ESG+ Newsletter – 18 July 2024

This week, our newsletter starts in California, where proposed delays to mandatory climate reporting may be a foot. In contrast, there is no delay in the UK’s latest attempts at revitalising its equity markets through altered listing rules. We also look at investor concerns around the EU’s regulatory framework, challenges to the approach of ESG raters, and the further integration of human rights into investor policies and approaches.

Amendments to climate reporting legislation in California  

As reported by sustainability business expert Tim Mohin, Governor Gavin Newsom of California has recently proposed significant amendments to two notable climate laws, SB 253 and SB 261. The Governor hopes to increase the transparency of climate reporting across California through realistic implementation. His concerns stem from the legislation timelines, deeming them “ likely infeasible.” The legislation was proposed with an original timeline requiring large companies with revenues exceeding $1 billion to disclose Scope 1 and 2 emissions by 2026 and Scope 3 emissions by 2027; companies with revenues exceeding $500 million would disclose climate risks starting in 2026 and then biennially. Newsom advised pushing back the reporting of Scopes 1-2 and Scope 3 emissions by one year each. In doing so, he believes the delay would allow the California Air Resources Board (CARB) more time to implement the legislation and adequately manage reporting auditing. In contrast to the Governor’s comments, Senator Scott Weiner maintained that the rules’ 6-year phase-in period would be intentionally and practically executed. These proposed amendments in California fit into a broader dialogue regarding the United States’ climate disclosure requirements, with rules in the Golden State going above and beyond those which will be required by the federal SEC’s climate rule, currently stalled due to legal challenges. No matter the amendments proposed by Governor Newsom, companies in California and beyond should be preparing for a future of more stringent environmental compliance and increased corporate reporting. 

New UK listing rules raise concerns among investors 

As highlighted in a recent Sky News article, the Financial Conduct Authority (FCA) has approved major changes to listing rules in an attempt to revive the attractiveness of the UK stock market. The rules are due to come into effect on July 29 and include the removal of the need for shareholders to vote on related-party transactions, the relaxing of rules regulating the use of dual class shares, and the merger of the “premium” and “standard” listing categories. Sarah Pritchard, from the FCA, acknowledged that “the new rules would allow greater risk but insisted they would better reflect the risk appetite the UK economy needs to achieve growth.” A number of investors have cited concerns though that the lowering of listing standards could negatively impact savers by allowing the inclusion of poorly governed companies in their (indexed) portfolios. These changes to UK listing rules were announced roughly a month after France announced its own set of new rules aimed at attracting more IPOs in Paris. The French rules include the possibility of implementing dual class capital structures (previously loyalty voting shares were already allowed in France) as well as the relaxation of the rules regulating the issuance of shares without pre-emptive rights. In the name of market attractiveness, we may be beginning to see a general rise in the governance risk associated with European stock portfolios in coming years.  

Data quality issues undermining EU ESG regulatory framework 

The CFA Institute, a global association of investment professionals, has surveyed its members on the ESG regulatory framework in the EU. The study has revealed challenges with the EU’s current regulatory framework, specifically the Sustainable Financial Disclosure Regulation (SFDR) and the EU Taxonomy. The study highlights the range of challenges faced by investors including ESG disclosures, data reliability, and the complexity of ESG ratings (more below), with 65% of those surveyed choosing the lack of reliable ESG data as one of the biggest challenges for asset managers in implementing the SFDR. To combat these challenges, the CFA Institute calls on regulators to create legislation that is more tailored to investor needs, providing practical legislation which addresses the specific challenges cited. There are hopes that the Corporate Sustainability Reporting Directive (CSRD) will improve the quality and comparability of non-financial data across the EU; however, the effectiveness of these measures is yet to be seen, and may take a number of years to embed. While the CSRD may provide some hope of data clarity, the EU Taxonomy continues to be criticised, this time by a coalition of NGOs, calling on regulators to align sustainable taxonomies with science. Launching the Independent Science Based Taxonomy (ISBT), the WWF claimed that a science-based taxonomy would “ empower informed decision-making and accelerate the transition to a sustainable future”. Launching the taxonomy, the WWF insisted that political considerations and lobbying must not supersede environmental evidence. 

Decoupling ESG for more purposeful ratings 

As long-time readers of our ESG+ Newsletter will be well aware, ESG ratings have been a high-profile target for criticism, particularly in relation to methodology transparency and data inconsistencies. A recent Harvard Business Review article looked at inherent biases within ESG rating metrics for certain industries and companies, which can lead to a measurement trap. According to the authors, this trap presents in three ways: a focus on what can easily be measured; using data in an existing categorical framework; and filtering multi-dimensional data into a single number. The authors advocate for a two-pronged solution. Firstly, decoupling E, S, and G ratings into individual ratings which would allow companies and investors to focus on reporting metrics that align with their respective businesses and investment objectives. Secondly, they believe companies should be allowed to declare which metrics they wish to disclose against within a ESG regulatory framework, pointing to the relevance of the measures to their individual business. The solution proposed is of more nuance than the more frequent suggestion to purely scrap ESG ratings. 

Investors placing greater focus on human rights 

The UN Principles for Responsible Investment (PRI) has released its annual review of reporting cycles, looking at a full year of 2023 reporting. The report analyses the practices of over 3,700 signatories to review the extent to which asset owners and investment managers embed human rights and social issues into their portfolios. Findings show a significant surge in investor action on human rights, in part due to evolving regulatory risks, such as the EU’s CSDDD, and broader social trends like economic inequality and supply chain risks.  Key highlights include that over half of PRI signatories now have responsible investment policies with human rights guidelines, and 78% address broader social issues, up from 69% in 2021. European and Oceanian signatories lead in incorporating these guidelines and making them public. Notably, 60% use one or more human and labour rights frameworks to identify sustainability outcomes. However, only 9% fully implement the UNGPs’ pillars of policy commitment, due diligence, and access to remedy, highlighting a need for better human rights governance. As stated by the PRI, the latest reporting demonstrates that investors “are increasingly concerned with the financial risks – legal, reputational, operational – as well as opportunities related to the human rights and social performance of their portfolio companies.” With human rights now part of investment guidelines and ESG assessments, companies must continue to take action to reduce risks within their supply chains and, subsequently, carefully report on these efforts. 

ICYMI 

• Brazil’s Treasury and Securities and Exchange Commission (CVM) is set to launch an innovative investment fund consortium aimed at early-stage sustainable ventures, ESG News reports. 
• Hong Kong-listed companies disclosing sustainability-related financial info, aligning with global standards, may see better valuations as markets integrate sustainability risks, says the Securities Industry & Financial Markets Association.
• 30% of benchmark-sized sustainability-linked bonds (SLBs) from 19 issuers are likely to meet their 2024 targets, as reported by The Anthropocene Fixed Income Institute (AFII).