ESG+ Newsletter – 9th March 2023

EU banking regulator pushes for action on gender diversity rules

The European Banking Authority (EBA) has called for a crackdown on EU financial institutions for failing to implement rules on gender diversity, according to the Financial Times. The EBA revealed this week that 27% of companies they reviewed had not implemented diversity policies for their boards, despite this becoming a legal requirement in 2014. Their review also highlighted a lack of progress in implementing gender diversity across both management teams and boards, which remain almost 75% male. Where institutions had implemented diversity policies – mainly larger institutions – mandatory diversity targets were found to be weak, with some setting goals of less than 25% female representation. The EBA is now calling upon national-level banking supervisors to implement measures to enforce diversity rules, including implementing higher capital requirements and restrictions on business.

While the EBA is opting for the ‘stick’ approach, there’s also a ‘carrot’ option with a Bank of America report revealing how gender diversity leads to better returns. Their analysis found that companies that have focused on gender diversity at the board, C-suite, and firm levels, produce better results across various measures, including return on equity, earnings volatility, stock valuation, and weighted average cost of capital. Specifically, BofA found that in the U.S., “gender diversity on the board correlates with 19% higher ROE in the next year and 43% lower earnings volatility in the following three years”. With this report highlighting that performance is obviously not a barrier to female progression, financial institutions need to work harder to identify the factors hindering gender diversity at the top levels of their organisations.

Market sentiment towards ESG investment rises despite difficult regulatory backdrop

Despite what has been coined by some as ‘the great reclassification’, whereby fund managers are downgrading their dark green, impact investment products to a lighter green classification, inflows into Article 9 funds continue to beat the wider market, according to Bloomberg, demonstrating investor preference for investment strategies which are geared towards sustainability as the central objective. Jefferies ESG researcher, Luke Sassams, has drawn attention to the fact that “capital flows to Article 9 products in Europe were positive every single month of 2022” which he viewed as staggering – particularly given fears amongst fund managers that the availability of Article 9 funds will continue to shrink regardless of the data.

The prevailing view has been that the EU’s Sustainable Finance Disclosure Regulation has been too challenging for investors to adapt to. While this is certainly true in part, not least down to unclear definitions around what constitutes a sustainable investment, that it acts as a deterrent to misleading labelling by providing a quasi-extra layer of due diligence is in fact a positive. It gives real reassurance to investors that Article 9 funds have been through significant vetting. The other side of the research is more black and white – the achievement of ESG progress via the free market continues to have great momentum and is an idea backed by the market as a whole. The next stage is an equilibrium where we see a growing pool of sustainable investing options that pass established hurdles. The Inflation Reduction Act and EU Green Deal will be among the catalysts here.

Looking ahead to a potentially exciting 2023 proxy season

Investor expectations on the role of companies in society have changed significantly in recent years, evidenced by the level of scrutiny of companies’ practices across ESG. This shift is reflected in investors’ engagement priorities and voting decisions over the last number of years. Now all eyes have turned to the upcoming (and potentially tumultuous) 2023 proxy season, with a recent Conference Board report forecasting an increase in shareholder activism in the US, as a result of the current macroeconomic environment, and the SEC’s universal proxy rule.  At the same time, despite ‘anti-ESG’ sentiment seeming to dominate some asset managers’ actions and statements, we continue to expect an increase in the number of votes against directors for perceived poor ESG practices at their companies in relation to climate, diversity, and remuneration. This is confirmed by Broadridge data on the 2022 AGM season in the US that shows a decline in investor support for directors, with 618 directors failing to obtain majority support (15% more than in 2021). As recent regulatory developments shift investors’ focus to environmental considerations, the recent activist campaigns in both the US and Europe show the importance of robust governance practices, based on meaningful and honest shareholder engagement with a view to enhancing enterprise and shareholder value.

Asian governments ramp up ESG reporting

Regulators and business leaders in Asia continue to emphasise ESG reporting in an effort to reduce carbon emissions. In China, regulators are reportedly planning to make ESG disclosures mandatory by the end of 2023 at a standard that will be recognised by the international community. The move could come in two phases starting with ‘comply or explain’ period, before transitioning to being fully compulsory. In Malaysia, Bursa Malaysia and the London Stock Exchange Group are introducing a sustainability reporting platform to support companies in reporting their ESG data in line with global standards. These moves follow similar steps in the Middle East including in the United Arab Emirates, where businesses could soon have to meet certain ESG benchmarks in pursuit of the nation’s 2050 net zero goal and in Saudi Arabia where the stock exchange is strongly promoting ESG reporting to support Vision 2030.

Incentivisation the emerging theme for EU’s framework for a sustainable food systems law

The Farm to Fork Strategy is at the centre of the EU Commission’s European Green Deal, which aims at making the EU’s food systems fairer, healthy, and more environmentally friendly. One of the flagship initiatives of this strategy is the framework for sustainable food systems (FSFS) law, with its objective being the integration of sustainability into all food-related policies the law is set to be adopted by the EU Commission by the end of 2023. With that deadline approaching, EURACTIV has revealed that mandatory requirements for sustainable public procurement and a voluntary harmonised sustainability labelling system have been ranked as the preferred policy initiatives according to a leaked impact assessment.

Upon review, a clear theme of incentivisation has emerged from the leaked impact assessment. On sustainable public procurement, there is a strong desire to enforce mandatory general and specific requirements, as it is believed that it will create greater market demand for sustainably produced food which – in turn – will incentivise food providers to go beyond the bare minimum sustainability requirements. On sustainability labelling, the belief is that it will incentivise food providers to have the strongest possible food disclosures on their packaging to ensure that they are placed high on the harmonised sustainability label, thus benefitting from a price premium for more sustainable products.

Addressing the gap between looming ESG reporting requirements and internal audit functions

Between the SEC’s proposed regulations and the EU’s Corporate Sustainability Reporting Directive (CSRD), enforcement is on the horizon for sustainability data in reporting, and non-compliance could have major consequences. FTI explores the implications of the impending regulations on internal audit processes and provides a roadmap to support corporates in developing audit processes and internal controls. This roadmap guides companies to effectively manage ESG risks, establish oversight, and make confident public disclosures. Ultimately, our research focuses on the importance of ensuring companies can be effective and timely in their reporting to limit liability due to increasing regulations and the risk of non-compliance.

ICYMI

• Canada looks to put transition planning at the heart of taxonomy. The proposed taxonomy, drafted by Canada’s Sustainable Finance Action Council (SFAC), is intended for use by investors, companies, and financial intermediaries “to assess the green and transition credentials of investment and business decisions”, and to identify “climate-compatible” investments. The taxonomy would require disclosure of transition plans with verification of emissions reduction targets and is set to be significant on an international scale, as its proponents believe that other nations could soon follow in Canada’s footsteps.
• New guidance to help businesses cooperate with the environment. New draft guidance published by the UK’s Competition and Markets Authority (CMA) explains how competition law applies to environmental sustainability agreements between firms operating at the same level of the supply chain. The new guidance will help companies take action on climate change without undue fear of breaching competition rules, enabling businesses to work together with confidence towards achieving their environmental goals.

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