ESG+ Newsletter – 26th August 2021

Governments vs capital markets – who should lead?

Earlier this week, Tariq Fancy, former CIO for sustainable investment at BlackRock who has received consistent coverage over the past six months, published his latest views on ESG in a three-part essay. The essay, he notes, details how his thinking has “evolved from evangelizing ‘sustainable investing’ for the world’s largest investment firm to decrying it as a dangerous placebo that harms the public interest.” One of the noteworthy aspects of the piece is the question of who should be drive change in behaviour of companies – government or capital markets?

Fancy argues that, when it comes to the climate crisis, investors and companies have thrust themselves into a leadership position on climate change, as opposed to governments taking the lead, in contrast to the COVID-19 crisis response. The risk with this is that investors are deciding what environmental and climate policies and strategies companies should adopt, rather than being guided by legislation. David Wighton writing in the Financial News argues that Fancy “misses his target” and that most companies have chosen to take the lead due to “political inaction” with most finance bosses being “very frustrated that governments are not doing more, such as imposing serious carbon taxes.” 

This appears to be the crux of the debate – have governments abdicated their responsibility to influence behaviour, leaving it to capital market participants to force companies to act? And has this dynamic created an environment where change has been slower as investors, who are obligated to maximise returns for their clients, are inhibited from seeking systemic change. Despite potentially being behind markets, as the climate crisis deepens globally, government are gradually taking action, with climate regulation impending in the US; and, a host of countries making TCFD reporting mandatory. What Fancy and others might miss is that ESG may well protect against regulatory costs as government actions forces unprepared laggards to change at a faster rate than those who have already placed an emphasis on sustainability.

Crescendo of ESG criticism misses a trick

While by no means a panacea, ESG can be a positive force for good. Of course, as ESG becomes more embedded in capital flows and business operations, it was always likely to draw critical responses. Robert Armstrong writes for the Financial Times on his agreement with Tariq Fancy that ESG is “intellectually bankrupt.” There may, however, be a misperception in all of this. As we highlighted last year – there has been an overemphasis on policies and commitments, as opposed to outcomes or impact. Indeed, an illuminating 2017 NYU Stern study highlighted that only 8% of the over 1,750 ‘S’ indicators reviewed actually evaluated the effects of company ‘S’ practices; meanwhile, 92% measured company efforts. Armstrong cites that without drastic actions, “we’re cooked” and indicating that some parts of the corporate world are “rattling on about” sustainable investing. However, the criticism may be a touch simplistic and without the needle being moved on ESG over the last few years, it is difficult to imagine that we would have arrived at a point where stakeholder relevance was at least challenging assumed wisdom on shareholder primacy. Whether ESG can be turned from an effort to an outcome through a combination of stronger regulation and consistency of measurement may well be the next phase that can make or break the argument.

DWS’ sustainable investing claims under investigation

Indeed, as the ESG naysayers – perhaps perversely – call for greater government action, the SEC may represent their white knight. Deutsche Bank’s asset management business, DWS, is facing potential legal issues as its sustainable investment wing becomes the subject of an investigation by US authorities. According to the Wall Street Journal, the investigation, being carried out by the US Justice Department and the SEC, follows allegations from an ex-sustainability chief that the firm overstated how much it used sustainable investing criteria to manage its assets. While new SEC Chair Gary Gensler’s approach to ESG has not yet been finalised, it will be interesting to see whether any such a reprimand sets a precedent for sustainability standards globally, and may be replicated by oversight of SFDR in Europe. ESG, with its range of nuances, has produced another peculiarity – self avowed capitalists calling for increased government intervention.

‘Green steel’ provides fresh hope for iron and steel sector’s energy transition

Last week, it was announced that HYBRIT had made the world’s first delivery of fossil free steel to manufacturer Volvo Group. HYBRIT is a Swedish joint venture between SSAB, LKAB and Vattenfall that was formed in 2016 with the aim of developing technologies capable of delivering fossil-free iron and steel. The delivery marked a significant milestone in efforts to reduce the environmental impact of an industrial sector which one of the most difficult-to-decarbonise.

