ESG+ Newsletter – 3rd February 2022

Resilience Barometer: Corporate Resilience in the ESG era

ESG is top of the agenda across the globe. While the majority of participants in our research now recognise the opportunities that ESG presents, many are aware of the risks associated with the increased scrutiny it brings. Despite increased spending and resource allocation towards ESG, there was a clear sense that there may be a lack of the necessary expertise, particularly in demonstrating meaningful impact and outcomes from ESG programmes. In line with a number of recent ESG+ newsletters, as expectations shift from commitments to action and delivery, key decision-makers are struggling to respond.

Some of the key findings from the January 2022 edition of the Resilience Barometer include:

• 86% of G20 business leaders agree that they have been allocating more resources to ESG and sustainability; however, 28% agree that their company is falling short when it comes to their climate action plan and 66% agree that they do not currently have sufficient ESG or sustainability expertise to cope with increasing scrutiny.
• 36% claim that they are under extreme pressure to improve ESG and sustainability over the next 12 months.
• 31% expect to be investigated by regulatory or government bodies in relation to their sustainability and ESG practices.
• 88% say they are shifting their approach to ESG from managing risk to identifying new business opportunities, an increase from 85% in the September 2021 report.
•  G20 companies expect media scrutiny on a range of areas, with significant areas of concern relating to ESG related topics, including employee wellbeing (38%), sustainability and environmental impact (35%), and diversity, inclusion and equality (30%).

Read the full report here

As the ESG market grows, greater scrutiny is required to mitigate greenwashing

In a recent interview with Bloomberg, Bank Investment Management CEO, Nicolai Tangen, discussed ESG investing and how sustainability considerations will continue to impact a company’s ‘licence to operate’. He highlighted that if a company is not sustainable in terms of its business model and operations, then it will be restricted from accessing finance and investment, insurance and struggle to attract employees and clients.

Tangen’s comments, and the Norwegian Sovereign Wealth Fund’s position, reflect its decision late last year to remove nine companies from its fund based on ESG risk-based screening. While it is clear that the wealth fund is sticking to its ESG convictions, an industry veteran believes the growth in ESG is “a little disconcerting”. Jerome Dodson, founder of Parnassus Investments – one of the world’s largest money managers dedicated to ESG – believes that as more capital is deployed into ESG, many companies and investors are exaggerating their efforts and impacts. Dodson believes company and investors ESG financial performance need to be more rigorously scrutinised, with greater market regulation to clamp down on potential greenwashing.

As we have highlighted previously, greenwashing remains a significant obstacle for ESG. While we have seen some movement in terms of market regulation, increased investor sophistication and scrutiny of company-specific actions remain important aspects of the market’s ability to underpin successful ESG outcomes.

Valuations elevated by ESG to fall as market conditions tighten

Amid rising interest rates and with growing bearish noise in the market, green energy stocks with weak earnings to valuation profiles are coming under scrutiny from investors. As reported by the Financial Times this week, a pattern of short selling is emerging as hedge funds bet against inflated ESG assets. Argonaut Capital is one of many referenced firms, with its chief investment officer Barry Norris citing: “In a bear market, a company doesn’t trade at 60 times earnings just because it does something morally good”. The wind power, hydrogen and electric vehicle sectors are all highlighted as being laden with companies with inflated valuations and therefore at risk, at a time when many UK and US-based hedge funds are reportedly scouting the market for discarded and lowly priced oil and gas stocks. Despite this, the piece notes the two specific dangers associated with this strategy – the increasingly favourable regulations for heavily ESG exposed companies and the continued inflows pouring into the sector. Underpinned by green reporting requirements growing in complexity, the shift from commitment to delivery for corporates, and growing bearish sentiment, the ESG landscape looks set for a degree of market correction in 2022 – separating those who can back up their credentials with performance.

Does hybrid work have a bigger carbon footprint than office work?

As the world emerges from the pandemic, what working life looks like in a post-pandemic world is still being worked out. A trial of a four-day working week in the UK is gathering momentum as businesses attempt to address work/life balance for their employees. Hybrid working is also being used to offer greater flexibility to employees, however, there are indications that this may come at an environmental cost. Full-time homeworking is more environmentally friendly as the extra lighting and heating needed at home is offset by a closed office and cancelled commute. However, the equation for hybrid work is more complicated and could present the worst of both worlds from an environmental point of view. The crux of the issue is that “a half-empty office needs much the same heating and air conditioning as a full one”. Also, just giving up a commute for two days a week may not be enough to offset the extra heating and lighting at home. However, certain factors may tip the balance such as using electric cars or public transport, as well as seasonal factors which necessitate the use of heating or air conditioning. Hybrid work appears to represent an ESG conundrum for organisations as the social benefits it provides for employees may in fact lead to a greater carbon footprint and damage environmental credentials, unless of course, offices are done away with all together.

