ESG+ Newsletter – 23rd June 2022

European Commission releases proposals to boost nature restoration, halve use of pesticides

The European Commission has adopted proposals to restore damaged ecosystems across the EU by 2050 and to reduce the use of chemical pesticides by 50% by 2030. The Nature Restoration Law would aim to repair the 80% of European habitats that are in poor condition and bring back nature to all ecosystems – from forest and agricultural land to marine, freshwater and urban ecosystems. If the proposal is adopted, legally binding targets for nature restoration in different ecosystems would apply to every Member State. An intermediate target for 2030 would aim to cover at least 20% of the EU’s land and sea areas.

Meanwhile, the second proposal aims to introduce legally binding targets at the EU and national level to reduce by 50% the use of chemical pesticides and hazardous pesticides by 2030, with the Member States setting their own national reduction targets to ensure this is achieved. Proposed measures include new rules on environmentally friendly pest control, and prohibiting the use of all pesticides in places such as urban green areas, protected areas in accordance with Natura 2000, and sensitive areas for threatened pollinators.

Both proposals will now be discussed by the European Parliament and the Member States, in a process that could take an extra year.

Financial vs ESG audits – who watches the watchmen?

As companies grapple with the growing reporting requirements under the EU’s SDFR and taxonomy frameworks, the need for additional resourcing has increased.  This has opened up new revenue streams for advisory and consultancy businesses, in part due to new disclosure legislation requiring companies to publish ESG Reports that have been audited and evaluated by approved and independent third parties. The new market stands to be incredibly lucrative, with the EU Commission estimating that ESG audits could in the future be worth between $4 billion and $8 billion annually. With a significant amount of money to be made, battle lines between the Big Four and smaller rivals are being drawn with a clear divide emerging. Proponents of the auditing firms, such as industry accountancy bodies, have raised concerns that other providers may not have the quality of services, qualifications and assurances that traditional audit firms offer. Conversely, supporters of smaller firms, principally EU lawmakers, are fearful that the Big Four will gain similar market share dominance that they already experience for financial audits – thus resulting in less competition and options for companies.

Potential fears over conflicts of interest have likely been reduced by EU lawmakers intending to prevent a company’s financial auditor from also reviewing its sustainability reports, but questions will remain regarding oversight if the Big Four’s financial audit dominance does carry through to a similar monopoly with sustainability audits. If this does transpire, questions around ‘who watches the watchmen’ will likely emerge and, as we have seen recently in the UK and US, regulators are attempting to break up the Big Four’s hegemony of the accounting industry.

Lack of tech diversity may have consequences for the metaverse

Poor diversity within the tech industry may see existing problems of harassment perpetuated as we move to “the metaverse”, the next evolution of the internet that will blur the lines between physical and digital reality.

With the creators of the existing social media platforms being predominately male and white, it is widely thought that the hate speech and harassment experienced by people of colour was not a central consideration at the point of conception. In other words, these issues are unlikely to have been front of mind when these platforms were being built. With Black and Hispanic workers only accounting for 7% and 8% of computer workers in the US, despite representing 11% and 17% of the country’s total workforce, there is a risk that the metaverse will continue to be a hostile environment for people of colour. There is evidence already emerging that underage gamers are being exposed to racist language on virtual platforms. The main operators within the metaverse state that they’re prioritising diversity, with Meta committing $1 billion annually to using diverse suppliers, and online gaming company Roblox offering rewards for creators of colour. However, activists state that diversity can only truly be addressed through diverse hiring that challenges the culture within tech companies. The metaverse offers the opportunity to address the many negative aspects of web 2.0 – now is the time to seize it.

Global banking regulator targets link between pay and climate

Banks should review their pay and bonus structures to ensure they are consistent with long-term climate goals, according to the world’s most influential global financial regulator, the Basel Committee on Banking Supervision (BCBS).

The BCBS released a set of 18 climate-related financial risk principles for regulators, which include a recommendation for banks’ boards and management teams to consider whether integrating climate risks in their business plans warrants changes to compensation policies. The principles could lead more firms to decide to adjust or claw back pay if climate-related financial risks occur. There is also the possibility that the integration of climate considerations into compensation necessitates the extension of remuneration deferral periods, in order to ensure that they capture the long-term nature of climate-related risks.

Although the proposal to link compensation to climate plans is new, many of the recommendations of the BCBS outline standards which are already commonplace among banks, including assessing borrowers’ exposure to climate change risk, and introducing controls so climate risks are managed. While the BCBS is an influential organisation, these are currently only recommendations, and regulators have not spelt out how they will work in practice. Those companies to have already integrated environmental factors into pay plans include NatWest, HSBC, and Citigroup. The practicalities of implementation, and whether these measures ensure company leadership take a sufficiently long-term view to mitigating climate-related risks, remain to be seen.

A corporate governance and industry driven approach to financial audit

The UK government roadmap to revamp the audit market and ensure businesses remain accountable to stakeholders was unveiled at the end of May 2022. The initial proposal of implementing a UK version of the Sarbanes-Oxley Act was dropped.

