ESG+ Newsletter – 28 July

Your weekly updates on ESG and more

In our last edition, before we take August off, we start with the potential long-term impact of the latest weather crises to hit the globe, both in terms of economies and a potential pullback from insurers. We also analyse what has been a big summer for the integration of reporting standards, the inability of funds to align activities with the EU’s Taxonomy and ask whether remuneration levels are a key consideration for businesses when choosing where to list their business. Enjoy your August and we’ll be back in September! 

Monthly regulatory update

As ESG regulations continues to evolve, FTI Consulting is providing a quick summary of essential updates from around the globe. This month, we cover the UK’s delay to its Extended Producer Responsibility legislation, Australia’s guidance for businesses to avoid greenwashing, Hong Kong’s proposed ESG taxonomy, and India’s updated ESG reporting requirements for its listed companies. Read more on our ESG regulations page.

Costs of extreme heat to the global economy becoming clear 

Over the last few weeks, parts of the US, Asia and Europe have sweltered under extreme temperatures caused by the climate crisis. With record highs reached across the globe, the FT reports that the era of extreme heat will create a need to reshape economies. A study published by academics at Dartmouth last year found that heatwaves cost the global economy an estimated $16 trillion over a 21-year period from the 1990s. According to the FT article, the International Labour Organization projected that by 2030 more than 2% of total working hours worldwide would be lost every year, either because it is too hot to work or because workers will work at a slower pace. It is not only reduced productivity that costs the economy though. Popular tourism destinations will face extreme heat and wildfires, reducing visitor numbers, and ultimately heat-related deaths will continue to increase. While recent events have highlighted the need to adapt to the changing climate which is already locked in due to historic emissions, it also demonstrates the need to urgently reduce global emissions to limit the extent of temperature rises. Current temperature rises since pre-industrial times are already at 1.1°C; however, the most optimistic predictions put the world on track for between 2.4°C and 2.6°C of warming by 2100. It is clear these extreme heat events are going to become more frequent, more extreme, and more costly. Climate-related risks are no longer medium or long-term risks, they are immediate.  

Insurers respond to climate risk by exiting high-risk markets 

And as the impact on economies, business and society increase, insurers are taking not and exiting high-risk markets due to climate change, threatening the equilibrium of our financial ecosystems, reports ESG Investor. US insurer State Farm announced that it would stop selling home insurance in California, in part due to “rapidly growing catastrophe exposure.” There is a short-term business case for exiting high-risk markets when considering that, in Florida, 15 insurers went bankrupt since 2020, running out of reserves following massive natural disasters. However, this poses a threat to the wider economy, with more individuals bearing risks due to the failure to contract proper home insurance; companies foregoing important infrastructure investments in certain regions due to the unavailability of insurance; and increased government intervention to cover uninsured losses, further raising their debt burden. In a similar vein, there is a growing number of insurance companies committing to no longer cover new upstream oil and gas projects; and they are also increasingly offering products that support the growth of low-carbon industries. Perhaps, as noted by Andrea Ranger, Shareholder Advocate at Green Century Capital Management, it is the job of investors to push the industry on the path of decarbonization. Growing climate litigation risks may also encourage insurers to act; however, in the round, it appears policy and regulation may be the easiest path to address current inaction. 

The summer of sustainability reporting integration

Following the publication of the International Sustainability Standards Board’s (ISSB) final sustainability standards at the end of June, the IFRS recently announced that it would be taking over the responsibility for the monitoring of companies’ climate-related disclosures from the Financial Stability Board’s (FSB) Task-Force on Climate-Related Disclosures (TCFD), representing an important step in the ongoing consolidation of sustainability reporting standards. The IFRS Foundation has now published a comparison of the requirements in IFRS S2 Climate-related Disclosures and the TCFD recommendations, with the former designed to integrate the four core recommendations and eleven recommended disclosures published by the TCFD. The reporting standards call for additional detail in a number of areas though, such as the requirement for companies to disclose industry-based metrics, the planned use of carbon credits and additional information about companies’ financed emissions. Momentum continues to build, as this week, the International Organization of Securities Commissions (IOSCO), which represents regulators overseeing c. 95% of capital markets, announced its official endorsement of the new IFRS sustainability standards. Given its reach, Environmental Finance estimates this could bring over 130,000 companies under the scope of IFRS S1 and S2 standards. 

As the variance in climate-related disclosures becomes simpler, progress has not been as swift in relation to reporting on social indicators. According to the responses published by the European Securities and Markets Authority, a number of investors have opposed the introduction of social factors under the SFDR, given concerns regarding the state of regulation on these matters, as set out in a recent Responsible Investor article.

MSCI finds low EU Taxonomy alignment among funds and companies   

New research published by MSCI this week examines the state of play of sustainable finance in Europe. Amongst its conclusions, the index provider has reported that only 2% of sustainable Article 8 and Article 9 funds disclose alignment with the EU Taxonomy, the framework used to assess how sustainable a fund’s investments are. Of a 6,600-strong group of products reviewed, MSCI found only 126 disclosed a figure of EU Taxonomy-aligned revenue, and only 12 had aligned revenues of over 60%. Of those 12, 10 had either a clean technology or renewable energy focus. MSCI’s analysis reflects two core important points of context, the first being that the Taxonomy is still a work in progress itself, and the second that the underlying needed data by fund management teams are not available due to corporate reporting gaps. As noted by the report’s researchers, the dearth of businesses disclosing Taxonomy revenue leaves investors with a lack of diversity and therefore a limited pool of options to invest in. 

