ESG+ Newsletter – 14th April 2022

Geopolitical events place focus on energy transition and ESG

As detailed in a previous edition of the newsletter, the war in Ukraine has forced governments to reassess their energy sources and requirements, with a shift back to the use of fossil fuels to bridge countries’ short-term energy needs. Additionally, certain countries are relying on Russia’s oil and gas supply to keep their economies running but are also acutely aware that they need to break this dependence for geopolitical and energy security reasons. However, it would appear that the conflict’s impact on soaring fuel prices and the energy crisis is accelerating the transition toward low-carbon fuel, most notably hydrogen. While the case for the use of hydrogen as an energy source had been growing due to its climate benefits, investment funds are now joining governments and energy companies in committing capital to hydrogen companies and infrastructure requirements.

The impact of the war in Ukraine and Russian sanctions is also being considered by ESG investors, with a recent survey by Bfinance published this week revealing that 39% of investors said that “recent geopolitical developments” were grounds for adjusting their approach to ESG. Investors cited that they were reviewing exposures to emerging markets, weapon manufacturers, and fossil-fuel companies as areas of concern and placing them under greater scrutiny. Indeed, the noise around the inclusion of certain stocks – primarily defence stocks – that are typically omitted from ESG funds, to be included in light of what is happening in Eastern Europe is addressed in a recent Bloomberg article. However, the article, which includes significant commentary from ESG investors, strongly advocates for its exclusion, with James Penny, the Chief Investment Officer at TAM Asset Management, stating that the inclusion of defence stocks would “undermine the whole ESG movement”. He adds that this type of investor reaction to an international event is a wider “problem right now with ESG,” and that a “topic that was widely outlawed a year ago is now suddenly potentially ESG-appropriate.” 

Policy and investment the key to renewable energy progress in Asia

Asian countries require significant capital investment in renewable energy if the industry is to reach its potential from an impact perspective, writes Environmental Finance. With Asia’s share of global energy consumption set to grow to over 50% from 34% over the next two decades, per the World Economic Forum, “enabling policy frameworks is critical to accelerate the global energy transformation required to achieve climate and development targets.” Of the $530 billion invested in energy generation capacity in 2021, about 70% was spent directed at renewables – demonstrating how the sector has evolved. When taken in the context of this week’s publication by the SBTi that called for the end of financing of coal assets by 2030 and oil & gas assets by 2040, the combination of growth to date and projected consumption makes clear both the size of the investment opportunity and how vital the region is to the global ambitions outlined at COP21 and COP22.

US states take opposing ESG stances

2022 proxy season activity and new bills put forward in some US states reveal divergence across US state lines regarding pension management and public fund management’s role in ESG investing. An Idaho Senate bill sponsored by Senator Steve Vick calls ESG Investments “disfavored” and calls upon public entities to disregard ESG factors as material to investment decisions. This bill comes alongside news from S&P Global of 5 states dropping pension managers for screening based on environmental records in their investment process. The same article reveals how, in contrast, 8 US States are fighting to drop fossil fuel companies from their portfolios. A Bloomberg article further highlights that some of the largest pension funds, such as the California State Teachers’ Retirement System, have become active on ESG matters this proxy season by supporting diversity and climate change efforts. Santa Clara University in California has also published research on the importance and ethics of integrating ESG standards into pension systems; naming California, Oregon and even Idaho’s neighbour, Illinois, as leaders in the space due to their push for sustainable investment policies in public funds.

The push and pull between US states will most likely continue while the SEC’s proposed climate rules are debated in the US. As of now, no federal discussion of how ESG policies relate to public fund investment has taken place. This could potentially change in future, but pushback should be expected from states that, similar to Idaho, want to keep supporting fossil fuel investments in their public funds.

Debt increasingly linked to sustainability achievements for European companies

According to research compiled by Bloomberg, ESG targets are present in 26% of European corporate debt deals this year, with companies increasingly linking ethical goals to securing financing. Sustainable facilities, which have increased by 19% in 2021, are being negotiated by a range of major businesses, across various sectors. The latest among those include Holcim Ltd, the Swiss cement maker, and high street retailer H&M. The particulars of the contracts vary, but they ultimately tie the raising of debt to ESG achievements. On a year-to-date basis, over 500 companies have linked borrowings to sustainability targets in 2022, up from 400 in 2021, which in turn is double 2020’s numbers. Insight into the broader corporate leverage strategy was given by an H&M spokesperson who stated that as “we refinance maturing facilities our intention is to refinance with sustainability linked.”

