ESG+ Newsletter – 6 June 2024

This week’s newsletter opens with a look at how passive funds are taking a more active role in challenging companies on their ESG performance. We discuss the widening wage gap between CEOs and employees across S&P 500 companies, and the growing concerns for EU banks regarding the environmental impact of their residential real estate mortgage portfolios. We also look at the struggles of sustainability linked bonds, and have ESG reporting updates from CDP and China. However, first we begin with our monthly ESG regulatory update.

ESG Regulatory Update

As ESG regulations rapidly develop, FTI Consulting is providing a quick summary of need-to-know updates from around the globe. In this update, we look at the status of the recently adopted climate disclosure rule in the US, efforts from the government in China to chart a path for sustainability disclosures, and the official launch of ISSB-aligned climate reporting standards in Hong-Kong. Read the FTI ESG Regulations Global Update. 

The Church of England Pensions Board, a non-traditional activist  

Historically, the Church of England Pensions Board (Pensions Board) could be viewed as a pacifist shareholder. Its focus is on delivering value for its shareholders, while also seeking to make the world around its investee companies a better place. However, a recent WSJ article highlighted that the Pensions Board is taking a more active role in challenging companies. As the article details, the Pensions Board has previously opted to engage with companies at board level to drive meaningful change, but recently it has taken a more activist approach through the use of shareholder proposals. This evolution in approach reflects an emerging trend from investors who have become more willing to leverage shareholder proposals as a method to put pressure on boards to enact change.  

While the Pensions Board is unlikely to be ever viewed as a true activist, its willingness to either engage with companies or exploring other avenues – such as shareholder proposals – shows its commitment to ensuring investee strategies are aligned with the long-term interests of its fund. And, if that is unsuccessful, then they have shown that they are willing to vote with their feet, as evidenced by their divestment from oil and gas companies last year due to their belief that the sector was not moving quick enough to change its ways in the face of climate change. 

CEO-to-employee pay ratios continue to increase at large US firms 

This week, the Associated Press published a report highlighting the widening wage gap between CEO and employee pay across S&P 500 companies. In 2023, median CEO pay increased by 13%; three times faster than the wages and benefits earned by employees. Median CEO pay reached $16.3 million in 2023, representing 196 times median employee remuneration, up from 185 times in 2022. In sectors with relatively low employee remuneration, such as retail, this ratio is even higher. Acknowledging the important responsibilities of CEOs and the high fraction of their pay that is variable, the widening of the gap still poses a number of social issues, including potential employee demotivation. The High Pay Centre, an independent think tank focused on the causes and consequences of economic inequality, highlights that “vast gaps between those at the top and everyone else are immensely damaging to social cohesion, democracy, political stability and public health and wellbeing.” In addition, as we live in a globalised world, large increases in CEO pay in the US have an impact on executive remuneration practices in other regions of the world, with pay comparisons between the US and the UK under the spotlight during this AGM season. 

Banks warn of growing energy-related risks in mortgage portfolios

The European Union’s implementation of stricter energy requirements for homes, is forcing European banks to acknowledge that their residential real estate portfolios have added energy-related risks. According to Bloomberg, 60% of homes in Germany will need to undergo green renovations over the next decade to comply with new requirements, with many households either unable to spend money on upgrades or unwilling. Chief economist for ING Germany, Carsten Brzeski, explains that that there is insufficient capital across Europe to bring this type of housing in line with the bloc’s targeted environmental standards. However, banks are making efforts to support customers in improving their homes energy efficiency. For example, Deutsche Bank recently implemented structured capital-relief instruments that allow it to grant discounts on more than €600 million of green mortgages in its home market. However, these efforts are only helpful if homeowners are financially able or willing to engage on energy efficiency, which many are not. Deutsche Bank estimated that one-third of its private real estate clients do not have the financial means to update their homes to the highest energy rating. Ultimately, this poses a threat to Germany’s net zero 2045 goal. 

Sustainability-linked bonds struggle for success 

Whilst global green bond issuance has remained stable in the first quarter of this year, the same cannot be said for sustainability-linked bonds (SLBs), reports the Financial Times. Whereas green bonds are issued by countries or businesses to pay for environmental projects, these newer sustainable investing products tie a company’s debt interest payments to climate targets – and punish the company with higher interest rates if they fail to meet those targets. When SLB’s first came onto the scene, they enjoyed a favourable debut: Italian energy group Enel was the first entity to issue an SLB back in 2019, and many companies followed suit. However, since then, the issuance of SLBs has significantly dropped: this year it has fallen by 51% compared to the same period in 2023, totaling only $12.5 billion. The decline has been attributed to growing skepticism about the credibility and impact of the targets set by these bonds. Moreover, political tensions in the US have resulted in even more pressure on SLBs. As sustainable debt continues to evolve, so do the demands and the scrutiny around the credibility of the targets and whether companies are on the path to achieving them.  

CDP works to streamline sustainability disclosures  

Earlier this week, CDP launched a new platform aimed at simplifying sustainability reporting for companies and improving the alignment with emerging global reporting standards. The platform includes a new questionnaire that is aligned with the ISSB’s IFRS S2 standard, set as the global baseline on climate disclosures, and “brings forests, water, biodiversity and plastics issues together in one questionnaire and dataset”. The new platform aims to ease compliance with new emerging sustainability reporting standards, particularly IFRS S1 and IFRS S2, which have been endorsed the IOSCO and adopted by jurisdictions covering 55% of global GDP. Additionally, CDP plans to integrate other frameworks, such as TNFD and ESRS, into its system. While the merits of reporting on environmental issues are undeniable, CDP is clearly conscious that action is more important that reporting for companies, noting that “every dollar an organisation spends on reporting is a dollar they cannot spend on action”.  CDP’s efforts to reduce reporting burdens and improving data availability will likely be welcomed by the 23,000+ companies that disclose through the CDP framework in 2023. 

Despite early doubts, China tables ISSB-aligned disclosure framework 

China’s Ministry of Finance has published its draft ESG reporting framework, which is aligned with the ISSB. As highlighted by Responsible Investor, while there were some initial concerns from a Chinese perspective that the ISSB framework didn’t consider different countries’ economic development levels and regulatory capabilities, this position evolved with the Ministry concluding that the ISSB requirements are applicable in China. The framework is based on the ISSB’s IFRS S1 standard – focusing on governance, strategy, risk management, and metrics and targets – while also incorporating “Chinese characteristics“. One noticeable difference is double materiality, where China has aligned with the EU’s stance rather than the ISSB’s enterprise value focus. Other differences include a broader user base for the Chinese framework, including investors, creditors, and regulators, and separate disclosure of sustainability reports from annual financial accounts. 

ICYMI 

• A recent survey of M&A leaders reveals a significant shift towards prioritising ESG factors in dealmaking. ESG today reveals that over 70% of respondents reported abandoning potential acquisitions due to ESG concerns, leading to a growing integration of ESG factors throughout the M&A process.
• Nature Action 100 establishes a science council to support its technical advisory group and oversee science-based research, Environmental Finance reports. The council, consisting of 11 members, aims to address emerging nature-related challenges and advance conservation efforts through metrics and methodologies.
• Germany to miss its 2030 greenhouse gas targets. According to Reuters, Germany’s Expert Council on Climate Issues predicts that the country is unlikely to meet its goal to cut 65% of greenhouse gas emissions by 2030 due to challenges in sectors like transport and construction.