ESG+ Newsletter – 7 March 2024

This week we cover the long-awaited enactment of the SEC climate rule and the potential lawsuits from both sides that may follow. We also cover investor sentiment on ESG data quality, and the challenging balance of managing ESG disclosures against an evolving regulatory backdrop and shifting investor demands. We finish by looking at the decrease in demand for sustainability-linked loans, while ESG funds appear to be demonstrating resilience, despite the ongoing ESG backlash. 

SEC climate rule enacted, immediately drawing lawsuits 

As reported in the Financial Times, the US Securities Exchange Commission (SEC) has enacted a climate rule which will mandate company disclosures on climate risks and emissions. The rule will require around 40% of the 7,000 US publicly listed companies registered with the SEC to disclose emissions for the first time, as well as 60% of the 900 foreign private issuers registered with the SEC. The climate rule was long delayed due to the extent of comments received during the consultation period, with significant pushback on some elements of the original proposal. In typically polarising fashion, the finalised rule is being criticised for both not going far enough and, simultaneously, overstepping the authority granted to the SEC. Notably, the final rule only includes Scope 1 and 2 emissions, with Scope 3 emissions omitted from the rule based on concerns relating to costs and complexity of calculation. Many feel that omitting Scope 3 means the rule doesn’t go far enough. These opposing views have led to the SEC bracing for lawsuits from both sides of the argument. Within two hours of the rule being passed, the first lawsuit was filed. Other legal challenges have also been announced, with a coalition of 10 states seeking to challenge the rule on the basis that the SEC has overstepped its authority, claiming that the rule is “illegal and unconstitutional”. While the rule has been ‘watered down’ to an extent, and seems like a minor step forward in comparison to far-reaching reporting framework, like the Corporate Sustainability Reporting Directive (CSRD) in Europe, it represents the first time climate disclosures which will be required across the US. Despite the lawsuits and challenges that lie ahead, the SEC rule still represents a step change in corporate disclosure: mandatory climate disclosure in the US.  

Investors concerned by ESG data quality  

According to a Bloomberg survey covered by ESG Today, investors are facing a number of ESG data challenges. Bloomberg surveyed more than 200 financial market participants across Europe to understand the ESG data challenges they are facing. The most commonly cited ESG data challenge was coverage and quality issues related to reported ESG data, with almost two thirds stating that this was their primary concern. The CSRD seeks to address this issue by creating standardised data disclosures across companies’ material ESG issues. While the CSRD may alleviate some data coverage and quality challenges through standardised and auditable reporting, it may create an issue in managing larger volumes of data. Managing this data will be a new challenge for investors who will need to monitor and filter large volumes of data to find important information to support investment decisions. More than 50,000 companies will be required to report against the requirements of the CSRD, including a large number of companies outside of the EU. Preparation for all companies covered by the CSRD is pressing, as covered in our recent thought leadership on the topic. The challenge thereafter might be placed on investors. Having requested more data, the difficulty then might be knowing what to do with it.

Correlation between board diversity and high credit rating  

An earlier edition of the newsletter in January detailed the growing gender diversity across boards around the world. Notably, credit rating agency Moody’s has recently published research which aims to dig deeper into the benefits of that progress, showing a correlation between the level of female representation on the boards and the credit rating of the business. Moody’s assessed over 3,000 of their rated companies, which found that their investment grade rated companies – defined as having high credit quality and deemed lower risk for investment – had a board composition with an average of 29% female representation, while lower rated companies had an average of 24%. While always cautious of the confusion between correlation and causation, gender representation on boards looks set to increase further due to diversity mandates and shareholder scrutiny, Moody’s believes that increase in the proportion of women on boards over the coming years will support good corporate governance and will be a positive for companies’ credit quality. 

Damned if they do, damned if they don’t – companies struggle to balance ESG disclosures 

A recent article based on research by Reuters has highlighted the ongoing practice of “greenhushing” as companies attempt to avoid backlash from incomplete ESG disclosures. Using analysis of news data, combined with survey data and interviews of key players, Reuters identified varying trends in ESG reporting across geographies and sectors. Unsurprisingly, US financial services companies are most at risk from “greenhushing”, with banks and asset managers targeted by anti-ESG campaigns, resulting in a 20% year-on-year reduction in ESG-related statements. It’s a different picture in Asia though, where, according to the Reuters article, companies are under pressure from governments to do more on sustainability. Perhaps unexpectedly, in the US utilities sector, ESG statements actually rose 5%, likely driven by the impact from extreme weather events. Other US industry sectors experienced a significant upward trend in ESG reporting too, notably in retail and food and beverage, where consumer power is driving the move towards more sustainable products. However, consumer-facing businesses often find themselves having to balance concerns regarding the legal or reputational impact of how they communicate sustainability initiatives. On the one hand, there are consumers and employees who are critical of slow progress on ESG, while on the other, there is the risk of greenwashing lawsuits from regulators or investors, leaving many companies stuck between a rock and a hard place. 

