ESG+ Newsletter – 5th May 2022

The future of carbon pricing

Whether it is through internal carbon pricing, government carbon taxes, or the purchase of offsets to achieve net zero goals, carbon has a price – and it’s a hot commodity. Last week we covered the need for strong governance to provide effective oversight of voluntary carbon markets. This week, the FT reported that a surge of investment into carbon credits has created a boom time for brokers, with the opaque, unregulated market creating prime conditions for brokers who have been accused of cashing in at the expense of environmental causes. Transparency on carbon pricing is desperately needed to ensure the credibility of voluntary carbon markets is not undermined.

The SEC aims to increase transparency on companies’ own internal carbon prices. The SEC climate disclosure proposals include an obligation for companies that calculate an internal carbon price to disclose their level of internal carbon pricing and how that price was set. Internal carbon pricing is a method for companies to assign a price to their GHG emissions. The internal carbon price is factored into investment decisions and can be used to incentivise investments which lead to increased efficiencies and reduced emissions. The SEC hopes that mandating disclosure on internal carbon pricing will provide valuable data for investors and governments considering carbon pricing and taxation. The IMF argues that for carbon taxes to be effective, the world needs a coordinated global carbon price floor, estimating that global emissions could fall by nearly a third by 2030 through effective, coordinated global carbon pricing. Of those countries that currently adopt carbon taxes, price per tonne varies widely from $7 to $50, with experts stating that carbon prices should be anything from $20 to $115 per tonne to be effective. If adopted, the SEC’s rules will provide much needed visibility of corporate internal carbon pricing levels, potentially allowing governments to determine an appropriate carbon price. For internal carbon pricing and the voluntary carbon market, transparency will be key to ensuring credibility and creating real, demonstrable impact.

SEC climate proposal faces pushback on disclosure cost

In addition to carbon pricing, the SEC climate risk disclosure proposal has faced public scrutiny and debate regarding the financial and operational burden the rule could place on publicly traded companies who would be required to disclose environmental metrics. With CFOs required to sign and attest to the accuracy of annual 10-K regulatory filings, the rule as it stands would make financial officers liable for the accuracy of carbon emission statements. This process could be costly and complex for companies, with carbon consulting and tracking company Persefoni predicting an average spend of $840,000 on compliance in the first year under the new rules. Proponents of the rule argue that such measures are necessary to ensure the reliability of ESG disclosures and incentivise corporations to combat climate change. The proposal is currently open to public comments, and the final rule may differ from the proposal as it currently stands and may soften some of the requirements. Litigation around the SEC’s jurisdiction could also ensue, which could potentially delay their implementation for several years. However, whether a groundswell of pushback that says increased disclosure on climate issues is ‘too costly’ can overcome the potentially greater push that current inaction is even more so, remains to be seen.

CEOs must champion sustainability and lead with purpose

Indeed, arguments against the cost of sustainability may increasingly fall on deaf ears. FTI’s latest publication in our CEO Leadership Redefined series indicates that in the face of global disruption caused by climate change, social volatility and geopolitical uncertainty, the actions that companies are taking to address these issues and make a positive impact on people and the planet have never been more important. While historically a CEO’s primary focus was to generate strong returns for shareholders, FTI’s research found that working professionals and investors – two of a company’s most important stakeholders – now expect CEOs are to deliver long-term, sustainable value that goes beyond the bottom line and serves the interests of society. Download the full report here.

First glimpse of EU sustainability reporting standards

EFRAG, the European Commission’s financial reporting advisory group, has launched a public consultation on draft EU sustainability reporting standards (ESRS), allowing corporations to weigh in until August 8.  These standards are required under the proposed Corporate Sustainability Reporting Directive (CSRD) and cover environmental, social and governance (ESG) matters. Commissioner McGuinness requested the initial technical development of these draft standards in May 2021, in parallel with the legislative process of the CSRD. EFRAG’s Project Task Force on European sustainability reporting standards undertook the work which was eventually handed over to EFRAG’s permanent structure. The public consultation survey is organised into three corresponding sections: Overall substance of the Exposure Drafts; ESRS Implementation prioritisation / phasing-in; adequacy of Disclosure Requirements. Respondents can provide their answers here (section 1 and 2) and here (section 3). The launch of the public consultation follows the appointment of a Sustainability Reporting Technical Expert Group on April 25, which will provide technical advice on the standards.

