ESG+ Newsletter – 25 January

This week we look at the importance of responsible AI, and the need for strong governance to manage AI-related risks and opportunities. We also cover new draft cybersecurity rules in the UK, gender diversity progress in boardrooms across the world, and investors shifting views on ESG and impact. The role of both collaboration and regulation in delivering sustainability goals comes under the spotlight; while, we also look at emerging greenwashing regulation that seeks to crackdown on unsubstantiated green claims.

ESG Regulatory Update

As ESG regulations rapidly develop, FTI Consulting is providing a quick summary of need-to-know updates from around the globe. This month we cover the fight against greenwashing in the EU, consequences of non-compliance with ESG regulations in France, and updates to climate disclosures in Australia.

Read more on our ESG regulations page.

Responsible AI Governance – Future Proofing Corporate Governance, Strategy, Risk Management, and Reporting

As businesses adopt AI, they bear the responsibility of establishing the guidelines that dictate its use in their operations and by their workforce. Recent developments, including the upheaval at OpenAI, the EU’s AI Act and the escalating expectations from investors, all highlight the growing recognition of AI’s risks and how important corporate governance is to address them. However, despite the increasing consensus on the importance of addressing these risks, the absence of an established framework presents a challenge for businesses seeking to develop an effective governance structure. 

To help companies navigate this challenge, our team produced a Whitepaper on Responsible AI Governance advocating for a proactive approach to AI governance, drawing parallels with ESG frameworks that offer valuable tools for managing AI-related risks. The report provides practical advice to business leaders looking to develop a robust governance framework with Responsible AI Principles, Key Questions and a Five-Step Action Plan. It also includes a review of AI’s opportunities and risks, the regulatory environment and investor practices.

The 2024 revision of the UK Corporate Governance Code

The Financial Reporting Council (the ‘FRC’) published the latest revisions to the UK Corporate Governance Code, at the start of this week, which is set to become effective from January 1, 2025. Following the FRC’s “largest stakeholder consultation on the Code in 2023 revisions have been kept to a minimum” noted in the recent ESG Clarity article. In formalising the changes, the FRC has included amendments regarding board leadership and culture, new reporting expectations around malus and clawbacks, and reviewed the provisions regarding diversity and inclusion. However, the main substantive change has been related to the request for boards to include a declaration in their Annual Reports explaining how they have done this and their conclusions, with the specific provision set to become effective from January 2026, in line with stakeholder feedback. The FRC’s CEO expects the proposed updates to balance “underpinning trust and confidence in UK plc for investors and others whilst keeping burdens on businesses to the minimum necessary”. 

While the “targeted changes” to the Code have been welcomed by some, others have criticised the FRC’s decision not to include certain initially proposed revisions, namely those related to ESG oversight, with the Executive of the think-tank, High Pay Center, noting that this decision represents “an interesting indicator of a recent backlash against the concepts of responsible business practice and accountability from some investors and corporate leaders“. 

Gender equality progresses around the globe, though major gaps remain

Two Bloomberg articles dated 22 January 2024 and 23 January 2024 highlight the progress made on gender equality in different regions of the world as well as the remaining road ahead. In the US, 33.5% of S&P 500 companies’ board seats are occupied by women, which compares to 16.7% for companies in Japan’s Nikkei 225, 19.5% for Hong Kong’s Hang Seng, 37.7% for Australia’s S&P/ASX 200 and 39.9% for Europe’s Stoxx 600. Only 29 S&P 500 companies have equal representation of women and men on their boards and, at the current pace, parity would not be reached before 2032, noting that the current conservative-led backlash may be slowing down a number of corporate diversity programmes.

In Asia, institutional investors have started to call for greater diversity and may vote against companies with no or little female board representation. The Japanese government has also required that major companies have at least one female director by 2025. In Hong Kong, it is the stock exchange that is seeking to eliminate single-gender boards with a deadline to create more than 1,300 positions for female directors by the end of the year. With board diversity levels closer to those observed in Europe, Australia is now focusing on the gender pay gap. While it has been decreasing, it remains significant, at A$26,000 (or €15,700). To further reduce this gap, Australia has required companies to put forward a strategy for six gender equality indicators, including wages. 

UK gets tougher on cybersecurity governance with new code of practice 

The UK government announced a call for views this week on a new draft cybersecurity governance code which aims to strengthen board and senior leadership oversight of cybersecurity. The code sets out five areas of focus – risk management, cyber strategy, people, incident planning and response, and assurance and oversight. It calls for a governance structure that clearly establishes ownership of cyber resilience at both executive and non-executive level and recommends regular engagement between cybersecurity leaders and senior leaders and the board – reflecting existing guidance by FTI. In announcing the call for views, Viscount Camrose, Minister for AI and Intellectual Property revealed figures showing that almost one third of businesses experienced a cyber incident in the past year and described cyber-attacks as “damaging to organisations as financial and legal pitfalls”.  

This announcement shouldn’t come as a surprise as it echoes a broader trend among investors and regulators who have been pushing for a top-down approach to cybersecurity. It follows the implementation of similar rules by the SEC which has increased pressure on US-listed companies to demonstrate appropriate oversight and management of cyber risk. The code will likely result in greater scrutiny of the Chief Information Security Officer (CISO) who may need to be armed with the appropriate resources and communication skills to meet these increasing demands. However, the code is clear that directors will need to take a more direct role in cybersecurity strategy and ensure the implementation of policies that foster a positive cybersecurity culture across the organisation. 