Gas and nuclear in the EU’s Taxonomy may be impeding reporting

The European Commission has presented its final political agreement on a Taxonomy Complementary Delegated Act (CDA) covering certain gas and nuclear activities. Importantly, the document confirms that there is a role for private investment in gas and nuclear activities in the energy transition. This decision comes after the Commission faced strong criticism following a leak at the end of last year. Commissioner McGuinness stated that the CDA was accepted with an “overwhelming majority” in the College of Commissioners. The fact that a vote did take place, however, is highly remarkable since the College almost always makes decisions in a collegial manner. As a reminder, several Member States have stated their opposition to the CDA, with some even threatening to pursue a lawsuit against the European Commission. This avenue might be the only one left to stop the progress of the CDA, since the objection thresholds that would be needed to be reached at this stage among Member States or in the European Parliament are likely too high to be met.

Debate around the designation of certain activities in the EU Taxonomy may be distracting companies from their reporting obligations though. A survey by the Conference Board found that the majority of European companies it analysed could fail to provide the data required by the EU Taxonomy regulation at their financial year-end. The regulation requires companies with more than 500 staff to publish their alignment with the EU Taxonomy; however, the survey found that fewer than ten of the almost 12,000 eligible companies surveyed demonstrated that they were ready to comply with the EU’s new regulations. While there are currently no fines for non-compliance, companies may find it harder to attract capital if they cannot demonstrate compliance with the regulation. We have released our thoughts on the EU Taxonomy today, outlining what needs to be reported and how the regulation can be viewed as an opportunity rather than simply compliance and a reporting challenge.

European investors remain most committed to ESG adoption; climate change top concern

A new RBC Asset Management survey of fund consultants, buyers and wealth managers indicates that Europe continues to outpace the world in ESG adoption. While 72% of global investors integrate ESG principles into their investment approach, that number is 99% in Europe, far higher than the 64% seen in the United States. There seems to be a significant difference between regions of the world on the belief that ESG-integrated portfolios do as well or better than others. While 97% of investors in Europe believe so, only 77% of US investors do. Interestingly, the respondents who said they placed more importance on ESG considerations due to the COVID-19 crisis also show the greatest conviction on ESG principles overall – they are significantly higher than the average in believing that ESG-integrated portfolios perform better than non-ESG integrated portfolios. It will be interesting to watch whether the clamp down on what genuine ESG integration looks like impacts the lofty numbers in Europe, with the degree to which integration is taking place likely varying significantly within the 99%.

Credit Rating Firms Have Risk in Entering ESG Boom

A new report from the SEC has warned credit rating agencies about the various risks they face in entering the ESG landscape. The report stated that by adding ESG factors, the credit rating firms will deviate from their usual methodologies and that these procedures may not be properly disclosed to investors. There have been certain issues identified in the overall consistency of ESG ratings and applying ESG factors, particularly around internal controls relating to the evaluation of ESG-related data may be problematic. Furthermore, the SEC stated that ESG is an area that could lead to multiple conflicts of interest. For one, many of the credit rating agencies offer ESG products and services themselves. This can lead to situations where credit rating agencies are advising companies on how to improve the ESG rating they have from the credit rating agency itself. Credit firms may feel pressure to increase the ratings/scores of companies if that company is also a client. Conflict of interests on ESG are not unique to credit rating agencies, as there are other entities that provide ESG ratings while also providing guidance on how to improve performance in the same area. While it is unclear what will specifically be done to mitigate these risks, the SEC has already considered requiring ESG ratings and data firms to disclose potential conflicts of interest. At the same time, recent research from S&P indicates that about 1 in 4 ratings downgrades were driven by ESG factors.

In Case You Missed It

• Nestlé moves to improve the chocolate trade. Nestlé has announced plans to triple its funding for sustainable cocoa to $1.4bn over eight years. Even more crucially, the chocolate giant is to start making direct payments to African cocoa farmers in a bid to eradicate child labour from its supply chain. Nestlé recognises that it cannot rely on governments or NGO’s alone to stop child labour, marking a trend of companies taking responsibility for their impacts within the value chain which we suspect will continue to spread.
• Citi Issues $2.5 Billion Bond to Support Affordable Housing. Citi has hired five Black-owned firms to underwrite and distribute their newly syndicated $2.5bn affordable housing bond to investors. The bond further entrenches Citi’s mark as the USA’s No. 1 affordable housing lender and reflects their commitment to increase the availability of affordable housing units within the very communities in which they live and work. The announcement comes following Citi’s 2020 $1.1bn three-year commitment, ‘Action for Racial Equality’ which saw them invest $1bn by November 2021.
• The global issuance of green, social sustainability (GSS) and sustainability-linked bonds (SLB’s) are set to reach a record high of $1.35tr in 2022, says Moody’s ESG Solutions. This record marks a 36% increase over the estimated $992bn issued in 2021, with the majority of growth coming primarily from green bonds ($775bn), followed by sustainability bonds ($225bn), sustainability-linked bonds ($200bn), and lastly, social bonds ($150bn).

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