Corporate power and stakeholder capitalism

Rana Foroohar, the Financial Times’ Global Business Columnist, this week published her analysis of the state of stakeholder capitalism. Using Elon Musk’s acquisition of Twitter as an initial case study, the article discusses how ESG investing has, to date, not properly accounted for market power. Foroohor contrasts the decision to sell equity in Tesla, a company integral to the electric vehicle movement and global net zero goals, to take Twitter private and further from regulation, and away from shareholder accountability. The central idea outlined is how corporate power and concentration, attained from various avenues including M&A, have the “political consequence” of corporations and leaders undermining the “public sector’s ability, effectiveness, and willingness to act in the public interest”. The U.S. is cited as being a geography where business’ influence over policymakers is significant. While the article does speak to the difficulties in capturing the elements of stakeholder capitalism, it is not necessarily critical of the philosophy itself. It instead points out how it needs a rethink. ESG and the surrounding associated themes are attempting to grow in sophistication and maturity on a daily basis; it may be that concentration of power and anti-trust discussions start to permeate the ESG and stakeholder capitalism area sometime soon.

Is SFDR confusion here to stay?

The EU’s Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March last year divides investment funds into three buckets: i) Article 6 funds, which make no claims of sustainability, ii) Article 8 funds, which have environmental and social characteristics, and iii) Article 9 funds, which invest specifically in highly rated environmental and social companies. With the fear of losing assets and market share, funds have been recategorizing, often without making any changes to their investment strategies. While the objective of the SFDR has been to reduce claims of greenwashing, certain participants have pointed to a lack of clarity around fund categorisation. In response, in April 2022, the EU published additional guidance, the Regulatory Technical Standards (‘RTS’), setting more specific guidelines around fund classification.

At a recent Environmental Finance ESG in Fixed Income Conference, one speaker provided their view that “Over the next few years, the main thing we’ll see is a lot of flux and movement between the articles and it should probably reach some equilibrium in the next five to 10 years”. He added that there are nine times more Article 8 funds than Article 9 ones, making it increasingly more important to ensure all ESG claims have solid grounding.

Greater data transparency as opposed standardization to improve ESG ratings?

A recent GreenBiz article looked at one of the biggest challenges facing ESG – the inconsistent ESG ratings that often diverge significantly from agency to agency. While there has been calls for greater standardization and homogeny for rating agencies, the ratings are subjective evaluations much like a ‘buy’ or ‘sell’, and should not be seen as more. A study by Todd Cort and Dan Esty from the Yale Center for Business and the Environment, outlined that standardizing the data for ESG focused investors would be “counterproductive” due to ESG’s different functions – some investors use ESG metrics to maximize financial returns, others to minimise risk, while others still look to achieve a particular goal. They argue that rating agencies should be required to show greater transparency throughout the data collection and validation processes, rather than attempting to completely standardize the data.

The sentiment expressed by Cort and Etsy was echoed by noted ESG critic, Aswath Damodaran, Professor of Finance at the Stern School of Business at NYU, who argues that no single measure can define the good or bad that a company does and that you can’t reduce a company down to a single figure or rating. He argues that you can’t standardize whether a company is ‘good’ or ‘bad’ as this is too subjective, rather investors should focus on data that is relevant to that company – for example he cites oil companies disclosing their carbon footprint and tech companies disclosing about their privacy and data sharing.

As covered frequently by the ESG+ Newsletter, regulators across the globe are placing their focus on creating a consistent reporting framework for ESG rating agencies to operate under. While this will be a welcome step for many investors, it should be developed to ensure that data collected is transparent. By grounding any approach in the accuracy and transparency of data, investors will be provided with the inescapable truth of numbers – and can continue to look for subjective ratings separately from as many providers as they want.

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