Sustainability-linked loans are losing popularity 

As reported by Bloomberg, increased costs and risks of greenwashing accusations have contributed to a contraction in the demand for sustainability-linked loans (SLLs). Like with sustainability-linked bonds, borrowers using SLLs generally enjoy lower debt costs upon meeting certain sustainability targets. However, the loans come with far less public documentation than the bonds as they tend to result from direct agreements between borrowers and their bankers. The SLL market is huge. BloombergNEF, an energy-focused research organisation, estimates that the SLL market is currently worth $1.5 trillion, making it the second ESG debt market in size, behind the market for green bonds. Last year, the issuance of SLLs halved. Though 2023 was a difficult year across debt markets, the drop in SLLs was almost twice as large as it was for green loans. Moreover, while the issuance of green loans has increased in 2024, that of SLLs has continued to decline. One factor behind this contraction is the disappearance of the ‘greenium’ i.e. the premium or lower coupon enjoyed by ESG borrowers, which now appears to be largely eroded by the cost of audits associated with SLLs. Another factor is the perceived additional risk of greenwashing accusation tied to the implementation of the CSRD and the amount of data that will need to be disclosed by companies (in line with the “greenhushing” findings above). In addition, the Loan Markets Association published updated voluntary guidelines last year asking that SLLs only use ESG metrics that are “relevant, core, and material” as well as “measurable and quantifiable”, much like similar expectations on the inclusion of ESG metrics in executive pay.

The remergence of ESG funds 

Recent analysis by the European Securities and Markets Authority (“ESMA”) has highlighted the resilience of environmental, social, and governance funds, particularly during the period of significant market turmoil brought about by the Covid-19 pandemic. The study found that between February and June 2020, when financial markets suffered from “an exogenous shock” impacting the market as a whole, ESG fund performance surpassed that of non-ESG funds. Funds with higher ESG ratings also yielded superior returns, throughout this period, attracting heightened investor attention even amidst market volatility, as noted in a recent Financial Times article. Concurrently, the ‘Sustainability Report’ published by Morgan Stanley’s Institute for Sustainable Investing this week, highlighted sustainable funds’ robust performance across global asset classes in 2023, generating median returns of 12.6%, almost 50% ahead of the 8.6% returns of traditional funds. This follows the findings from Morgan Stanley Institute’s survey of individual investors which indicated that “a majority look for both competitive financial returns and sustainability in their investment strategies”, further emphasising the maturing landscape of sustainable investing. ESMA confirmed that it would “press on with its ESG fund name guidelines, despite strong industry opposition” with a view of publishing its updated guidelines in 2024 which will hopefully support greater transparency for investors. 

AI’s next frontier? Fashion sustainability

This week, ESG News examined AI’s transformative potential to improve sustainability in fashion, spotlighting how it can slash the $101 billion annual costs incurred through returns, while concurrently mitigating environmental impacts. Generative AI is a key enabler, offering personalised recommendations to ensure shoppers receive accurately sized garments. Brands can also leverage data analytics to anticipate market trends with unprecedented accuracy, thereby reducing waste and overproduction. Moreover, AI-driven solutions enable businesses to track their products’ lifecycle, facilitating compliance with stringent EU sustainability regulations and the demands of sustainability-conscious consumers.

However, AI’s impact, like all technology, will depend on usage. Will smaller companies have equitable access to these transformative technologies, enabling them to harness its benefits and contribute to circularity? Or will AI perpetuate a culture of consumerism, fuelled by the desire for instant gratification and fast fashion? Ultimately, AI’s implications on sustainability are contingent upon the choices made by individuals, businesses, and policymakers. 

ICYMI 

• Singapore and Australia formalise collaboration to establish green and digital shipping corridor. Under the signed Memorandum of Understanding to formally establish the Singapore-Australia Green and Digital Shipping Corridor, both countries will work with interested partners to explore opportunities to develop zero or near-zero greenhouse gas emission fuel supply chains for the maritime industry, as well as ways to facilitate digital information exchange. 
• Netherlands central bank first to carry out LEAP assessment. De Nederlandsche Bank (DNB), the Netherlands central bank, has become the first central bank to carry out a LEAP assessment. Developed by the Taskforce on Nature-related Financial Disclosures, the LEAP approach is designed to help organisations identify and tackle their nature-related dependencies – with the aim of this helping to inform nature-related disclosures. DNB said it undertook the assessment as a first step towards exploring the nature-related financial risks within its investments.
• Proxy adviser ISS expands offerings for ‘ESG skeptic’ clients. Institutional Shareholder Services (ISS), the influential proxy adviser that recommends how shareholders should vote in corporate elections, will offer a new “ESG skeptic” option designed to appeal to clients who want to go further against ESG. The move was made after Republican politicians said the firm backs too many shareholder resolutions on ESG topics