A secondary interesting analysis provided by the report relates to the disclosures of investable companies, specifically how the Principle Adverse Impacts indicators aspect of the EU’s Sustainable Finance Disclosure Regulation has been integrated into corporate reporting to date. Conclusions at the fund level include the significant difference in carbon intensity between Article 9 funds and Article 8, despite the latter’s integration of ESG and carbon emissions perhaps being the most high-profile sustainability issue, while at a security level reporting of social PAIs is notably low globally. One specific PAI referenced, Gender Pay Gap, is worth examining given the low rate of disclosure of 3.1%. This PAI requires assessment of an entire workforce, across the entire global footprint, which is often a point of confusion given specific geography’s having their own regulation in place to report.

‘Big Food’ perhaps the next ESG battleground

Over the past decade, a number of major books and documentaries have pointed to potential issues with the food industry, including its relationship with accurate information and the impact of its products. An opinion piece in Bloomberg took up the baton this week, arguing that “Big Food Should Be ESG’s Next Target.” The article points to the relentless focus on environmental considerations at food companies, including emissions, supply chains and pollution. But, while recognising a focus on health and safety and diversity at the same, it questions whether the most material part of ‘Big Food’s’ S is being captured – potential health degradation among consumers. With diabetes taking up 10% of the NHS budget in the UK, there are clear societal (remember ‘S’) costs to nutritionally deficient products. Again, as ESG attempts to become more sophisticated and seeks to shift to an outcomes-based model, investors, regulators, and other stakeholders need to be able to evaluate the impact of business and products. The food sector is just the latest example of this. 

FTSE executives argue remuneration impacting London’s competitiveness  

This week, Numis published a report that outlined potential options to strengthen London’s reputation as a leading global financial centre and improve its attractiveness for companies to list. The report, which includes survey results from 150 FTSE leaders at listed companies, showed that – while 92% of respondents agreed that London remains an attractive market for IPO and capital raising – there are a number of areas that could be improved upon. One specific area of concern that was highlighted was the lower executive remuneration, with 38% of respondents citing the need for a more competitive executive remuneration environment as the most important reform needed. The report outlines that the perception around remuneration – specifically its competitiveness and “negative headlines” – is having an impact on both attracting and retaining top talent, as well as on companies’ decision-making in selecting the LSE as a listing destination.  

Against the wider backdrop of the cost-of-living crisis, executive remuneration levels have come under closer scrutiny than ever in the UK. However, the competitiveness aspect is an interesting one – particularly in the broader context of the pay disparity between US and UK CEOs. A report from Equilar and Deloitte revealed that S&P 500 CEOs made, on average, $14.5 million in total compensation in 2021 compared to about $4.5 million for FTSE 100 executives. This led to Julia Hoggett, Chief Executive of the LSE, stating that the pay disparity has “not received enough attention” and called for a level playing field in an effort to ensure the LSE retained its attractiveness. 

Market confusion for ESG investing continues 

Two new studies released have noted how the market for ESG investing remains complex. A recent study by the Centre of Economic Policy Research, covered by Responsible Investor, has suggested that U.S. mutual funds are manipulating their sustainability ratings by timing the sale and purchase of certain stocks around mandatory disclosure periods. According to the study, 100-120 active U.S. managers are engaging in “green window-dressing,” with ESG fund portfolios exhibiting 31% higher ESG exposure immediately prior to mandatory portfolio disclosures than immediately afterwards. Morningstar uses these public disclosures to calculate their ESG ratings, and funds reverted to positions on controversial stocks afterwards. Though these claims have not been verified by Morningstar, experts state that the remedy to this is increased reporting periods and enhanced transparency.  

On the regulatory front, CDP is raising alarms about regulatory fragmentation around ESG ratings, according to IPE. In recent years, various policy initiatives have been announced globally, and regulators in different jurisdictions have taken a variety of approaches. For example, in the UK, the definition of ‘ESG ratings’ set by HM Treasury has a broader scope than what is considered the global baseline set by the International Organization of Securities Commissions. This deviation in definitions and scope, according to CDP, causes confusion for the wider market and limits cross-border activities. 

ICYMI 

• Amazon will ask supply chain to report emissions starting in 2024 – Amazon’s latest sustainability report includes a major policy update: suppliers will be required to report on their emissions and set reduction goals from 2024 onwards. Amazon plans to support suppliers in their decarbonization efforts, offering products and tools for tracking emissions and transitioning to renewable energy. Last year, the company reduced its carbon footprint by 0.4% and aims to achieve 100% renewable energy usage by 2025.  
• 82% of Business Leaders Confident in Meeting New Sustainability Disclosure Requirements: Honeywell Survey – Honeywell’s recent Environmental Sustainable Index found that over 80% of global business leaders are confident in meeting emerging disclosure requirements for sustainability reporting. The report also revealed that 93% of organisations have formal plans for reporting sustainability progress, and almost three-quarters are optimistic about achieving their 2030 sustainability goals. The report also unveiled an increase in the proportion of companies planning to grow spending on environmental sustainability initiatives over the next 12 months.
• Responsible Investor’s Biodiversity Report 2023 – As policymakers face up to the extent of global nature loss, biodiversity is becoming a key topic for investors to consider in their ESG strategies. Responsible Investor recently published their 2023 Biodiversity Report, which looks into how collective action initiatives are helping investors to coordinate their response, and how frameworks for reporting nature dependencies and impacts will create a more consistent approach to corporate disclosure.   
• Abu Dhabi Global Market introduces a regulatory framework for sustainable finance - Abu Dhabi Global Market (ADGM) has implemented its sustainable finance regulatory framework, aimed at boosting the growth of sustainable finance and supporting the UAE’s transition to net zero emissions. The framework covers rules on sustainability-orientated investment funds, managed portfolios, bonds and ESG disclosures. The move has received overwhelming support from the industry, and crystallised ADGM’s intention to proceed with one of the first and most comprehensive sustainable finance frameworks in the region.