While there is significant merit in such a model, where directors are personally accountable for internal controls over financial reporting, there was significant pushback from companies across the UK. The Chair of the Financial Reporting Council responded that, while the specific legislation has not been implemented, boards still need to be held responsible for their company accounts. The watchdog stated: “We will be consulting about the merit of using the corporate governance code and the audit reforms we are working on to put more pressure on boards of directors to take responsibility for their own internal controls. It won’t be Sarbanes-Oxley, but it is the same idea”. 

Furthermore, the Institute of Directors (‘IoD’), which has approximately 20,000 members, has proposed a voluntary code covering ethics, diversity, lawfulness and competence. It seeks to improve boardroom behaviour following the high-profile collapses of companies, including Carillion and Patisserie Valerie, as a result of audit failures. The objective of the voluntary IoD code is to complement the existing UK Corporate Governance Code and general regulatory requirements in the UK, with the difference being that this code would be administered by industry rather than the government. Despite the differences in scope between the FRC’s regulatory approach and the market-based IoD code, both can play a significant role in ensuring directors and boards take responsibility for the financial stability of their companies.

New social and environmental reporting rules for large companies

The non-financial information that companies are currently incentivised to report is largely insufficient for investors and other stakeholders. Reported data can also be hard to compare.

On Tuesday 22 June, Members of the European Parliament and the 27 EU governments struck a provisional agreement on new reporting rules for large companies – the Corporate Sustainability Reporting Directive (CSRD). The goal is to make businesses more accountable by obliging them to disclose their impact on people and the planet. In turn, the legislation aims to end greenwashing and lay the groundwork for sustainability reporting standards at a global level. From 2024, large companies will need to publicly disclose information on the way they operate and manage social and environmental risks. The new EU sustainability reporting requirements will apply to all large companies (with over 250 employees and a 40-million-euro turnover, as defined in the Accounting Directive), whether listed or not. Companies will have to report on their impact on the environment, human rights, social standards and ethics, based on common standards.

Japanese government-backed bank set to spend $40 billion on sustainable financing

The Development Bank of Japan (DBJ), which supported companies during the pandemic, is now focusing on sustainable financing. It has earmarked 40% of its total lending and investment, equating to approximately $40 billion, for ESG purposes over the next five years which started in April 2021.

Fumiyo Harada, an executive officer and chief manager of the sustainability management office at the DBJ, said it will scrutinize the use of funds to ensure companies are not greenwashing. This stance is in line with a global push by regulators to stamp out greenwashing – as evidenced by the DWS and Goldman Sachs investigations. The investigations have been extensively covered in our ESG+ newsletters over the past couple of weeks. At FTI we believe the scrutiny over greenwashing is likely to continue with more companies coming under the spotlight but in the longer term, this will benefit ESG financing and the fight against climate change.

Tariq Fancy lays out next steps for ESG

Almost a year on from his heavy-hitting critique of ESG investing, BlackRock’s former chief investment officer for sustainable investing Tariq Fancy has penned a follow up essay – in part to address the recent comments of HSBC’s Stuart Kirk and the growing levels anti-ESG rhetoric from Republican politicians.

Fancy sees Kirk’s comments as being in a similar vein as his own ten months ago – ultimately that the ESG investing is not without flaws and is in need of government level intervention for legitimisation and progress. Fancy also notes the contradictions presented by PR-led corporate social responsibility initiatives in comparison to reluctance to disclose certain material ESG information to the market.

The essay goes on to criticise the stance of Mike Pence and the wider Republican movement he believes to be misusing his arguments to push an anti-woke agenda. Fancy cuttingly references the latest Intergovernmental Panel on Climate change to make his point – posing the question to Pence and co: “What part of the latest IPCC report did you see that made you think this is woke”?

In Case You Missed It

• Montreal will host COP15, the UN biodiversity summit, instead of China. The decision to relocate the summit follows concerns over further delays due to the country’s Covid-19 policy. COP15, initially scheduled for October 2020, in the Chinese city of Kunming, will now take place from 5 to 17 December 2022.
• A survey showed that SMEs in the UK are increasingly investing in environmental sustainability, despite the rising cost of living. More than 50% of respondents said their company invested in environmental sustainability over the past financial year, including initiatives to improve workplace recycling and reduce travel-related emissions, versus less than 20% in the previous year. Most respondents also confirmed their willingness to maintain or increase these investments in the future.
• Natural gas should be excluded from the UK’s Green Taxonomy, according to three major sustainable finance organisations. The CEOs of the Institutional Investors Group on Climate Change (IIGCC), the Principles for Responsible Investment (PRI) and the UK Association for Sustainable Investment and Finance (UKSIF) published an open letter in which they expressed their opposition to including natural gas in the Taxonomy. The CEOs highlighted the importance of a credible and science-based Green Taxonomy.

Gain insights and stay informed on ESG, sustainability, building back better or on any industry or topic that interests you here. To be added to the distribution list for our ESG+ Newsletter, please click here to input your details or email [email protected].