Latest developments in ESG

I attended a panel discussion recently on ESG and wanted to share some of the comments from the presenters as well as the audience. 

Why invest in ESG 

The speaker from McKinsey referenced their recent report that looked at five ways that ESG created value. These were: 

• Building brand loyalty with customers and may offer opportunity for premium pricing 
• Providing a better outcome with regulators and governments (via subsidies and greater strategic freedom)  
• Improving people retention with research suggesting a 2% gain to the share price over time 
• Reducing costs through lower consumption and the “greening” of supply chains 
• Improving investment returns and the allocation of capital into areas that will not be affected by ESG considerations

Recent developments 

1. The FRC has issued a new Stewardship code effective January 2020, setting high expectations of those investing money on behalf of UK savers and pensioners. The code consists of 12 Principles for asset managers and asset owners, and six Principles for service providers. These are supported by reporting expectations which indicate the information that should be publicly reported in order to become a signatory.    

Organisations will remain signatories to the UK Stewardship Code until the first list of signatories to the 2020 Code is published. Existing signatories to the Code will need to submit a Stewardship Report that meets the FRC’s reporting expectations in the 2020 Code, in order to be listed as signatories to the UK Stewardship Code. At this point, the list of 2012 signatories will be archived. 

2. The Institute of Directors has proposed 10 policy initiatives to encourage a longer-term, sustainable approach to business behaviour, create better directors and increase the accountability of the corporate governance system as a whole. These are: 

• Support the development of an industry-led Code of Conduct for Directors. 
• Deliver proposed reforms to the regulation of auditors. 
• Establish an independent Corporate Governance Commission. 
• Transform the operation and functioning of Companies House. 
• Mandate minimum requirements for director training. 
• Encourage the adoption of a Code of Practice for board evaluation. 
• Create a framework through which companies can project their Business Purpose. 
• Encourage a consistent approach to Climate-Related Corporate Disclosures. 
• Explore opportunities to establish an ESG-oriented Sovereign Wealth Fund. 
• Establish a newly-defined corporate form – the Public Service Corporation. 

3. The Association of Nominated Trustees, as part of a formal complaint to the FCA, released the first detailed review into the voting policies and practices of fund managers across the UK, mainland Europe and the US. The report, ‘AMNT review into fund managers' voting policies and practices’ found that only a few fund managers had what the AMNT considered best practice public voting policies and guidelines on climate change, gender and ethnic diversity.  

The research was prompted by the continued unwillingness of fund managers to accept client-directed voting in pooled fund arrangements - most notably the AMNT’s Red Line Voting policies which were launched at the end of 2015. The report’s analysis was centred around concerns representing the three ESG pillars of the AMNT’s Red Line Voting policies; namely climate change, gender and ethnic diversity, and excessive pay.  

4. EIB launched an ambitious new climate strategy and Energy Lending Policy under which the bank will: 

• End financing for fossil fuel energy projects from the end of 2021 
• Will accelerate clean energy innovation, energy efficiency and renewables 
• Unlock EUR 1 trillion of climate action and environmental sustainable investment in the decade to 2030 
• Align all financing activities with the goals of the Paris Agreement from the end of 2020.  

5. The Swedish central bank deputy governor announced in a speech recently that the bank had sold bonds issued by the provincial governments of Alberta (Canada), Queensland and Western Australia.  It claimed that greenhouse gas intensity was more than three times higher in production in Alberta than in Ontario and Quebec.  

6. The FCA issued a feedback statement on climate change and green finance in response to feedback from stakeholders. The statement applies to all regulated firms, issuers, investors and their advisors. Its focus is on greenwashing, disclosure and integration of climate change risks and opportunities into business, risk and investment decisions.   

Key actions and next steps include: 

• Consulting on new rules to improve climate-related disclosures by certain issuers and clarifying existing obligations  
• Finalising rule changes requiring Independent Governance Committees (IGCs) to oversee and report on firms’ environmental, social and governance (ESG) and stewardship policies, as well as separate rule changes to facilitate investment in patient capital opportunities  
• Publishing a feedback statement in response to a joint Discussion paper with the Financial Reporting Council (FRC) on Stewardship setting out actions to address the most significant barriers to effective stewardship 
• Challenging firms where we see potential greenwashing, clarifying our expectations and taking appropriate action to prevent consumers being misled 
• Contributing to several important collaborative initiatives, including the Climate Financial Risk Forum (CFRF), the Fair and Effective Markets Review (FEMR) working group, the Government-led cross-regulator taskforce on disclosures and the European Commission’s Sustainable Finance Action Plan (SFAP) 

7. MIT has a project on ESG called the Aggregate Confusion Report. Currently agencies assign ESG ratings to firms but these ratings diverge substantially between different rating agencies. The report found that taking two of the top five ESG rating agencies and computing the rank correlation across firms in a particular year, they were likely to obtain a correlation of the order of 10% – 15% and there were many instances where the firm that is in the top 5% for one rating agency belonged to the bottom 20% for the other. This discrepancy makes the evaluation of social and environmental impact impossible. 

8. An independent report commissioned by the Labour Party found that the current financial and regulatory regime would not deliver the change needed anywhere near far enough or fast enough. This applies to both the regulated and the so-called shadow banking sector. More radical steps would be needed to: 

• Establish a much more rigorous classification (taxonomy) of what is regarded as ‘green’ and what is regarded as ‘brown’. 
• Ensure that the valuation of brown assets properly take account of the risks involved for those assets as moves to decarbonise the economy accelerate. 
• Introduce regulatory and other changes that will more rapidly move investment and lending away from brown and towards green assets and activities. 
• Ensure that private finance is more readily available for those businesses who want to advance the green agenda through innovation. 

9. The World Bank launched a Sovereign ESG data portal which is free. The online platform provides users with sovereign-level environmental, social and governance (ESG) data. It is designed to help investors better align ESG analysis with key sustainable development policy indicators and analysis, as well as to increase data transparency and support private sector investments in emerging markets and developing countries.