating progress on diversity requires a more subjective approach; however, investors have a general mistrust in boards making these judgements, particularly when it relates to pay. The article draws attention to an initiative by private equity firm Carlyle Group to reward employees for “going above and beyond” on diversity, with the programme rewarding conduct rather than financial achievements. Although vague, because they were casting a wide net, they were able to identify several significant actions taken on diversity, such as an employee surrendering a seat on a board to improve its diversity. The importance of rewarding progress on diversity was also recently communicated by the UK’s Financial Conduct Authority, however, they stopped short of prescribing how exactly remuneration should be tied to diversity and inclusion. With board discretion a core component in evaluating progress on diversity, investors may need to start placing more trust in their judgement.

Are sovereign wealth funds making enough progress on ESG?

Reuters published new coverage on sovereign wealth funds which assessed their progress in adjusting and changing their investment decisions for ESG factors. Reuters highlights that, while sovereign wealth funds have stepped up renewable investing over the last number of years, its $7.2 billion investment in renewable energy since 2015 represents less than a third of the amount invested in the oil and gas sector over the same period. Consequently, sovereign wealth funds have invested more capital in the oil and gas sector, often viewed as the heaviest emitting sector, than in the renewable energy sector in almost every year from 2015 to 2021 – with the only exception coming in 2016.

As we highlighted in a recent edition of the newsletter, sovereign wealth funds – along with other financial institutions such as central banks and public pension funds – are committed to transitioning towards ‘greener’ investment products and decision making. However, as the Reuters article highlights, any “failure or lag in future-proofing portfolios could threaten the long-term performance of sovereign wealth funds” and, given the fact that these funds are some of the world’s biggest investors, their ESG positions can materially impact the speed at which corporations transition their businesses towards more sustainable operating models.

Issuers increasingly using ESG terms on calls

New data from Sentieo shows that issuers are increasing their use and inclusion of certain key ESG words and phrases in conference calls. In June, there were 1,200 transcripts with mentions of ESG during conference calls – the largest number on record and representing a more than 200% increase from June 2020. Other popular words include sustainability, emissions, and climate change, but notably, the phrase climate crisis has seen an uptick, after nearly no mentions of it for most of the last ten years. In addition, words like diversity, diverse, gender, and women reached new highs in June, including 1,500 transcript mentions for diversity and diverse. However, even though the data indicates that corporates are increasingly conscious of showing investors that these considerations are on their agenda, it remains to be seen if their actions are effective enough to truly foster diverse and sustainable workplaces. Indeed, stakeholders and investors will soon notice those who generously speak about these issues but who are too sluggish to act.

Using culture to identify long-term investment opportunities

Asset Manager Ninety-One has issued a report that analyses how to use corporate culture as a factor in investment decision-making. It makes the case for the influence of culture by citing academic research which demonstrated that companies who were included in the ‘Great Place to Work’ top 100 list delivered higher returns and profits over the past 28 years. The report acknowledges that culture is difficult to measure but that investments are likely to be mispriced as a result. To address this, Ninety One has developed a framework to evaluate corporate culture that consists of two components – the universal perspective and the contingency perspective. The universal perspective outlines the four key attributes of companies with strong corporate culture:

• Ownership Mindset: employees are empowered and encouraged to perform at their best
• Recognition: employees are motivated via a combination of monetary and non-monetary rewards
• Trust: strong two-way communication where dialogue and diverse perspectives are encouraged
• Support: availability of mentoring and coaching together with evidence of talent mobility

The contingency perspective looks at cultural elements that are only attributable in certain environments. For example: businesses where cost and risk management are critical, where customer service is prioritised, or where flexibility and innovation are key. To fully appraise corporate culture, analysts need to look at how all the above attributes interact. The report points out that the framework is most effective when informed by cultural insights gleaned from direct interactions with management teams. It seems that personal engagement remains core to successful investment decisions – and point which chimes with last week’s story ‘Knowing the C-Suite key to ESG out-performance’.

In Case You Missed It

• Electric Vehicle sales are projected to increase sharply, rising from 3 million in 2020 to 66 million in 2040, Bloomberg reported. The transition is mainly driven by improvements in battery density and cost, as well as government policies that make driving traditional cars more difficult. Globally, this will represent more than two-thirds of passenger vehicles sales in 2040, with Europe and China leading the transition.
• Reuters reported that US President Joe Biden and his administration are targeting 2050 as the date to transition commercial aircraft off fossil fuels. To achieve this, the Biden administration will incentivise the private sector to produce sustainable aviation fuels.
• As part of its commitment for innovative change beyond carbon reduction, EasyJet is introducing a new uniform for cabin crew and pilots this month, made from around 45 recycled plastic bottles The roll-out across the airline is estimated to prevent around half a million plastic bottles from ending up as waste each year.
• Boris Johnson is under pressure to be more ambitious over hydrogen production capacity if the UK is to reach its net-zero emissions goal, the Financial Times reported. Energy groups said that Boris Johnson must move with “more urgency” and double targets for producing so-called low-carbon hydrogen by 2030.
• New research by Aviva shows that two-thirds of 1,200 people surveyed said it is important to consider ESG factors before investing, with one in five saying that investing sustainably was more important to them than investment returns. The study also shows that women are more likely to consider ESG investing, while workers are actively concerned that their pension savings should be invested in a way that respects ESG issues.

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