Article 27 January, 2022

Top ESG themes in 2022

R&M's Head of ESG, Roger Lewis, provides an overview of the key ESG themes for 2022, why we expect these to be big, and what investors can do, as well as considering the ‘now what’ for net zero carbon.

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Whether ESG starts to be done properly this year or just continues to head in that direction remains to be seen. The past year saw commitments for investors to net their portfolios to zero carbon exceed half of worldwide assets under management ($57tr), the ‘forgotten middle child’ – Social - catching up to Environmental and Governance, and some very active stewardship.

Expect more of the same this year, with two new themes joining. The first is almost certain to gain a lot of attention and prominence: new sustainability disclosure standards and regulations will emerge. The second has been discussed for some years now but its importance in 2022 is uncertain: the risks, opportunities and disclosures for nature and biodiversity.

2021 continued

Just like going in to the office five days a week feels a long time ago, the first net zero carbon commitments were made at a similar time to this change, in 2019. It is therefore no longer enough just to have made the commitment. Expectations of clients, staff, journalists, analysts, industry associations and regulators are rightly shifting towards the need for evidence of the commitment and a clear set of objectives to achieve it.

Critical here for 2022 are pathways and the interim target of a 50% reduction in carbon emissions for a portfolio from Dec 2019 to Dec 2030. These are starting to be published by signatories to the Net Zero Asset Managers initiative. As stakeholders become more and more familiar with these, strong vs. poor examples should become clear to see. Compare two pathways:

  • Slick Asset Management Plc.
    • covers 100% of a firm’s AUM
    • has clear pointers for start, duration and end. For example, with 1.5m tonnes of carbon, it targets an annual reduction of 75,000 tonnes with the aim to achieve an output of 0.75m by the end of the decade
    • a sensible investment strategy covering top-down sectoral allocations, bottom-up stock picking impacts and structured engagement to manage the data and then reduce the emissions of investees.
  • Slack Asset Management Plc:
    • has minimal AUM in scope for the interim target
    • doesn’t have any emissions data to identify the baseline
    • hasn’t put a climate reporting and disclosures policy in place
    • and plans to rely on carbon offsets – also known as an ‘easy way out’.

While these are extreme examples, it is not difficult to imagine reactions, and ultimately fund flows and support, to both asset managers.

Related to this net zero activity within asset management is the green revolution in the wider world gaining pace this year.

In the UK, decarbonising the Grid by closing coal power generation facilities and increasing renewables (or importing gas) continues, as does the Committee on Climate Change monitoring progress and providing carbon budgets towards our (legally binding) net zero emissions target.

The impacts of the UK’s own Net Zero Strategy and related Greening Finance Roadmap, both released in Q4 2021, should start to be seen. Expect Sustainability Disclosure Requirements for corporates, the UK’s own Green Taxonomy, a verdict on sustainability standards disclosures (more below) and sectoral focuses on hydrogen, transport, heating buildings and, of course, power.

In the EU, SFDR should gain critical momentum as asset managers focus on launching or re-classifying funds as Article 8 or 9, in order to demonstrate transparency as well as their own ESG credentials.

Notwithstanding the debate over New Year on whether to class natural gas and nuclear as green, the Taxonomy labelling system will be implemented in order to help investors identify ‘activities that contribute substantially to climate change mitigation and adaptation objectives’.

Finally, for the EU, there could be the introduction of carbon border taxes to ensure the negative externality of emitting greenhouse gases into the atmosphere is paid for, regardless of where in the world it actually occurs.

The focus in the US is likely to continue to be on the decarbonising success story through energy efficiency programmes and using shale gas which, despite being a fossil fuel, contains around half the carbon of coal. This is in addition to Biden’s already well-documented ‘Build Back Better’ reforms and the $0.5tr spend planned for climate and clean energy.

A focus on individual companies’ emissions (known to investors as Scope 3) may be seen in the US too. This is especially likely when considering the climate-friendly directors that shareholders installed on the Board of ExxonMobil, or the order for Chevron to report the use of product emissions for the fuel it sells in petrol forecourts.

Across all regions, the Glasgow Climate Pact is, in theory, now in force, from development finance and a global carbon market to revised Nationally Determined Contributions (NDCs). These NDCs can be viewed as a country-level equivalent to a fund manager’s own net zero plan, as discussed above. COP27 in Egypt will be a good time to reflect upon progress and the success of the Pact.

The final carryover from 2021 is the evolution of ‘S’. We previously cited four clear instances where this is occurring, and all bar one are very much still underway.

Results from the Dept. for Work & Pensions consultation on social factors within occupational pension schemes are expected soon and could have material implications for pension assets integrating ‘S’.

There is focus on a company’s supply chains, both for emissions and also for labour or human rights, as the ten principles of the UN Global Compact track. Remaining with the UN, we have just entered the third year of the ‘decade of delivery’ for its 17 Sustainable Development Goals (SDGs). An increasing number of clients are asking us to rate their portfolios against these SDGs, to show the impacts of their assets.

The one exception is social disclosure platforms. Unlike CDP (formerly the Carbon Disclosure Project) for climate, these do not exist, nor are there plans for any that we are aware of.

Happy new ESG year

CDP has been a huge success. Over 20 years, it has become the only real source of standardised, robust and independently validated environmental data for an entity.

Wider ESG disclosures are a different story, with no generally accepted principles. Many corporates do now publish non-financial sustainability reports . But the quality and content varies widely, an issue compounded by the multiple guidelines, associations, standards and regulations that exist worldwide for ESG reporting – even in this short article, we are illustrating how complex the landscape for reporting can be.

Following the success of their accounting standards, IFRS (the International Financing Reporting Standards) have turned their attention to sustainability disclosure standards with the International Sustainability Standards Board. Working groups are now penning the Standards, drawing upon inputs like SASB (the Sustainability Accounting Standards Board) for ESG materiality and TCFD (the Task Force on Climate-Related Financial Disclosures) for climate. Expect further details before year-end. The UK’s own consultation on adopting and endorsing these Standards will be a major signal for how they’ll be integrated into investment, engagement and reporting activities by fund managers.

While one COP is now front-page news, there is another COP that will receive attention over Q2. This is the ‘Conference of the Parties to the Convention on Biological Diversity’, the 15th COP on biodiversity, taking place in China. Crucially, this will look at global frameworks and resources for natural climate change mitigation and food production.

Similarly, hoping to replicate the success and almost-mandatory de facto climate- related financial-disclosures of TCFD, the Taskforce on Nature-related Financial Disclosure (TNFD) framework should evolve over 2022. Testing and pilots of the data and templates are planned, with launch expected next year.

Just like nature is one ecosystem, a proper environmental strategy should consider climate, net zero, air, water, carbon, natural capital and waste as one framework, rather than individual, siloed solutions. This can be from a corporate, from an investor and from a provider of debt or equity to that corporate point of view. The two examples above should provide the inputs for nature to this framework, and we await their outcomes.

It just remains to be seen whether there is as much attention given here as there is to the other Conference of the Parties – to the Framework Convention on Climate Change…

Looking forward

All this points to an exciting 2022 in the world of ESG. River and Mercantile remains very active in all the above. Our own milestones include our plans to launch the first SFDR Article 8 and 9 funds, investing in renewable infrastructure, contributing to the Climate Action 100+ collaborative engagement with the heaviest polluters, publishing our own net zero carbon plan in July and further integrating the SDGs to our investment and engagement.

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