ESG+ Newsletter – 22nd July 2021

Border Taxes: a global tool to achieve climate goals

Global momentum continues to build around carbon border taxes. In the US, Democrats have proposed a tax on imports on carbon-intensive products, such as iron and steel, from countries that are not acting to significantly reduce climate change risks. The legislation was announced on 19 July by Senators Chris Coons and Scott Peters and received the support of President Biden and his administration officials as it is seen as a tool to progress their climate objectives.

The border tax is designed to level out the competitive advantage for companies abroad selling iron, steel, aluminium or other carbon-intensive products, as they will be required to pay a price for each tonne of carbon dioxide they emit in making their products. Proponents of the tax also argue that it will mitigate the risk of “carbon leakage” by preventing American companies from relocating to countries with looser environmental rules. However, as the new taxation could create serious diplomatic challenges for the US ahead of United Nations climate negotiations set for November in Glasgow, the hope is that the move will encourage other countries to also price carbon and drive down emissions.

The European Union recently announced a similar Carbon Border Adjustment Mechanism based on trading in certificates on actual or direct emissions for imports of iron and steel, aluminium, cement, organic basic chemicals, fertilizers and electricity. Turkey also has announced a formal green plan to cut carbon emissions, which could limit the burden for domestic companies competing with the EU under the carbon tax initiative. Taken together, these regulatory changes are important steps towards pricing embedded emissions in traded items.

Sustainable investments growth continues with transition towards ‘green’ products

This week, the Global Sustainable Investment Alliance (GSIA) published its biennial Global Sustainable Investment Review which revealed that sustainable investments now total $35.3 trillion in five of the world’s biggest markets. The asset class now represents 36% of all professionally managed assets across regions covered by the data and has grown by 15% in two years. Continued investor focus is clearly impacting how central banks and sovereign wealth and public pension funds are operating and behaving, with a Global Public Investor report published by the Official Monetary and Financial Institutions Forum (OMFIF) this week detailing that these institutions are transitioning towards ‘greener’ products. According to the research, 65% of central banks plan to add to their green bond holdings, an increase from 45% on the previous year, and 20% of central banks now see sustainability as their joint-most important institutional priority. As highlighted in last week’s newsletter, the continued growth in sustainable investments and ESG linked financing reflects the fact that investors are increasingly driven by ESG factors when making investment decisions. These two reports further highlight the scale and speed with which that is happening.

Green Asset Ratio: European banks comment as regulators implement change across the globe

The introduction of the Green Asset Ratio (GAR) rules by the European Union will push European banks to bolster their disclosure on how ESG issues are handled and is designed to provide investors with a better tool to assess green credentials in the financial industry. The metric will measure the portion of a bank’s loans and securities which meet the EU environmental taxonomy on total balance sheet assets, offering comparable information on ESG exposures and strategy, as well as plans on mitigating climate risks. Disclosure underlying the new ratio is expected to be adopted gradually starting from 2022, with the first set of reporting to be completed by 2024.

While European banks may benefit from the GAR rules, as they could become more attractive for investors than Non-European credit institutions, Bloomberg reports that concerns have been raised regarding the accuracy of the results. Banks argue that, as they have to rely on data provided by their clients to calculate the ratio, small or international companies who are not subject to reporting requirements may not provide the data needed which will lead to biased GAR estimates. Complaints have also been made on the timing of its introduction and the failure to acknowledge efforts to support companies transitioning away from carbon. However, given the high demand for ESG data from both regulators and investors, it is expected that banks are prepared to meet the new disclosure requirements and support their claims for green credentials.

The strengthening of the EU regulatory framework has also set an example for other jurisdictions. This week, Russia’s central bank recommended domestic companies provide disclosure on their ESG plans and details on their evaluation of related risks. Brazil is also moving in the same direction, receiving praise from Fitch for its progress, clearly indicating that as expectations on disclosure standards for ESG risks continue to grow, policy makers worldwide are under pressure to update regulatory frameworks.

Shareholder opposition on pay and support for diversity resolutions grows

Earlier this week, BlackRock published its ‘2021 Voting Spotlight’ which revealed that it increased its opposition to executive remuneration in Europe over the course of the last year. BlackRock voted against 33% of Board renumeration proposals in the 12 months to the end of June, an increase from 26% during the previous year. BlackRock opposed companies who granted pay increases and bonuses during the COVID-19 pandemic even when they missed financial targets, cut jobs or accepted government support, with Sandy Boss, global head of investment stewardship, stating the asset manager  “opposed executive pay programmes when companies were not able to explain how these adjustments supported long-term, sustainable value creation for shareholders”. It is not just executive remuneration that is facing dissent at AGMs though, with companies facing shareholder pressure for failing to address race and other diversity issues. According to Proxy Insight quoted in the Financial Times, the average investor support for diversity-related resolutions has grown rapidly from 23.9% throughout 2020 to 42.4% in the first half of 2021. Additionally, some companies have faced a shareholder backlash via support for shareholder proposed diversity resolutions, with Heidi Soumerai, senior ESG adviser at Boston Trust Walden, a US asset manager, suggesting the high levels of “for” votes at annual meetings “indicate that many large asset managers and asset owners are backing up their words in support of racial justice through their voting practices”. It is becoming more apparent during proxy voting and AGMs that shareholders are more willing to exercise their vote as a method of voicing their displeasure on more than just governance matters, with the ‘S’ in ESG becoming a growing focus.

