ESG+ Newsletter – 26 September 2024

This week’s edition of the ESG+ looks at the FRC’s annual review of corporate reporting; the growing importance of ESG materiality as part of risk assessments for asset managers; the ongoing impact of the incoming EU and UK’s regulatory rules regarding sustainability fund names; and the diverging approaches towards employee stock ownership. The newsletter opens with a look at New York Climate Week, asking whether it is the new COP? 

Is New York Climate Week the new COP?

New York Climate Week is in full swing this week, with as many as 100,000 participants attending over 900 sessions. According to ESG News, this year’s bumper attendance at Climate Week will be in contrast to this year’s climate COP, which is expected to only see attendance of around 40,000 people. The number of senior leaders attending Climate Week has more than doubled and, according to organisers, so have the number of speaker applications. The excitement around Climate Week seems in stark contrast with criticisms of COP29, which is plagued with concerns around Azerbaijan’s human rights record and its close links to the fossil fuel industry. While these concerns have no doubt impacted the expected attendance figures, so have the logistical challenges of travelling to Azerbaijan. While these concerns and challenges are difficult to overcome, they seem to compound at a time when the entire COP process has begun to be questioned, given the lack of accountability and the number of unfulfilled promises issued during each COP meeting.

TCFD and climate-related reporting needs greater clarity according to FRC’s Annual Review 

Earlier this week the UK’s Financial Reporting Council (FRC) released its Annual Review of Corporate Reporting. While the FRC was pleased with the quality of corporate reporting among large and mid-sized listed companies (FTSE 350 constituents), the institution pointed to a widening gap between those companies and smaller listed and non-listed ones. The report outlines the top ten reporting issues, with one issue identified as TCFD and climate-related narrative reporting. The FRC noted that their main source of challenge for this issue was linked to companies’ statement of consistency, particularly when their disclosures failed to identify areas of non-compliance with TCFD recommendations. The FRC also challenged companies to be more transparent, noting that “it was unclear how the impact of climate had been reflected in their impairment assumptions.” The connectivity between financial and sustainability information and the governance of this integrated reporting is a topic that is gaining prominence, particularly among companies preparing to comply with the EU’s CSRD.  The advice given by the FRC for companies is to focus on “providing material disclosures that are clear, concise, and company specific.” 

Asset owners focusing on materiality to understand ESG risk and return implications

Material ESG factors are of increasing importance to asset owners, according to a Morningstar’s most recent annual survey of investors that lead strategy on behalf of pension funds, insurance companies, and the broader landscape of asset owners. The headline takeaway from the survey is that ESG has become being increasingly material to investment decision making, largely driven by risk mitigation. This factors directly into fiduciary duty, as ESG performance has distinct risk and return implications, and the concept of active ownership to guide investee companies to succeed.  Data quality was a further point of note, with investors preferring granular and asset-level information to ratings agency aggregation and index inclusion as a source to inform decision making. This is due to improved flexibility in how data is used and weighted, according to company performance and also investment strategies. 

While ESG investing is at an interesting stage in its cycle – particularly against the backdrop of politicisation in the US, geopolitical conflicts, and its evolution as an investment product – It is clear that investors continue to use ESG data as a part of their risk assessments and due diligence in their investment decision-making process. As readers of the ESG+ will be well aware, companies need to ensure that their materiality assessment is aligned with the expectations of all their stakeholders.

Impact of incoming sustainability fund name rules already evident  

The impending ESMA and UK regulatory rules regarding sustainability fund names is continuing to have a reverberating effect across the investment community. Investment Week reported that MSCI will remove ‘ESG’ and ‘impact’ labels from a wide range of its sustainability related investment products. Ignites Europe is also reporting that only nine funds have adopted the UK’s new sustainability product labels. It is believed that this relatively low level reflects the challenges firms are faced with meeting the new regulatory requirements, as well as overall softness in demand for ESG related investment products. The name changes and withdrawal of funds follows on from a recent Bloomberg analysis recently which revealed that nearly 75% of Article 8 funds under the EU’s Sustainable Finance Disclosure Regulation (SFDR) may violate incoming ESMA fund name rules.

The objective of the incoming fund naming rules is to minimise any potential greenwashing. However, a byproduct is that it is creating a further layer of regulation that must be navigated. It is also likely that, beside removing non-compliant funds, companies providing ESG related investment products are erring on the side of caution with the names of their funds.

Two opposing approaches on employee stock ownership 

There is a trend emerging among a number of leading international tech companies who are reducing stock-based employee compensation. As reported by Bloomberg, Zoom has cited stock dilution as a concern, as issuing shares to employees reduces the value of existing stock. While stock compensation aims to align employees’ interests with company success and hopefully reduce turnover, it can also prompt investor concerns about dilution. To address this, Zoom intends to phase out stock grants and offer higher cash bonuses instead. On the other hand, the WSJ reported that a coalition, led by KKR executive Pete Stavros, is advocating for broader employee stock ownership in US companies to combat wealth inequality. They are pushing for reforms to the 1974 federal law to make it easier for workers to own company shares and to develop employee stock ownership plans by offering tax incentives. While investors welcome incentives that align the workforce and a company’s financial and business objectives, it is important that the plans fairly benefit front-line workers not top executives, ensuring stock is provided at a fair valuation and tax breaks go to workers. 

ICYMI 

• The Guardian reports that Switzerland has voted to reject a biodiversity proposal aimed to expand protection of endangered ecosystems, as they believe it is too extreme and posed risks to business development.  
• Only 11% of asset owners feel ESG regulation is a hindrance to sustainability policies. This figure has more than halved over the past year, according to a survey conducted by FTSE Russell.
• Responsible Investor has revealed that EFRAG plans to release implementation guidance for its transition plan for a one-month period of public feedback in January 2025.