ESG+ Newsletter – 15th September 2022

Nowhere to hide with ESG risks in the supply chain

Reuters this week has published the first of a two-part series aimed at shining a light on how scrutiny of ESG issues within supply chains is at an all-time high. Specifically, the article looks at the Global Supply Chain (GSC) and the pressure felt by GSC companies from buyers, suppliers, regulators and even activists to accept responsibility for ESG issues. With the latter group achieving sustainability-based wins in the Oil & Gas industry in the last twelve months, and new labour focused legislation high on the agenda of the world’s major economies, ESG issues in the supply chain are under the microscope more than ever before.

In the EU, the Corporate Sustainability Due Diligence Directive places responsibility for supply chain issues with buyers (despite pushback from certain bodies – see below). The bottom line is that companies must avoid doing business with compromised entities and so acting upon, and crucially taking responsibility for, these problems is tantamount to the survival of the GSC. For listed companies linked to the GSC, reporting obligations will add another layer of pressure – although that is not to say privately held businesses are not under a similar level of scrutiny, with private investors and regulators also placing far more impetus on understanding the risk profile of investments and supply chains.

Clothing line says “Earth is now our only shareholder”

The sustainability credentials of the fashion industry have been a much-scrutinised topic this year, including in previous issues of our ESG+ newsletter. One business going the other way it seems, however, is Patagonia. In transferring all voting stock to a trust charged with ensuring the brand’s values and environmental goals are respected, and by committing to providing all profits not reinvested to environmental causes, the founder of the outdoor apparel maker, Yvon Chouinard, announced “As we began to witness the extent of global warming and ecological destruction, and our own contribution to it, Patagonia committed to using our company to change the way business is done.” While the naysayers will surely come back to call it ‘woke’ or a publicity stunt, it will be interesting to see if others seek to raise impact above profit.

Increase in climate litigation set to push up insurance premiums

There has been an exponential increase in environmental disclosures recently as pressure ramps up on companies to disclose their environmental and climate risks and opportunities. The growing requirements mean that more extensive company disclosures may increase the risk of litigation. In a classic case of actions versus words, climate-related legal action is being pursued by activists who believe some companies are failing on their disclosures, greenwashing or have weak emission reduction targets. The success of these litigations could result in insurers increasing the cost of directors and officers (D&O) liability insurance. Even if companies win the legal battle, D&O insurers typically cover the costs related to defending the case. There could also be further legal action down the line if companies fail to meet the targets they have committed to. The risk of falling victim to this type of litigation may be mitigated by enacting and reporting on a strong science-based transition plan, which integrates climate risks and opportunities into business strategy.

As sustainable bonds soar, concerns grow over rigour of oversight

The third-party review industry has grown in recent years alongside the rapid rise of green finance. Moody’s is projecting $1 trillion in sustainable debt issuance this year and has tripled staffing for providing reviews to “meet the needs of market participants.” Additionally, there have been 414 external reviews of sustainable bonds during the first half of 2022, compared with 450 in all of 2020, according to Environmental Finance. Companies driving the ESG rating business include Moody’s, Sustainalytics, ISS, and S&P Global. While ESG reviews are not formally required for green transactions to be undertaken, they have nonetheless become the market standard and provide assurances to external stakeholders.

While the $100 trillion bond market has an opportunity to play an active role in the sustainable finance space, doubts remain about the rigour of green bond reviews due to concerns about greenwashing. Some remain sceptical about impartiality since issuers pay for reviews leading to a perceived conflict of interest associated with reviewers assessing their customers. To enhance accountability, there has been a new push for additional reviews to track progress after a bond is issued, a particular concern as certain sustainable-linked bonds allow for adjustment to targets post-issue, without the approval of creditors. Indeed, T. Rowe Price, the trillion-dollar asset manager has become the latest critic of green bonds, arguing they fail to spur change.

While the market remains unregulated, the European Union is in the process of developing a green bond standard, which would turn market guidance into regulation mandating external reviews on allocation reports, minimising conflicts of interest, and perhaps starting to eradicate the inconsistencies and lack of oversight that might undermine the market.

Investors split over human rights issues

The UN recently undertook a review of its Guiding Principles, concluding that “considerable challenges remain when it comes to coherent implementation with respect to ensuring better protection and prevention of adverse human rights impacts”. While it is clear that regulators have a role to play in forcing companies to address adverse human rights impacts, investors too are demanding more. Aviva Investors has set out a clear position and it has actively engaged with issuers with some success. However, not all investors are prioritising human rights. Insurance Europe, an insurance sector lobby group, has called on the EU to prioritise setting climate standards over social ones. Insurance Europe argues that climate disclosures are more mature than social disclosures, and current data availability on human rights would create a significant burden on reporters. In the complex ESG landscape, with many issues to grapple with, it is understandable that financial institutions want regulators to prioritise certain topics. However, without considering human rights, financial institutions risk losing sight of a just transition, as well as failing to grasp the major risks that human rights and labour practice failures can represent to the bottom line.

In Case You Missed It

• There are two developments in terms of carbon capture and storage (CCS) projects: A partnership has been signed between Samsung Heavy Industries Co. and BASF to capture emissions from ships. This should help the maritime sector to meet its carbon intensity reduction target of at least 40% by 2030. This partnership was revealed shortly after Mitsubishi announced it will deliver engineering design for a CCS at a gas-fired power plant in Scotland.
• A new series of climate-focused market benchmarks, the S&P Net Zero 2050 Carbon Budget Indices, will target carbon emissions reductions and align with IPCC’s estimated carbon budget to align with a 1.5°C scenario: The carbon budget of each index is based on its launch year and will be rebalanced each year based on the decarbonization achieved by constituents. The 2022 series will be required to reduce emissions by 25% in the first year, then by 10% per year until 2050.

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