According to the International Energy Agency, the sector is one of the heaviest emitting industries – accounting for 2.6 gigatonnes of direct carbon dioxide emissions each year. Furthermore, the steel sector is currently the largest industrial consumer of coal, providing around 75% of its energy demand, but we also know that coal emits a significant amount of CO2. As pressure mounts for emission to be cut across the globe, it is critical that continued progress is made to replace this energy source as a means of ensuring the survival of the industrial sector and to ensure the EU meets its’ green targets.

Nabisco strike spreads to five US states

Around 1,000 workers at Nabisco across five US states are currently staying off the job in what they claim is a fight for a fair contract and for “the middle class”. CBS News reports that Nabisco workers have been working without a contract since May. Negotiations between the company and the workers’ union, the BCGTM broke down after its parent company, Mondelez International, proposed changes that include turning eight-hour shifts into 12-hour ones without overtime, as well as bearing the cost of health insurance.  This is the latest in a wave of industrial disputes across the world that have emerged as a result of proposed row-backs on basic terms and conditions of employment – a move that is out of step with the widely flagged corporate renewal of valuing of workforce related matters in light of the pandemic. It also points to the uneven nature of work throughout COVID-19, with workers in some sectors experienced improvements due to added flexibility and remote working. In contrast, others are having to take to the picket line to maintain what they already had, representing a material risk for companies who fail to appropriately weight the importance of their workforce.

Assessing the Business Roundtable statement two years on

In August 2019, 136 leaders of the biggest U.S. companies signed a historic Business Roundtable Statement designed to commit them to deliver value to all stakeholders, not only shareholders. However, new research reported  by the Wall Street Journal casts doubt on how far the statement has been backed with action. For instance, the WSJ notes that of the near 100 companies that updated their corporate governance guidelines by the end of 2020, close to none included language that elevated the status of other stakeholders and instead reaffirmed their incumbent governance principles supporting shareholder primacy. Further, the research noted that about 85% of companies did not mention their signature to the Business Roundtable in their proxy statements the following year, stirring questions about its true impact on company practices. While investors and stakeholders can both agree that the statement could be powerful step in the right direction, it remains to be seen whether the concrete changes in policy, compensation, or hiring reinforce the principles of that revolutionary commitment – not just for the benefit of corporate America, but for the positive impact it can have for all stakeholders. Once again, the differences between effort and outcome are to the fore.

ESG reporting purely for the sake of ESG reporting

Although increased reporting on ESG matters is certainly a positive trend, Matt DiGuisseppe, head of Diligent’s ESG Center of Excellence and former head of stewardship at SSGA, pointed out that it should not be thought of simply as a reporting exercise. Aligning with ESG frameworks and creating ESG reports should be a by-product of a strong ESG programme that is tied to a company’s strategy. Therefore, ESG reporting also should not be an annual process that is done at the time of the release of an ESG report. One way in which ESG may become less of a pure reporting exercise is if more companies move towards integrated reporting. Bill McNabb, former CEO and chair of Vanguard spoke in favour of this trend and said, “On reporting, we’re going to end up being very integrated in the proxy statement. I don’t want to see two sections – one with the financials and one on ESG metrics. I want to see how we’re doing overall.” Currently, it is difficult to tell what data is decision-useful and what is simply noise. That can change if companies, or indeed regulators, provide real metrics that are linked to strategy and long-term performance.

The role of auditors in tackling the climate crisis

While the risks posed by climate impacts are frequently called out in annual reports, a study last year by the UK Financial Reporting Council found that companies rarely make reference to climate change in their financial statements. This creates several problems. Companies may fail to account for how changing weather patterns could affect business or how the push towards net-zero could impact earnings. They may also continue to invest in carbon-intensive activities that could result in longer term clean-up costs, and of course have a broader impact on society.

