ESG+ Newsletter – 2 May 2024

As demand for green financing grows, tracking progress remains a challenge

Green bond issuances in 2024 are at record-breaking pace, with $188 billion being issued so far this year. 43% of this issuance has been from corporate issuers, which is already ahead of previous annual records. The value of green bonds is that they support companies’ decarbonisation efforts by effectively providing a bridge between their long-term targets and investments and short-term decarbonisation progress – such as investing in R&D of new technology and transitioning away from carbon intensive operations. A by-product of this, which was recently highlighted by Environmental Finance, is that green bond issuances come primarily from carbon intensive companies – like the utility sector –  which results in green bond portfolios having larger carbon footprints. The dichotomy of high carbon footprints from green bonds does not likely sit well some ESG investors and one solution, that the article advocates for, is that carbon accounting be applied specifically to emissions associated with projects or activities associated with the green bond. Currently, the carbon footprint of a green bond is calculated based on the overall emissions of the issuer, rather than the specific projects financed which are likely to have a lower carbon footprint than the overall business. Therefore, having carbon accounting exclusively for project emissions financed, through green bonds, could ease investor concerns, while also potentially boosting demand for this type of financing. Green bonds are, and will continue to be, an integral part of financing the net zero transition. However, to ensure investor alignment and ultimately attract a larger pool of capital, providing greater transparency on the efficacy of green bonds would be a welcome addition.

Helping CFOs and IROs pull the ESG value creation levers

Chief Financial Officers (CFOs) and Investor Relations Officers (IROs) have traditionally taken a more passive stance when it comes to matters of ESG and sustainability. To date, the traditional skills and methods used in shareholder engagement and financial reporting have served them well. So why change what isn’t broken? FTI’s Bryan Armstrong and Ben Herskowitz authored a thought leadership piece titled ‘A Quickly Evolving ESG & Sustainability Landscape: Bringing IROs and CFOs Along for the Ride’ that answers this question. It explores how company leadership attitudes must change as we enter a new sustainability reporting regime. More specifically, as disclosures increasingly standardise – driven by a shift to mandatory reporting – the market will also shift in its evaluation of ESG programmes. Investors will no longer credit companies for simply providing a comprehensive set of sustainability disclosures and will instead focus on the actual performance of such disclosures relative to peers and the broader market. To help IROs and CFOs focus on what matters most, the article outlines four levers to consider to augment investor relations programmes and help drive value creation in this evolving, regulation-centered environment.

The transatlantic executive pay gap continues to widen 

In our ESG+ Newsletter last week, we discussed how a growing number of UK companies intend to put significant pay increases to a shareholder vote during the 2024 AGM season – much of it driven to better compete with their US peers in the market for talent. A recent Financial Times article on US executive pay figures revealed that the median pay for S&P 500 CEOs increased by 9% year-to-date, which is likely to amplify calls for pay increases for UK executives to keep apace with their US counterparts. While stock market performance can explain part of this increase, pay also rose at 65 companies despite them experiencing a decline in performance. As illustrated in an article published by Reuters, the correlation between pay and performance remains closely scrutinised by proxy advisors and investors. Instances of severe disconnects between pay and performance that can’t be properly rationalised by companies often resulting in negative vote recommendations from proxy advisors, which can translate into significant shareholder dissent at AGMs and, in turn, damage a company’s corporate reputation.  

The FTC’s move to reshape work culture in the US

The US Federal Trade Commission (FTC) voted to ban and invalidate non-compete agreements that prohibit employees from working for a competitor for a period of time after they leave their current job. The FTC argues that these measures, that affect approximately 30 million workers, restrict employees from freely switching jobs, keep wages low and stifle innovation – ultimately robbing the “American economy of dynamism”. The FTC move invalidates existing non-compete agreements for most employees and for all new contracts starting in August. The only exemptions are for senior executives, or those earning more than $151,000 annually, for whom non-compete agreements remain in force. While there is optimism about the rule’s potential, the move has already sparked legal pushback. Critics argue that the ban will hinder protecting IP and trade secrets, with legal experts predicting an increase in trade secret lawsuits and challenges in restructuring contracts. Nonetheless, this move should be viewed as an opportunity for companies and regulators to rethink work culture, seek alternative ways to safeguard proprietary information and increase compensation to retain talent, shifting from contract-based pay structures to placing a more enticing incentive structure.