SDFR introduction delayed by a further 6 months

It was recently revealed that the European Union has once again delayed the second phase of Sustainable Finance Disclosure Regulation (SFDR) which aims to standardise the way that ESG factors are reported across the EU, making it easier for investors to identify those firms which are truly meeting their obligations when it comes to ESG. In a letter by John Berrigan, Deputy Director-General for Financial Stability, Financial Services and Capital Markets Union at the European Commission, he stated that the further delay of six months to July 2022 would ensure a “smooth implementation of the standards by product manufacturers, financial advisers and supervisors”, while also negating a last-minute rush for market participants. The delay comes against a backdrop where the volume of capital being deployed across ESG related financial products has never been higher and amid concerns that the prevalence of “greenwashing” is growing, with some even some arguing that it is the biggest challenge facing ESG investing. However, in drafting and implementing new legislation to standardise ESG reporting, it is important that the EU listens to all feedback from stakeholders, gets it right the first time and avoids having to revisit the legislation soon after its implementation.

Trend towards stakeholder capitalism clear

Undoubtedly there has been an orientation towards a stakeholder capitalist model of corporation in recent years, as businesses increasingly communicate their regard for the needs of their customers, employees, and communities alongside their shareholders. While proponents of the shareholder primacy model of doing business have not been shy in expressing their concerns for this orientation, McKinsey’s Dame Vivian Hunt DBE ponders for Fortune on who exactly fears stakeholder capitalism. Concern for key stakeholders should not, in Hunt’s view, be controversial. Nor is it. Dame Hunt adds that “except for the fringes”, there is broad agreement about how companies should act and that a lot of commonalities exist in the two sides of the public debate. In 2019, when the Business Roundtable (BRT) changed its statement of purpose to emphasize serving all stakeholders, it later clarified to critics that this was “not a repudiation of shareholder interests in favour of political and social goals.” Equally, according to Dame Hunt, the Milton Friedman-influenced side does not believe “that it is justifiable to pursue profit by mistreating workers, diddling suppliers, or deceiving customers.” If ethical justifications for this orientation towards stakeholder capitalism do not resonate in the Boardroom, Dame Hunt suggests that self-interest might do. Put simply, executives simply may not have any choice. 45% of the FTSE 100 are linking executive pay to ESG metrics. Since 2018, the number of companies that include environmental or social considerations in executive pay has doubled.

Nuclear energy may be the solution to Bitcoin’s environmental impact

Bitcoin mining has long been associated with excessive energy consumption, the primary source historically being fossil fuels. US energy start-up Oklo aims to address this by providing low-emission energy for Bitcoin mining in the form of nuclear fission. They’ve announced a 20-year partnership with Bitcoin mining and hosting firm Compass Mining, during which they’ll provide them with energy from Oklo’s small nuclear fission reactors.  Although Oklo is still awaiting regulatory approval, Bloomberg reports that other energy firms, such as Energy Harbor Corp, have entered into similar partnerships with other mining businesses in what seems like a win-win for all concerned. Whether Bitcoin can truly address regulatory and sustainability concerns as it attempts to move to the mainstream remains uncertain.

Sustainability software market heats up as Microsoft enters fray

Setting targets for emissions can be the easy part of a sustainability program; measuring progress towards those targets is often where businesses struggle. Sustainability software aims to ease that burden and Microsoft has now joined Salesforce and SAP in developing software that can track and report greenhouse gas emissions. Microsoft Cloud for Sustainability allows organisations to track and store both their own data and information from third parties on Microsoft’s cloud infrastructure. Predictive analytics then identify opportunities to reduce emissions and alert businesses to problems such as faulty air conditioning. However, as with any analytics, its effectiveness will be limited by the quality of its underlying data, something identified as the Achilles heel of sustainability software currently. Microsoft has something of an advantage here given its footprint on both corporate networks and in the cloud. Sustainability software may not yet be the silver bullet for tracking emissions goals but with three software and data giants now competing in this space, businesses shouldn’t dismiss it just yet.

In Case You Missed It

• The proportion of women on the boards of 200 of Britain’s top financial firms has risen to nearly a third in the five years. Reuters reported this week that, since the launch of the HM Treasury Women in Finance Charter in March 2016,  the number of women sitting on boards has risen to 32% from 23%, with female representation on executive committees increasing to 22% from 14%.
• UBS has launched a portfolio that invests solely in hedge funds that are led by women to improve diversity and spot hidden talent in the traditionally male-dominated sector. The Financial Times reported that the launch comes at a time of growing investor interest in women- and minority-run owned funds, with US pension plans and other large allocators increasingly looking to make investments based on ESG criteria.
• Waste Management World reports that the Israeli government intends to double taxes on single-use plastics in a move to curb plastic consumption. The tax raise should lead to a 40% slash in plastic consumption, but the exact tax amount on flexible plastics such as cups, plates, bowls, cutlery, and straws has not yet been determined by the government.
• American Airlines announced a commitment to reduce its greenhouse emissions by  2035. American’s fundamental aspiration is to make consistent operational improvements, which means flying more efficient routes with more efficient aircrafts powered by low-carbon fuel.  The company is the first airline in North America to seek validation from the Science-based Target’s initiative (SBTi), a collaboration between Customer Data Platform (CDP), the United Nations Global Compact, Worlds Resources Institute (WRI) and the World Wide Fund for Nature (WWF).

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