Auditors have been put forward as the solution to this as they can flag accounts that don’t reflect the transition to net-zero, for example. The main audit firms have formally acknowledged that they have a role to play in addressing the climate crisis and have committed to checking whether financial statements consider climate risks. However, they don’t explicitly refer to the Paris Agreement and the associated push towards net-zero. By making a firmer commitment to call out inconsistencies with climate agreements and targets, auditors stand to provide a vital public service.

Gender wage disparity at the top remains, executive average pay is down year on year

FTSE100 female directors average pay is 73% less than the average pay for male FTSE100 directors. The average female director pay is £237,000 whereas the male equivalent earns around £875,900. The pay gap is worse than is seen in the broader market which sees women paid 17% less than men. The pay gap at  board level is primarily due to 91% of female directors at FTSE100 companies holding non-executive roles. Even in executive roles, there is a gap in average pay. Boards need to examine themselves to understand if there are barriers preventing women from reaching the top and if there are ways to overcome these barriers. Meanwhile, the annual HPC survey also revealed average CEO pay is down from £3.25 million in 2019 to £2.69 million in 2020 but remains at 86 times the median worker.

CDSB releases new water reporting guidelines

The Climate Disclosure Standards Board (CDSB) revealed there is an information deficit for investors on the reporting of material water-related financial risks and opportunities in the current reporting landscape. Considering this, the CDSB has issued new guidance to assist businesses report water related information. The guidance is aligned with the Taskforce on Climate related Disclosures (TCFD). The recommendation encourages disclosures on the governance around water polices, water risks and opportunities, and water related environmental impacts such as challenges related to wastewater. In the Intergovernmental Panel on Climate Change’s sixth Assessment Report, water-related climate risks such as extreme rainfall, flooding, drought and cyclones were one of the key risks expected as a result of the warming planet. As such, accurate reporting and integration of these climate related risks and opportunities into financial decision making has never been of greater importance.

Desertification: the environmental cost of Spain’s agribusiness

Desertification is the often-irreversible process by which previously fertile land deteriorates and become desert. The problem is often man-made, typically the result of increased agricultural machinery usage and intensive irrigation. These practices have helped Spain increase its income from agriculture by 50% over the past decade but according to the Financial Times it’s come at a price – a fifth of its land is now classed as desertified, forcing the Spanish government to come up with a national strategy, due to be announced later this year. The problem has also been exacerbated by ever more frequent forest fires.

The olive industry has been called out as a significant contributor to the problem. While olive crops have historically required little water, the increased use of machinery for harvesting has led to greater water demands. While some argue that more efficient irrigation has reduced overall agricultural water usage in this century, consumption has been creeping up in the past decade, to levels which may soon become unsustainable.

Desertification is not only a problem for Spain.  Italy and Greece are also suffering the effects, but the situation is worse again in parts of north Africa, the Palestinian territories and the American West. While climate change dominates much of the environmental discourse, desertification is becoming an increasing problem from which there may be no return.

In Case You Missed It

• From 2024, large Swiss firms will be legally obliged to report on their climate-related risks, FINMA, Switzerland’s independent financial-markets regulator, announced this week. The disclosure rules will be based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and will apply to public and private companies with over 500 employees or over CHF40 million (€37.2 million) in turnover.
• McDonald’s said that 99.6% of the paper bags, food wrappers, napkins, cup carriers and other fibre-based materials used to package meals for customers came from recycled or certified sustainable fibre sources, according to Reuters. The company has set a larger goal for all customer packaging to come from renewable, recycled or certified sources by 2025.
• The Partnership for Carbon Accounting Financials (PCAF) announced that is drawing up a revised and expanded standard to be relaunched ahead of the COP26 climate summit in October. Environmental Finance has learned that the standards will cover three new areas:  how to account for carbon offsets; greenhouse gas accounting methodologies for sovereign bonds; and greenhouse gas accounting methodologies for green bonds.

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