ESG+ Newsletter – 22nd September 2022

Building effective cybersecurity governance

The increasing prevalence of cyber-attacks, coupled with the declining availability of cyber insurance is leaving companies exposed to the impacts of cybersecurity incidents. The reputational impact of such an incident may be long lasting, and for this reason, the management and oversight of cybersecurity risk should be a key focus for company leadership. In our latest paper on this subject, we outline the key cybersecurity governance considerations for companies, drawing on both investor and regulatory scrutiny of the subject – and look at the demand for increased shareholder engagement and reporting. We also propose a reporting framework that attempts to address how companies can proactively demonstrate oversight of cybersecurity to investors and other stakeholders.

Could credit ESG ratings provide increased investor confidence in ESG financing?

As previously detailed in this newsletter, sustainability linked loans (SLLs) have become the fastest growing segment of sustainable financing instruments. The lack of regulatory guidelines for this type of ESG product, and the promotion of this form of financing by policymakers, have acted as a significant tailwind for lenders, with more than $170 billion of SLLs issuances since 2019. However, as Bloomberg reports, this form of financing is gathering increasing scrutiny from investors who have become concerned that these financial instruments have become vehicles for ‘greenwashing’ – with investors citing that some of the targets associated with the loans are not ambitious enough.

A potential bridge to assuage investor scepticism of ESG-linked financing could be tied to the increased incorporation of a credit ESG rating from credit rating agencies. A recent FTI report highlighted that these new credit ESG ratings have the potential to influence traditional credit ratings and there is growing evidence that credit ESG ratings –  issued by Fitch, Moody’s, or S&P – are being more consistently used as part of financing terms by banks and other lenders.

Consistent with many aspects of ESG, increasing transparency and confidence around disclosure and targets is crucial to the continued evolution and adoption of ESG financing across the capital markets. The integration of a new credit ESG rating in credit ratings reviews of borrower sustainability targets could become increasingly valuable, potentially allowing investors to evaluate ESG-linked financial issuances more thoroughly.

Australia’s 2023 AGM Season and the focus on long-term risks

Following two proxy seasons marked by the impacts of the Covid-19 pandemic on company performance, 2023 is set to be the first AGM season where institutional investor focus is expected to shift from assessing recovery plans and ability to navigate economic turmoil to companies’ approach to non-financial systemic risks. As companies in Europe and the US enter their “off season” engagement period, all eyes are on the Australian market. Climate risk management will likely be the biggest challenge for investors from a sustainability perspective, with a growing expectation for boards to provide oversight on this material topic. As companies prepare for their AGMs, early and open engagement with their investors constitutes a great opportunity to forge relationships and create trust. The growing focus on environmental and social risks has also been impacting support for remuneration and election of directors’ resolutions, further highlighting the need for clear engagement and disclosure. Furthermore, the majority of ASX 200 companies will be holding hybrid AGMs which, according to the Australian Shareholders Association, has become the gold standard post-pandemic, as it allows for greater shareholder participation. While there are some significant differences between markets, the Australian proxy season will provide some useful insights into institutional investors’ expectations as European companies prepare their 2023 AGMs.

Push for executive pay to be tied to ESG goals

TESG investors are responding to the rapid growth in executive pay that hit a median of $14.2 million at the 500 largest companies in the US in 2021. Campaigns were launched globally at the beginning of this year with activist groups such as As You Sow putting pressure on major companies to link their ESG metrics to longer term bonuses. Large asset managers are also taking action and requesting that ESG pay metrics be explained with more information, including describing how progress against published goals is measured, alluding to the demand for quantifiable measures of performance.

Outside of investors, SEC rulings may also increase pressure on companies to update compensation plans to include ESG metrics. The SEC’s proposal on climate disclosure will require companies to provide specific information on their emissions and this information has the potential to provide a framework for companies to create targets and goals that can be better compared to peers and also be included in bonus pay metrics. The SEC’s performance versus pay rule and human capital management disclosure could also increase the use of ESG-linked pay metrics.

Biodiversity a clear investor priority

This week, the FT reported that biodiversity is the next big theme in responsible investing, a fact highlighted by FTI previously, from articles on how biodiversity was following in carbon’s slipstream, to our July thought leadership piece on biodiversity as the next ESG hot topic. According to Catherine Howarth, chief executive at responsible-investment group ShareAction, biodiversity is “now the fastest developing ESG theme in global capital markets”. Investors are beginning to see the necessity of biodiversity in the transition to net zero with the investment community taking action by either raising capital for nature-based economic opportunities or analysing how portfolio companies are contributing to biodiversity loss. These approaches are combined with collaborative initiatives such as the Natural Capital Investment Alliance, which aims to funnel $10bn towards nature capital this year. Back in 2020, ShareAction found that only 11% of the asset managers reviewed had policies requiring portfolio companies to mitigate harmful impacts on biodiversity, demonstrating a concerning disregard for the financial risks associated with biodiversity loss amongst the investment community. As biodiversity moves from a minor issue to a consideration which is fundamental to the net zero transition, companies need to be prepared to engage with investors on how biodiversity is integrated into performance and risk frameworks.

Supply chain issues under the microscope

A new publication released collaboratively by the International Labour Organisation, Walk Free, and the UN’s International Organization for Migration has reported that the number of people currently enslaved under the definition of modern slavery has grown by 10 million in the last five years.

The trio, building upon research initially published in 2017, have estimated that 50 million people are currently experiencing one of the many exploitative practices categorised under modern slavery. The report states that no country is exempt from cases, debunking the myth in the west that human rights abuses tend to only happen in faraway places. The primary form of abuse, accounting for approximately 28 million people, is forced labour and of those, the majority are noted to be found in the private sector. The new data raises vital questions about the global supply chain and, as highlighted in our newsletter last week, the risks for businesses are coming under increased scrutiny from investors, regulators, and commercial partners, driving greater reporting obligations and accountability for issues such as modern slavery breaches.

The report directly calls out the Global North as being complicit in failings, with the inference being that businesses in leading economies are not fulfilling adequate due diligence across the entire supply chain. The cross-border, global `level findings demonstrate how vital the role of aligned supranational regulation is if true change is to occur.

In Case You Missed It

• Norway’s wealth fund to up ante on net-zero: As net zero discussions become ubiquitous, NBIM has pointed to “delayed transition” as the biggest financial risk facing its investments. Perhaps surprisingly, NBIM noted that only 10% of its portfolio companies had set a net zero goal, in contrast to the higher prevalence at the world’s larger companies, including 63% of the Fortune 500.
• EU faces backlash on green labelling: With calls for clear distinction of what is “green” or not growing, environmental groups are commencing legal challenges against the European Union’s executive branch, arguing that natural gas and nuclear power generation should not be included in the bloc’s list of sustainable activities. While energy security remains a key issue across the globe, the groups argue that treating gas as sustainable undermines the EU’s net zero 2050 commitment, thereby clashing with other aspects of EU law.
• Significant potential losses for Agri and food sectors: Race to Zero, a U.N.-backed campaign to address climate change, has published a report analysing how 40 big companies including agricultural producers and food retailers could fare under scenarios that are key to reducing emissions, such as carbon emissions prices or if consumers reduce their consumption of meat. The report estimates a loss of approximately $150 billion for food and agricultural investors by 2030 if current practices do not change.

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