ESG+ Newsletter – 19 October

Your weekly updates on ESG and more

This week, we review the TCFD’s latest assessment of reporting against its framework, detail the back and forth over the differing types of materiality investors expect to see and provide updates on the latest European regulatory focus. We also analyse the usefulness of carbon credits and potential issues in that market as well as reviewing diversity levels in the latest data on UK board appointments. We also include below our monthly global regulatory update.

Regulatory Updates

As ESG regulations rapidly develop, FTI Consulting is providing a quick summary of the need-to-know updates from around the globe. This month, we cover Brazil’s pending carbon caps and California’s passing legislation on emissions reporting and climate-related risk reporting. Read more on our ESG regulations page.

TCFD adoption up, but most are failing to report against all recommendations 

The Taskforce on Climate-related Financial Disclosures (TCFD) has released its final progress report before it is absorbed into the International Sustainability Standards Board (ISSB) in July 2024. In its review of 1,350 company reports, the TCFD found a significant increase in the number of companies providing TCFD-aligned disclosures. According to the report, 90% of companies in 2022 provided disclosures in line with at least one of the TCFD’s 11 recommendations, compared with 80% in 2021. While this is promising, the number of companies reporting against all 11 recommendations is still only 4%. Some may view this as companies paying lip service to the TCFD rather than implementing its entire set of recommendations; however, the low levels of full alignment may reflect the TCFD’s own approach which encourages companies to take an incremental approach, building to full alignment over time. Regardless of the cause of the lack of full alignment, we are likely to see an increase in climate-related disclosures over time with the increasing adoption of the ISSB and the upcoming Corporate Sustainability Reporting Directive (CSRD) in the EU.  

Attempted CSRD pushback fails, with more than 50,000 companies to report on sustainability from 2024

Yesterday, the far-reaching Corporate Sustainability Reporting Directive (CSRD) overcame a challenge from right wing opposition. A cross-party group of 44 MEPs raised a motion to block the sustainability reporting standards in an attempt to reduce the administrative burden of compliance, however more than half of MEPs rejected the motion. This is a victory for supporters of the CSRD, who believe the standards will create standardised, transparent, and comparable data to inform investors and consumers. While the proposal was rejected, there are some anticipated delays and changes to the CSRD which seek to reduce the reporting burden. Sector-specific standards were due to be adopted in June 2024, however this will be pushed back by two years. Additionally, it is anticipated that the revenue threshold for large companies which would need to report from 2025 will increase to reduce the number of companies in scope of the regulation. There is still a significant amount of work ongoing on the CSRD, with the final details being ironed out by the European Financial Reporting Advisory Group (EFRAG). Despite the final elements still being finalised, 50,000 listed companies will have to comply with the CSRD from next year.

ISSB suggest EU’s CSRD-aligned reporting falls short of its standards 

Despite evidence of increasing uniformity in sustainability reporting, the International Sustainability Standards Board (ISSB) declared this week that sustainability reporting aligned with the EU’s Corporate Sustainability Reporting Directive (CSRD) does not fulfil ISSB requirements. Speaking at an event, ISSB board member Richard Barker said companies cannot claim that reporting using the European Sustainability Reporting Standards (ESRS) also satisfies ISSB. The issue here is the use of ‘double materiality’ under the ESRS, which goes beyond ISSB’s single – or financial – materiality. Double materiality necessitates disclosing both ESG impacts on a company as well as the company’s impacts on society and the environment. ISSB focuses solely on ESG effects on the company, in alignment with the International Financial Reporting Standards (IFRS) materiality test. Barker added that double materiality means reporting to multiple stakeholders, while ISSB targets investors specifically, with ESRS including data investors may not want. His remarks follow the EFRAG chair of Sustainability Reporting Patrick de Cambourg stating mandatory ESRS reporters likely won’t need separate ISSB reporting. In response, Barker advised companies to differentiate between investor needs and total ESRS compliance. The ESG space has long been calling for standardisation of reporting and the hope was the ISSB and CSRD were going to lead that revolution, but recent comments perpetuate the global debate between the frameworks surrounding double versus single materiality in emerging sustainability reporting.  

County Clare, South Pole, and the cautionary tale of the use of carbon offsets 

Earlier this week, the world’s leading sustainability benchmarking and performance improvement programme for destinations, Global Destination Sustainability Index, published its top 40 destinations, with Ireland’s County Clare coming in at number 38. Following the announcement, one of the stakeholders involved in facilitating the assessment stated that the “next goal must be to find new ways to offset the carbon that’s consumed when people travel to this region”. However, that very sentiment might be part of the problem with carbon offsets. Fundamentally, they do not change human behaviour – or indeed, total emissions – and, as a result, many argue that they should not be part of the solution to the climate crisis. 

A New Yorker article from this week added to the cautionary tale around offsets, looking at the South Pole’s Kariba project, a forest preservation effort near Lake Kariba in Zimbabwe that was the basis for a vast array of carbon credits sold to some of the world’s leading companies to offset their emissions. The project, spanning an area ten times the size of New York City, was among the world’s first ‘avoided deforestation’ programs. However, as the article reveals, the owner of the land couldn’t provide reliable accounts for how the money was spent or whether he invested the money locally. South Pole used certification agency Verra (which has experienced its own controversies), who require that – after ten years – a company must compare its performance against the projects original predictions. It was revealed that South Pole vastly overestimated the projected number of trees saved from the project, with c. 64% of the carbon credits the project generated over 10 years failing to offset any pollution. As a result, companies – unbeknown to them – falsely used the offsets from the project to claim the net-neutrality for marketing and/or selling products. So, as the stakeholders in Clare turn their attention to improving their Global Destination Sustainability Index ranking, their focus should be on positively changing behaviour and reducing their carbon footprint, as opposed to offsets. This will also help them reduce the air pollution in their community.  