Research indicates that investors ‘care’ about biodiversity

It has been a big week for biodiversity news and, in particular, for developments on investor approaches to engaging companies on biodiversity and nature. Last week, Nature Action 100 launched the details of the benchmark it will use to assess target firms, according to Responsible Investor. Nature Action 100, an investor-led initiative representing more than $28 trillion in assets under management or advice, is seeking to actively engage with companies with the biggest impact on nature, using the recently released benchmark to analyse areas for potential improvement. This is just one indication that investors are increasingly paying attention to nature and biodiversity, which adds to recent research seeking to work out whether investors actually care about biodiversity. The research, published in Review of Finance, found that following the signing of the Kunming Declaration and the launch of the TNFD in 2021, stocks of companies with large biodiversity footprints lost value, indicating that investors have started requiring a risk premium based on “future regulation or litigation to preserve biodiversity”. Another observation by the authors is that “the link between biodiversity and finance has received little attention by academics.” A space we will continue to watch.

As we continue to get through the 2024 AGM season, we also see investor action gaining pace on biodiversity-related issues through a number of shareholder proposals.  It seems that investors really are starting to care about biodiversity.

G7 agrees to stop using unabated coal by 2035 

Following two days of discussions in Italy, ministers from the G7 countries have agreed to end the use of unabated coal power plants by 2035, reports the Financial Times. The pledge marks the first time G7 economies have set a target on coal in an attempt to curtail rising GHG emissions. Italian Minister of the Environment and Energy Security, Gilberto Pichetto Fratin, spoke of the agreement as a “very strong signal from industrialised countries” and “a big signal to the world to reduce coal.”  However, always be sure to read the fine print. The document refers to “unabated” coal, allowing countries to keep burning coal if they employ carbon capture technology, while also leaving room for countries to continue investing in gas, despite leaders pledging at COP28 to transition away from all fossil fuels by 2050. It also provides leeway for countries that are heavily reliant on coal, such as Germany and Japan, by offering the option of “a timeline consistent with keeping a limit of 1.5C” of global warming above pre-industrial levels. Industry experts and policy advisers have praised the move away from coal but have criticised the relaxed timeline in the face of the current climate crisis.  

EU ESG ratings regulation gets final approval  

In our previous newsletters, we tracked the EU ESG ratings regulation and last week the European Parliament approved the final text. The regulation mandates rating providers to separate E, S, and G ratings, instead of providing an aggregated ESG metric. This – together with the obligation to disclose whether a double materiality approach was used – provides greater transparency for investors. The disclosure of “the rate and weight” of individual E, S, and G components will facilitate comparisons between ratings agencies, allowing investors to make more informed decisions. Notably, in a last-minute amendment aimed at mitigating conflicts of interest, ESG rating providers are now barred from offering credit ratings, benchmarks, auditing, or insurance activities under the same entity. Instead, firms offering such services must establish distinct legal entities solely dedicated to ESG rating services. The new laws will be enforced by the European Securities and Markets Authority.  For investors, these regulations offer clear advantages, enabling them to develop credible sustainable investment strategies. Meanwhile, for companies, the newfound consistency in ratings will aid in discerning differences between rating agencies and potentially mitigate the risk of accusations of greenwashing. 

ICYMI 

• IPCC scientists say SBTi approach not sufficient to meet net-zero targets. Responsible Investor reports that scientists have criticised the effectiveness of company-level emissions reduction approach endorsed by the SBTi. They argue that these approaches, while widely adopted, may not lead to global decarbonisation and could hinder the emergence of new, innovative companies. 
• Social and Inequality TCFD equivalent to launch in September. The Taskforce on Inequality-related Financial Disclosures and Taskforce on Social-related Financial Disclosures have merged to form the Task Force on Inequality and Social Related Financial Disclosures. According to Responsible Investor, the working group will aim to develop a global framework for inequality and social-related disclosures. 
• China Cuts Air Pollution After Reimposing Winter Controls.  China’s reintroduction of a pollution action plan this winter helped improve air quality after its removal last year led to a surge in smog, Bloomberg reports. A new report by the Centre for Research on Energy and Clean Air (CREA) found that national PM2.5 levels dropped 3.6% in the first three months of 2024, representing an improvement from the 4.7% increase in the winter of 2022-2023.