ESG+ Newsletter – 4th May 2023

What the US can learn from Europe on ESG

Recent coverage of ESG in America has been dominated by the ongoing political war around ESG (more on that below), with critics citing ESG as confusion between business and politics. Bloomberg has used the differing opinions over ESG as an opportunity to look at what the US can learn from Europe’s regulatory and legislative efforts. While the European ESG movement has not experienced the same vitriolic backlash that it has in the US, it has faced several setbacks of its own, with criticisms from a variety of stakeholders. The ongoing market confusion over fund classification under the Sustainable Finance Disclosure Regulation (SFDR) – which has seen certain funds downgraded, and then upgraded again – has caused widespread consternation across capital markets. While the EU Commission has sought to ease investors’ concerns by providing recent clarification regarding fund classification, the Bloomberg article notes that “continual revisions to incomplete rules, leaving clients wondering how sustainably their savings are being allocated.” Similarities between the confusion and criticism around how ESG funds are classified, their transparency, and regulatory oversight, can be seen with ESG ratings with some investors calling for greater oversight of the industry. Perhaps the problems being experienced in Europe is that of ‘growing pains’, as a once nascent aspect of capital markets has evolved into a central part of how investors allocate capital – and how regulators look to fund the transition to a lower carbon society. However, for ESG investing to have the support of capital markets, a stable and transparent regulatory environment that provides investors with trust and confidence in the veracity of ESG-related financial products is paramount. Maybe the push for subsidies rather than regulation in the US is one way to do so.

DeSantis signs anti-ESG legislation

After much fanfare, and linked to our first piece, Florida Governor Ron DeSantis has signed into law a bill that prohibits state officials from using public money for ESG investments and selling ESG bonds. The bill is one of the most extensive anti-ESG efforts to date by US Republicans. However, there are some questions about how the bill might be implemented. Brandon Owens, VP of sustainability at Insight Sourcing Group said that the bill was largely political “with little practical effect beyond limiting Florida’s future investment options.”  

Other US states (i.e., Wyoming and North Dakota) have attempted and failed to enact similar measures this year due to concerns that without the ability to incorporate ESG risks into financial decisions, the affected retirement investments and banks could lose money. Greg Hershman, head of U.S. policy at the PRI, said that the law creates “confusion” for investors who are analyzing every risk, including climate-related risks, which Florida is particularly prone to. With presidential nominees vying for the limelight though, we’re likely to see more criticism and/or support for ESG investing over the next 18 months.

EU’s Corporate Due Diligence ruling receives mixed feedback

On regulation, as covered by ESG Investor, last week’s update from the EU’s Legal Affairs Committee on the Corporate Sustainability Due Diligence Directive has sparked both positive and negative reactions from different parties. The position, which will require firms that are “in scope” to identify, prevent, and mitigate the negative impact of their activities – across the supply chain – on both human rights and the environment, has been most divisive in relation to the financial sector. Specifically, critics have deemed the optional inclusion, at the discretion of nation states, of pension funds, alternative investment funds, market operators, and credit rating agencies as being a watered-down set of rules. The Directive itself, even for the in-scope asset manager and institutional investors, has also been termed weak and “light touch” by NGO ShareAction, who stated that a fuller regulatory framework was needed.

Conversely, certain specialist lawyers have been notably bullish on the developments, with ESG Investor’s article quoting two firms that see MEP’s commitment to tying human rights and environmental due diligence as a strong step – despite any watering down that occurred over the negotiating process. The truth of it remains to be seen, with further significant changes likely before the final adoption. The current iteration in summary would apply to all EU-based companies with more than 250 employees and a worldwide turnover higher than €40m. For parent companies, this expands to 500 employees and turnover at €150m. Like in many other areas, action in the EU is likely to reverberate through value chains globally.

EU’s CSRD scope wider than many think

While the EU’s Corporate Sustainability Reporting Directive (CSRD) has been covered extensively here, the scope of the Directive goes well beyond the EU’s borders. Over the coming years, as set out in FTI’s recent thought leadership piece, a significant number of international companies will have to report against its requirements. The final reporting standards are set to be confirmed in June and if you’re a company within – or outside – the bloc’s borders, it would pay to start to evaluate your ability to report against its requirements. Indeed, even if a company is not in scope, the requirements of the Directive are likely to mean  customers or suppliers will be asking  for details on certain aspects of it.

Asian asset managers lag on ESG

To the other side of the globe, The Financial Times reports that Asian fund managers trail their European counterparts in addressing environmental, social and governance risks. In a survey conducted across forty asset managers based in Europe and Asia, only one-third of Asian managers acknowledged nature-related risks, compared with 73 per cent of European managers. Further, Asian asset managers lagged across metrics such as responsible investing, disclosing voting records, and a direct link between the remuneration of senior management and/or portfolio managers and ESG performance. However, some countries perform better than others within Asia. Asia ex-Japan, and ex-China, which includes Singapore and India, saw their responsible investment policies minimum score improve by 43 per cent from 2021 to 2022.