Insurers rethinking net-zero group after backlash and member exodus

The Net-Zero Insurance Alliance (NZIA) was hit last year in the US backlash against ESG policies. A series of high profile insurers left the group last year in fear of opposition from US Republican politicians citing anti-trust concerns. Despite the departing members asserting that they would continue their sustainability journeys, the departures were a blow to the UN-convened group and, more broadly, to the concept of cross-industry collaboration on climate change. Now, the FT reports that the remaining members are in talks to overhaul the group, including the possibility of widening it to include regulators, brokers, and campaign groups, with hopes that the involvement of these stakeholders would demonstrate that the group has nothing to hide. Ultimately, discussions around the role of groups such as the NZIA continues. In particular, there is debate around whether these groups should set frameworks and protocols for members, or whether this acts as quasi-policy, which should instead be left for governments. While these concerns may continue, there is little doubt that collaboration is required to achieve shared climate goals. Groups that encourage transparent, meaningful collaboration may help to deliver these targets. Whether the NZIA can restructure to alleviate the anti-trust concerns cited by US Republican politicians remains to be seen, but it may well be an impossible task. 

European Banking Authority moves to put ESG risks at centre of banks transition plans 

Last week, the European Banking Authority (EBA) launched a public consultation on guidelines regarding new standards for ESG risks for capital-based transition plans. The intention is that the draft guidelines will set out requirements for financial institutions for the “identification, measurement, management and monitoring of ESG risks, including through plans aimed at addressing the risks arising from the transition towards an EU climate-neutral economy”. While the EBA have stated that the consultation and instructions should not be interpreted as a signal to divest polluting assets, the banking sector should view it as an opportunity to work with clients to prepare to adapt to the EU’s transitions toward a more sustainable economy.

The consultation on guidelines follows on from the EBA previously recommended that banks integrate ESG into risk management. The banking sector has long faced accusations of continuing to finance fossil fuel companies and projects despite their own stated their intentions to stop transition away, as well as recent claims of greenwashing with their own financial products. Following the conclusion of the consultation, the guidelines’ final wording expected by the end of 2024. This then will set the scene for how banks will have to operate and integrate ESG risks into their decision-making, particularly against the backdrop of the expectation that the banking sector plays a leading role in the green.

World’s top natural disasters caused $380bn in economic damage in 2023

In 2023, the world experienced a devastating surge in natural disasters as reported by Business Green, resulting in over $380 billion in economic losses and approximately 95,000 lives lost—marking the highest death toll since 2010, as revealed by Aon’s recent analysis. The report attributes this grim reality to earthquakes and severe storms, with Turkey and Syria’s earthquakes alone causing economic losses of around $92 billion. Significantly, climate change emerges as a major culprit, amplifying the intensity and frequency of these disasters. Record-breaking temperatures, seven consecutive hottest months, and 24 countries hitting all-time temperature highs in 2023 underscore the urgent need for global action against climate change.

Aon’s CEO, Andy Marcell, underscores the escalating threat of climate change, urging organisations and governments to bolster resilience through forward-looking diagnostics. The report also calls on investors to approach climate change from three perspectives: safeguarding portfolios, capitalising on climate solutions, and contributing to a net-zero emissions world. This alarming trend aligns with S&P Global’s 2024 outlook, emphasizing the economic impact of climate adaptation, the significance of risk disclosure regulations, and the pivotal role of the voluntary carbon market. As the world grapples with unprecedented dangers, 2024 emerges.

Greenwashing regulation ramps up in the EU 

The European Parliament recently approved a new law aimed at stopping companies from making exaggerated or unfounded environmental claims, known as “greenwashing.” The Directive on Empowering Consumers for the Green Transition will ban false statements about a company’s climate-friendly actions when marketing to consumers. This includes banning broad claims like “eco-friendly” or “carbon neutral” without proof of actual environmental performance.

The rise in greenwashing regulation serves as a warning to companies globally about legal risks from unfounded climate claims. As climate change awareness grows, so has consumer and investor demand for environmentally responsible businesses. However, there are mounting concerns businesses are deceiving stakeholders through marketing and ESG reporting exaggerating their efforts. Regulators are now cracking down.

The new EU law highlights a broader global crackdown on greenwashing spanning marketing, investment disclosures and more. Recent years saw major regulatory expansions around climate reporting and environmental claims. This includes harsher ESG investment disclosure rules in the EU and expected similar regulations from the US SEC. The EU consumer law technically applies to marketing but its principles arguably extend to voluntary ESG publications also serving promotional aims.

The EU law bans environmental claims without verified excellent supporting performance. Offset-based net zero or carbon neutrality claims are prohibited without recognised offsets. Companies have up to two years to comply once states enact the EU legislation nationally. But the spirit of the law warns any multinational about legal hazards from unsubstantiated environmental assertions. With greenwashing transitioning from marketing gimmick to liability, diligence in sustainability claims is now a must.

ICYMI

• Investors Pull Billions From Sustainable Funds Amid Political Heat. The money flowing out of funds that invest in companies with ESG principles has gone from a trickle to a torrent, with a new report showing that $13 billion was withdrawn last year, as investors become increasingly concerned by a sector hit with green-washing issues, red-state boycotts and boardroom debates.
• New jobs, green jobs: planet-friendly roles dominate hiring. Roles focused on sustainability and environmentally-friendly activities now make up a third of postings in the UK. Among the fastest-growing are land acquisition mangers, waste management specialists and sustainability analysts. The need for white-collar workers to help manage and finance green transitions is also increasing, and experts hope that this growth will counterbalance jobs lost to the green transformation.
• German police paid second visit to DWS over suspected greenwashing. The Deutsche Bank-owned asset manager DWS said on Tuesday that it had provided prosecutors with further information during a visit to its offices in an ongoing case involving allegations of greenwashing. Since 2021, regulators on both sides of the Atlantic have investigated accusations sparked by a whistleblower that DWS may have misled investors by falsely marketing its funds as green.