The conscientious consumer is back

Last week we covered how the IPCC’s sixth assessment report outlined for the first time the power of collective action for climate change mitigation. As we emerge from the pandemic, Fair Trade USA point out that the conscientious consumer is back and, once again, demanding sustainable products. It seems that the IPCC’s message is getting through regarding the importance of individual actions in fighting the climate crisis. This presents both an opportunity to provide sustainable products to customers, but also presents the risk of boycotting based on poor environmental or social performance. Issues should also be considered in tandem to create a genuine sustainability impact and avoid potential accusations of greenwashing. Fair Trade argue that “environmental and social disconnect created inefficiencies, leading to a breakdown in holistic sustainability”.’ The need for brands and products to meet the expectations of consumers presents an opportunity for product certifications which had previously seemed to slip out of the consumer conscience. To ensure that these certifications are relevant, they will need to ensure they do not look at issues in silos but instead, address the intertwined social and environmental issues in the supply chain.

“To divest or engage, that is the question”

The decision to divest or engage has become a key question for investors, particularly as they are increasingly being called upon to play their stewardship roles and do the ‘right thing’. In recent years, a number of institutional investors committed to eliminating companies from their portfolios based on the proportion of their revenues that derives from fossil fuels. However, this divestment comes at a cost, as investors may lose out on substantial returns as well as lose their voice as partial owners of the companies that they have invested in. The recent PRI paper notes that “the decision to engage with or divest from ESG laggards depends on the ESG issues concerned as well as the (sustainability) objectives of their clients and beneficiaries”. While there are some important considerations favouring divestment, such as circumstances where investors are seeking value alignment vs real-world impact or if other escalation methods have been exhausted, this approach – in isolation – may not be sufficient to push companies towards the achievement of ambitious sustainability goals and in the elimination of the risks posed by systemic issues. Investors who wish to play a role in shaping sustainability outcomes need to consider alternatives to direct stewardship of their investees.

Measurement challenges shouldn’t diminish the importance of the ‘S’

The ‘S’ is often the forgotten child of ESG, despite the important role it plays in sustainable business practices – notably around issues such as human rights, labour practices, and diversity and inclusion. One of the reasons cited for this is the difficulty in measuring ‘S’ issues is the development of appropriate metrics and indicators. But lessons can be learnt from climate issues which similarly suffered from a lack of data at the outset, but which didn’t stop investors from focusing on these issues.  A number of civil society organisations have already begun initiatives to provide data sets on social matters for investors. These include Corporate Human Rights Benchmark, part of the World Benchmarking Alliance, KnowTheChain, part of Business & Human Rights Resource Centre, and the Workforce Disclosure Initiative, part of ShareAction. Organisations can also prepare for any future data-driven metrics or targets by developing business models that are centred around workers’ and communities’ rights. Similarly, professional services, such as lawyers and accountants, can ensure the focus is placed on the ‘S’ by being aware of the changes in laws around workers’ rights and advising clients appropriately. While engaging with S may seem voluntary now, as happened with climate issues, it may soon become mandatory for companies and investors.

In Case You Missed It

• Mercedes revealed plans to cut CO2 emissions per passenger car by more than 50% by 2030. The company will look to achieve this through electrifying its vehicle fleet, charging with green energy, improving battery technology, and using recycled materials and renewable energy in production. It also revealed plans to ramp up the use of sustainability-linked finance.
• Energy provider Ørsted, along with energy service provider ESVAGT, announced plans to invest in a green fuel vessel for offshore wind farms. It will be the world’s first investment into a green fuel vessel and is an attempt to decarbonise the maritime sector and offshore wind industry. The vessel will be powered by batteries and dual-fuel engines running off e-methanol produced from wind energy and biogenic carbon.
• Investor groups call on the EU to mandate climate transition plan disclosures in the upcoming Corporate Sustainable Reporting Directive (CSRD). In an attempt to back up net-zero commitments, the European Sustainable Investment Forum (Eurosif) and the Principles for Responsible Investment (PRI) sent letters to the EU lawmakers urging disclosure rules to include detail around decarbonisation.

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