The region however has aggressive growth plans to grow its ESG AUM from $1tn in 2021 to $3.3tn over the next four years with Europe expected to grow by 35% and North America by 133% in the same period. Increased focus on embedding ESG-related metrics and principles will need to be adopted across the value chain including but not limited to policies, regulations and penalties to enable and sustain such growth, much like we’ve seen stock exchanges across the region leading the charge.

Adoption of Net Zero transition plans gathers pace

Banks have up until now often neglected to provide detailed information on how they plan to achieve their Net Zero targets, running the risk of being labelled as ‘greenwashers’. However, according to Bloomberg, GFANZ’s head of transition finance has stated that he expects to see a significant increase in the publication of transition plans in 2023 with a number of major banks having already published their transition plans this year. These plans are intended to arm investors with sufficient detail to assess the likelihood of a company achieving their 30-year goals. While there is currently limited guidance on what a good transition plan looks like, a high-level approach has emerged from the examples already in public domain. The usual sequence of events is that the initial net-zero commitment is followed by the implementation of governance structures and initial metrics and targets which are focused on the decarbonisation of loan portfolios. Once these commitments and targets are in place the bank can then develop a plan for “operationalising” them. The UK’s government-backed Transition Plan Taskforce (TPTs) intends to address the current lack of guidance around transition plans, setting the scene for a potentially mandatory framework. Regulators and investors alike are shifting gears – and will soon expect to see clear actions, not just words, on climate transition plans.

Is rewilding the answer to the dual nature and climate crises?

This week the Economist covered whether rewilding could help businesses build increased resilience against the risks associated with the climate crisis and nature loss. Rewilding is a term for the concept of returning a space to as close to its natural state as possible, which includes reintroducing previously lost cornerstone species and planting and protecting native flora. Rewilding has historically faced some controversy, particularly due to fears that the practice may take land away from agriculture or from local and indigenous peoples. However, in the UK the article shows that there has been a steady increase in support for rewilding, with more than 80% of the British population supporting the concept. While the benefits to nature are self-evident, proponents of rewilding also site the important co-benefits of the practice for people. From improved physical and mental wellbeing to potential financial benefits from nature markets or carbon credits, rewilding has the potential to create significant benefits for local communities. As interest in biodiversity from regulators, financial institutions and civil society continues to increase, companies will need to react to demonstrate efforts to protect and restore nature. While we may see a rise in demand for voluntary nature credits, there are also opportunities for companies to invest in rewilding to support wider business resilience, in particular to increase supply chain resilience by securing long term availability of natural resources such as wood and water. The interconnected nature of environmental issues from water use to carbon emissions means that these issues should be viewed in tandem. Nature-based solutions such as rewilding may help companies to address these highly linked issues.

The life lessons of a leading climate diplomat

As the world prepares for the 28th edition of the COP, we draw on the experiences of Pete Betts, one of the worlds most respected climate diplomats, who has acted as the lead negotiator for the UK and the EU and helped deliver the historic Paris agreement treaty in 2015. At an inflection point towards achieving the targets set out in the Paris agreement, Betts shares some important life lessons in an FT article. Betts points to the range of considerations when developing policy at national and global level, making it difficult for any individual to be on top of all activities and discussions, as delegates are grouped into different negotiation groups covering various issues such as finance, adaptation, measuring and reporting on emissions, for instance. Finally, as preparations for COP ramp up – nationally and from corporates – personal relationships and collaboration between nations, as highlighted by this year’s COP President-delegate and covered in last week’s edition of the newsletter, remain fundamental to success.

ICYMI

• Korea leads on greenwashing crackdown in Asia – Korea is set to become the first country in Asia to give fines for greenwashing with a new law expected to be passed later this year. Although fines can already be given out for the practice in Korea, none have been issued so far. The new law will see companies fined if the Ministry of Environment believes that they have misled the public. This follows action in other areas including a proposition for a new law from the European Commission which would force companies to supply scientific evidence for green claims and the first ever fine for greenwashing in Australia in November last year.
• Southeast Asia companies must recognize climate change risks. Southeast Asia’s increasingly competitive economic activity comes not without the costs of accelerated urbanization and rising energy demand, leading to a surge in greenhouse gas emissions. Yet, Andrey Berdichevskiy and Paul Marriott have written for Nikkei that Southeast Asia is uniquely positioned to drive tangible change through climate action on account of the region’s diversity, meaning it is time for corporations in the region to act. Companies need to improve their emissions disclosures and should also take action to define and implement both adaptation and mitigation strategies formed around existing best practices.
• State Street CEO: Divestment Will Slow Clean Energy Transition. State Street’s Chief Executive Officer Ron O’Hanley has said the pressure on large asset managers to divest from polluting companies will only stoke political division and slow down the energy transition, thereby doing nothing to help the Earth. Speaking at the Milken Institute Global Conference on Monday, O’Hanley said instead that, to curb carbon emissions and transition to cleaner forms of energy, polluting industries require investments so they can start to change. Environmentalists have targeted State Street, alongside its larger competitors Vanguard and BlackRock, for their investments in oil and gas companies. O’Hanley is calling this counterproductive and an “ugly” narrative.

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