ESG+ Newsletter – 29th September 2022

Evaluating the social implications of ransomware

When considering cybersecurity and ESG, for many it’s a governance matter – a topic we covered extensively in our recent paper. However, cybersecurity – and ransomware in particular – can have wide-ranging social and societal implications. The healthcare sector has experienced this more than most, with several examples of ransomware incidents disrupting hospitals and even whole healthcare systems.

Many in the U.S. experienced first-hand the impact of a cybersecurity incident on critical infrastructure following a widely reported gas pipeline incident, which left many without access to fuel.  There’s the obvious impact of an incident on those whose data has been stolen, but how an incident affects staff is frequently overlooked. The impact on employees of a victim organisation can be quite severe, most notably for the cybersecurity team tasked with recovering from the incident, who are often forced to work lengthy hours under severe pressure. The disruption caused by the incident may also present challenges for employees who are simply trying to go about their daily work. With regulators and investors pushing for greater disclosure of cybersecurity incidents, and a growing awareness of the implications of an incident, companies may find how they mitigate not just the financial impact but also the social impact of an incident coming under greater scrutiny.

The Scope 3 emissions data gap, and the link with pay

Measuring Scope 3 emissions can be extremely challenging since, by nature, these emissions sources are within the value chain and outside of the operational control of the reporting entity. For this reason, Bloomberg claims that modelling Scope 3 emissions is an essential part of closing the data gap. Citing a lack of data availability, as well as inconsistent reporting across companies and even inconsistent reporting from individual companies year on year, Bloomberg makes the point that, to overcome current irregularities, estimates are required. While this type of modelling has its limitations, it does plug the large gap in Scope 3 disclosures. However, when it comes to measuring supply chain emissions reductions, widescale modelling may not capture the decarbonisation caused by interventions in the supply chain, limiting its usefulness in decision making for the investment community in understanding which companies are effectively reducing emissions.

Instead, the best way to understand a company’s commitment to decarbonisation is to identify how it is being incentivised.  This week, a new working paper was released that draws the link between ESG-linked CEO pay and decarbonisation. The paper found that companies which specifically cited emissions performance as a pay factor were more likely to see an emissions outcome than those that set vaguer ESG metrics.

Vivek Ramaswamy’s war on stakeholder capitalism and ESG

The self-styled anti-ESG fund manager, Vivek Ramaswamy, recently launched two new Exchange Traded Funds (ETFs) in direct response to the growing influence of stakeholder capitalism. His new products are both passive index trackers and explicitly seek to pressure companies to drop ESG targets, commitments, and workstreams so that they may prioritise shareholder return above all else.

The launch of these ETFs is rooted in his belief that corporations have overstepped their respective marks and extended way outside their purview – focusing on ‘political issues’ not relevant to their businesses or, in some instances, changing strategic direction to appease the wider public. He believes that the fundamental purpose of a corporation is to generate returns, and this is being directly threatened by the prioritisation of environmental and social causes. This sentiment is shared by some along the political spectrum, who believe that company and asset managers’ use of ESG factors is negatively influencing both business and investment decision-making.

The politicisation of ESG, and the recent backlash it has received, reflects both its growth and its emergence into the mainstream. However, as readers of this newsletter will be aware, while responsible investment and capital allocation have an important role, it is misguided to think of ESG as a panacea for all the world’s issues or even a finished product. ESG should also not be considered a replacement for the significant role that government policy and regulation needs to play in devising and implementing policies that require action and influence behaviour, rather than leaving it up to businesses or asset managers to dictate the course of change.

Contrasting market feedback highlights ESG difficulties in a bear market

A recent survey conducted by asset manager Schroders has provided valuable insight into ESG investing. Of the 23,000+ investment professionals around the world who were surveyed, 68% of those who self-identified as “savvy” investors reported that sustainable investing principles are “the only way to ensure profitability in the long term”; while 69% of respondents felt that “sustainable investing can drive positive change when it comes to issues such as climate change.” 