Political preferences drive ESG-tilts in stock portfolios 

A new academic study covered by the Financial Times shows that, unsurprisingly, the composition of investors’ stock holdings differ with their political views. The authors investigate the issue by looking at the investments made by wealthy American households over the past 25 years. They carry their analysis at the county level, with investor political preferences proxied by the voting outcome in the last US presidential election in any given county. The study notes that, while political opinions did not appear to play a role in the earlier years of their sample, they emerged as a significant determinant of portfolio composition in the last decade. To distinguish between correlation and causality, the authors consider the entry of a conservative TV network into local media markets as an exogenous shock to investors’ political opinions in different counties. The paper further shows that differences in portfolio compositions between republicans and democrats are linked to their ESG preferences, with democrats tilting their portfolios away from companies with environmental and social concerns. The results of this research suggest that the increasing political polarisation of the society may impact future investment offerings and the composition of companies’ shareholder bases, as well as client offerings in financial services.

Diversity of UK board appointments declines 

Research conducted by headhunters Spencer Stuart has revealed a drop in the diversity of board appointments with the UK’s top listed companies favouring experienced candidates in the face of ongoing geopolitical and economic challenges. Ethnic minority candidates made up 15% of non-executive board appointments in the 12 months to April 30, compared with 27% in the previous year, spurred on by the need to meet official targets for at least one board member from an ethnic minority. Female non-executive appointments also fell from 60% to 51%. While appointments appear to have slowed, one other explanation is that overall progress on board composition has been healthy, with women now holding 40% of all board roles and ethnic minorities holding 13%, both figures up from the previous year. Analysis of the research results indicates that while targets have undoubtedly acted as an incentive for PLCs to tackle board diversity, it’s not yet clear whether this has been a “compliance exercise” or an indication of more meaningful change. When looking at specific appointments, only 3 out of 20 chief executive appointments went to women. While targets and quotas can be an effective means to an end, companies need to recognise that meeting targets doesn’t mean that the job is done and ensure that efforts on diversity are balanced with the need for continued strong oversight at board-level; and, promoting diverse talent pipelines for senior leadership positions.

EBA requires lenders to integrate ESG risk  

The European Banking Authority is in the process of revising its requirements for lender risk assessments, to now incorporate both environmental and risk factors. The impact will ultimately be that bank stress testing programmes to influence funding decisions to clients, will now include those factors, with significant implications for high-emitting sectors or those with more systemic ESG issues. The EBA’s move is a world first, as Europe once again has forged ahead of the rest; its new guidance is being rolled out in phases with some obligations to be enforced imminently. As reported by Bloomberg, banking and financial stability organisations globally are reviewing respective frameworks. Should other geographies follow suit, the entire sector may face fundamental change as ESG factors are tied even closer to credit risk.  

The funding of fossil fuel intensive projects as been debated for years. Many industry leading banks, especially in the EU, have started the adaptation process. BNP Paribas, amid climate activist scrutiny, in June stated that it would no longer arrange bond deals if the issuer intended to use the capital in new fossil fuel exploration and adaption. A major part of ESG is risk identification and long-term management; factoring it into long-term lending appears to make sense. 

ICYMI 

• Bad management has prompted one in three UK workers to quit, survey finds. Study shows widespread concern over quality of managers, with 82% of bosses deemed ‘accidental’, having had no formal training. Research by the Chartered Management Institute found that almost a third of UK workers said they have quit a job because of a negative workplace culture. Other factors cited by respondents included a negative relationship with a manager (28%) and discrimination or harassment (12%). 
• Alaska shuts down its snow crab harvest for the second year in a row. The Bering Sea snow crab population has collapsed, likely due in part to past marine heat waves, researchers say. Alaskan officials recently canceled the Bering Sea snow crab season for the second year in a row — and the second time ever — due to dwindling crab population levels. Warmer ocean water and less ice formation could be the blame as we experience record high global temperatures.  
• Canada’s top court backs Alberta challenge to Trudeau environment law. A federal law assessing how projects such as coal mines and oil sands plants impact the environment has been considered unconstitutional. This decision is a victory for Alberta, Canada’s main fossil fuel-producing province, which challenged the Impact Assessment Act (IAA), saying it gave Ottawa too much power to kill natural resource projects. This is a potential positive move for the Canadian energy sector development, and oil and gas investors. 
• RI Survey: Investors reveal Nature Action 100 engagement plans. Last month, Nature Action 100 began sending initial engagement letters as it named its target firms and investor participants. The RI survey reveals how most respondents prioritized quality over quantity when engaging with companies. Also, of the eight priority sectors identified, food, biotechnology and pharmaceuticals were the most popular sector of engagement target firms. Most firms remain optimistic when engaging on nature, but a focus on disclosures and documentation remains key to move forward.