ESG+ Newsletter – 24th November 2022

COP27 testing the limits of its usefulness

As detailed in our final COP27 update, despite a couple of notable developments, COP27 has not delivered the progress that was hoped for, and potentially signals a new era of climate change discussions. While headway was made on one of the central issues at the outset – the question of whether, and how – wealthier countries would compensate developing countries for costs incurred related to climate change (the so-called “loss and damage” debate), COP27 arguably failed to make progress on the single biggest issue: decarbonisation commitments. Without commitments to reduce carbon, other pledges and steps forward may prove redundant.

In light of the absence of material commitments on the reduction of emissions, some players in the investment community have stated that they have no confidence that a 1.5° climate target will be hit. Investors argued that the final implementation plan was underwhelming, the language was weak and the gap between policy incentives and climate ambitions is widening. While the Sharm el-Sheikh Implementation Plan highlighted the need for $4-6 trillion of investment a year to transform the global economy to a low-carbon one, certain investors maintain there is nowhere near enough being spent by the private and public sectors. Since COP 1 in Berlin in 1995, there have been numerous positive developments made at a range of COP meetings – most notably the Paris Agreement in 2015 – however, as the climate crisis deepens and regulators focus on climate issues year-round, questions are rising as to whether an annual event hosted in different locations has passed its sell-by date.

The Net-Zero Transition – Committed vs Deployed Capital

As outlined above, financing the global energy transition has been in focus this week, with concerns about the gap between the committed capital and the actual scale of investment to date. Through the Glasgow Financial Alliance for Net Zero (GFANZ), the private sector has pledged more than $150 trillion of assets to tackle the climate crisis. Despite commitments, the deployment of this capital has been held back for a number of reasons: assets are tied up in existing investments; and lack of available projects that meet the criteria for investment. The last claim was addressed in a recent report by the United Nations Race to Zero campaign, which criticised the lack of investment by the private sector in clean energy projects in the developing world while rebuking claims that there was a lack of projects available – highlighting that there are more than 100 projects ongoing that require in excess of $120 billion of financing.

As we highlighted in a recent edition of this newsletter and following on from discussions at COP27, net-zero goals are under increased scrutiny. While wider conversations continue, across the board, there has been a clear shift in expectations on the private sector putting their money where their mouth is and delivering the finance needed to secure the transition to Net Zero.

Investor diversity progress sits in contrast to the World Cup

Despite frequent scepticism towards the impact of ESG, engagement and proxy voting, a paper released this week has revealed how campaigns from institutional investors have led to greater female representation on US corporate boards. The working paper from the National Bureau of Economic Research estimates that 2017 campaigns from “The Big Three” institutional investors – BlackRock, Vanguard and State Street – led to US companies adding 2.5 times as many female directors in 2019 compared with 2016, with many firms also promoting more female Directors to Board positions. The success is attributed to senior managers looking beyond their usual networks and loosening requirements for executive experience. The researchers believe that the actions of “The Big Three” – which included voting against Directors with poor records on diversity – have also driven other investors and proxy advisors to push for change. While it’s heartening to see how change can be effected within companies, in a week that showed football associations swiftly backing down on LGBTQ+ solidarity campaigns, there is evidentially a lot more work to done to make broader progress on diversity matters.

Regulation of ESG issues continues apace

It’s been a busy week for ESG from a quality and control perspective, with the FCA announcing a working group to develop a code of conduct for data and ratings providers and ESMA publishing a new consultation paper proposing new requirements for funds with ESG in their label.

The discussion around ratings agencies has been one of the more contentious topics in 2022. While many value the different approaches are taken by various rating agencies, others are critical of their opaqueness. The FCA working group will include a range of investors as well as ratings agencies and data providers. Their approach follows its recent public confirmation that it will follow the EU in developing sustainable finance regulation – demonstrating the UK’s commitment to being a leading economy in socially responsible investment.

The EU has long been the leading regulator in the sector. Its own proposal that any fund with ESG in its name must achieve a benchmark of 80% of investments meeting an environmental or social objective, per the SFDR, is illustrative of the evolving complexities of greenwashing and, in turn, efforts to address it.

There is still work to be done on the standardisation of reporting, but the market and regulatory tailwinds have the capacity to provide greater confidence in what ESG can (and cannot) achieve.

EU member states push back on the scope of the due diligence directive

The Directive, originally proposed by the Commission on February 23, 2022, requires member states to introduce legislation that holds companies accountable for violations of human rights and environmental standards throughout their value chains. In response, companies would have to conduct due diligence on their suppliers and customers and would be held accountable for the way their products are used and disposed of. While certain companies already have rigorous processes in place to address these issues, the Directive would significantly raise the bar across the market by introducing regulations mandating the same.

However, it seems that a coalition of EU member states, including France, Italy, Spain and Portugal, is attempting to narrow the scope of the Directive to companies’ supply chains – excluding the wider value chain requirements. Indeed, they stated that covering the supply chain is already ambitious, along with the fact that including downstream parts of the value chain raises some difficult legal issues. Notably, any shift to solely include the supply chain – and not the value chain – would result in financial institutions avoiding responsibility for what their invested money may end up being used for, perhaps reducing the Directive’s effectiveness.

US DoL ruling strikes out Trump-era anti-ESG rules on pension funds

Trump-era rules pushed forward in 2021 to limit pension funds’ abilities to incorporate ESG factors in investment decisions are being struck down as the Department of Labor sets out a rule that allows the funds to incorporate ESG factors. The Department of Labor’s final rule allows workplace pensions to incorporate ESG into investment research.

The final rule allows all impacts to be incorporated into investment decisions, designed to curb the impacts of past rules dictating that ESG considerations could not be included in investment decision-making. The ruling is the latest in an increasingly polarised debate in the US, with politicians continuing to be at odds over fund labelling, emissions requirements and a range of social issues.

In Case You Missed It

• The new Proxy-Voting Rules introduced in the US in September, which modified the ballot format for Director elections, will ease entry barriers for first-time shareholders activists. The number of newcomer activists and campaigns has been on the rise for the past few years increasing the pressures on underperforming companies. The new rules will make it easier for smaller activist players to gain board seats.
• A new report analysing the corporate statements of 92 companies with high-risk supply chains has found that the majority do not meet the mandatory reporting requirements of Australia’s Modern Slavery Act. The report demonstrates that 56% of companies reviewed are not fulfilling their commitments, 43% are not identifying obvious modern slavery risks in their supply chain and 91% could not demonstrate meaningful action and engagement to address these risks.
• Climate change was high on the agenda at APEC 2022, hosted in Thailand, along with geopolitical tensions and food security. On Saturday, the Asia-Pacific Economic Cooperation (APEC) leaders adopted the Bangkok Goals on Bio-Circular-Green Economy, proposed by Thailand. The Goals cover climate change mitigation, sustainable trade and investment, environmental conservation and waste management.

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