The coalescence between ESG driven and profitability focused investments is an important and encouraging trend in the sustainable investment space, especially as the two themes have often been perceived as at odds with each other. While in theory “most people [surveyed] believe that sustainability is critical to long-term profitability” a separate survey recently highlighted that 43% of asset managers did not base a single sell order on ESG issues in the past year and that 35% did not base a single buy order on ESG issues over the same period as well. These results indicate that, despite pressure on investment managers from asset owners to apply ESG principles when making investment decisions, financial returns still take precedence when pitted against sustainability goals. Given current market conditions, it is to be expected that active ESG integration and similar investment strategies are conducted in a way in which outperforming against the market is the fundamental goal.

ESG action still trails broader corporate ambition

The economic and social turmoil that has characterised the last three years, has created the perfect storm of challenges for how businesses can operate. It has also broken some of the scepticism around managing ESG risk, which has now become a key priority for companies. A recent HBR article notes that, while the number of companies setting ambitious sustainability goals and targets has improved, the “gap between ambition and action” remains, and points to companies’ difficulties in scaling their sustainability strategies.

The article identifies four key “enemies” that significantly impact a company’s ability to effectively carry out these strategies while providing some food for thought on the importance of setting the appropriate corporate governance structures that can ensure sustainability is integrated across all levels of the organisation. As keen advocates of the ‘reverse’ ESG: “GSE”, this comes as no surprise to us. The piece notably includes the importance of culture and leadership in putting sustainability at the heart of the organisation, and separately accurate and complete processes and metrics. Our view is that while sustainability reporting frameworks and regulations are more recent, information should be prepared with the same rigour as traditional metrics. As sustainability develops into the new corporate imperative, addressing the above organisational concerns will play a significant role in supporting companies to implement and scale their strategies.

Article 9 outperformed Article 8 funds while there are issues with Paris-aligned benchmarks

Research from Jefferies has found that funds classified as Article 9 under SFDR have outperformed those under Article 8 since the start of the year – albeit both are down significantly over the period. On a year-to-date basis, Article 9 funds are currently down 20%, while Article 8 funds are down 21.5%. The underperformance of ESG funds this year has been well covered but is often removed from the context of wider market performance, which is illustrated in the U.K., at least by the 29% drop off of the FTSE250 year-to-date. When looking to dig into why exactly ESG funds have struggled, it is important to note the underperformance of the tech sector, that oil & gas securities have boomed with the energy crisis, and that the EU SFDR regulation is still in its nascency. An unintended consequence of the latter factor is that fund managers have experienced difficulties in updating portfolio holdings and weightings due to the framework.

The US Inflation Reduction Act is a recent significant development in the green investment space. In separate research, Osmosis Investment Management warned that Paris-aligned benchmarks (PAB) are pushing investors into building low revenue portfolios – with one reason being flaws in the way Scope 3 emissions are calculated. Due to the poor nature of Scope 3 disclosures (as noted above), index providers use estimation models. The models generally use a calculation of revenue multiplied by an emissions factor. Tom Steffen, Head of Quant Research at Osmosis detailed that “given PAB’s actively seek to reduce emission intensities calculated as described above, the index construction rules will minimise revenue divided by EVIC thereby pushing investors into portfolios with low revenue generating companies.” These issues represent the need for further work on standardisation in reporting as ESG moves into the next phase of its maturity.

In Case You Missed It

• Impact investor, Big Society Capital (BSC), has estimated that the UK’s social impact investments sector has grown nearly 10-fold over 10 years, reaching £7.9 billion ($8.5billion) in 2021. This represents a significant rise from the £830 million figure it observed in 2011. Last year, BSC said it intends to catalyse the growth of the UK’s social impact market, predicting that it could be worth £15 billion by 2025.
• easyjet announced it would scrap its carbon offsetting scheme at the end of the year and instead target a 78% drop in emissions by 2050 via investments in efficient aircraft, sustainable aviation fuel and operating improvements. The British airline has contracted all its sustainable aviation fuel needs for the next five years from its supplier Q8Aviation. From January 2023, easyJet will also offer a voluntary offsetting option for customers.
• Renewable power is set to break another global record this year since the invasion of Ukraine has spurred the world to emit less carbon. Gas prices are five times higher than they were a year ago, and the IEA expects global gas demand between 2021 and 2025 to rise by less than half the amount it previously forecast. China and India, which produce little domestic fossil fuel apart from coal are ramping up the production of renewable energy. The tension between America and China has influenced Joe Biden’s Inflation Reduction Act, which will allocate $369 billion towards clean energy.

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