Our sustainability specialists dissect this month’s trending ESG trades and themes in the April edition of the Corporate ESG newsletter.
Institutional Developments: Regulators / Standard setters
The SEC unveils proposed climate disclosure rules. The US Securities and Exchange Commission (SEC) announced the release of its proposals for climate disclosures for U.S. public companies. The proposals will require US companies to provide information on climate risks facing their businesses, plans to address those risks, along with metrics detailing their carbon footprint. In addition to this, companies will need to disclose information on the impact to financial statement line items of climate-related events, such as severe weather events, and of risks related to the transition to a low carbon economy, such as regulatory, market or competitive changes. For companies that have adopted a transition plan, the rules would require a description of the plan, including the metrics and targets used to identify and manage physical and transition risks. For companies that use scenario analysis to assess resilience to climate-related risks, required disclosures would include: information on the scenarios used including the parameters, assumptions, analytical choices and projected financial impacts from the scenarios.
TNFD unveils nature-related disclosures framework. The Taskforce on Nature-related Financial Disclosures (TNFD) announced the release of the first draft of its disclosure framework aimed at enabling and guiding organisations to report on nature-related risks. The framework will encompass foundational guidance relating to science-based concepts, disclosure recommendations and guidance on conducting nature-related risk analysis. The framework has been designed by over 30 senior executives chosen across a broad range of sectors and the final release is expected in September 2023 following subsequent iterations of this draft. Elizabeth Mrema, Co-Chair of the TFND, highlighted the uniqueness of the collaboration between market participants and the world’s leading authorities in natural sciences and standard setting.
The EU’s Platform on Sustainable Finance released a report regarding Social Taxonomy considerations. In their final report on Social Taxonomy, the Platform for Sustainable Finance (the Platform), a permanent expert group of the European Commission, states that there is a need to invest in social sustainability to help achieve the UN’s Sustainable Development Goals (SDGs). The financing gap to achieve the SDGs in developing countries is estimated to be $2.5-3 trillion a year. While most economic activities may have detrimental impacts directly on the environment, the Platform believes most economic activities such as the creation of new jobs, paying taxes and the production of socially beneficial goods and services can be considered socially beneficial. The Platform suggests that a social taxonomy needs to be created to distinguish between the two taxonomies. The suggested structure of the social taxonomy would consist of these structural aspects taken from the environmental taxonomy: (i) the development of social objectives; (ii) types of substantial contributions; (iii) ‘do no significant harm’ (DNSH) criteria; and (iv) minimum safeguards.
The UK government proposes new legally binding targets on nature, air and water. The UK government has proposed an Environmental Bill with new targets to boost biodiversity, protect habitats, reduce water consumption, pollution and waste. The Bill was designed to help the UK strengthen environmental protection ambitions following Brexit. The Department for Food, Environment and Rural Affairs (Defra) confirmed that the Bill would be used to introduce legally binding targets. The Department has also announced a target to halt biodiversity decline by 2030. This is in line with the international biodiversity targets currently being drawn up by the UN, which are due to be formally adopted in the coming weeks. Defra builds on that pledge for nature with confirmation of the UK’s commitment to conserving 30% of land and water for nature by 2030. There is also a new 2030 target to increase species abundance on land by 10%. Read more.
The International Financial Reporting Standards (IFRS) Foundation and Global Reporting Initiative (GRI) announced an agreement to align capital markets and multi-stakeholder standards for sustainability disclosure. This move seeks to resolve complaints from the market on the regulatory burden imposed upon companies from reporting to multiple standards and/or frameworks. This collaboration represents a move towards a two-pillar approach to international sustainability reporting, incorporating (i) the investor-focused capital markets standards of IFRS Sustainability Disclosure Standards developed by the International Sustainability Standards Board (ISSB) and (ii) GRI sustainability reporting requirements set by the Global Sustainability Standards Board (GSSB), which are compatible with pillar (i) and are designed to meet multi-stakeholder needs. This follows the trend of increased consolidation and a move towards global alignment in the sustainability reporting landscape post-COP26.
Sustainability and CSR data software provider ESG Playbook and sustainability solutions developer Native Energy recently announced a new partnership. ESG Playbook will provide sustainability reporting solutions to a wide range of organisations globally, with a particular focus on the financial sector. The platform supports frameworks and standards including Taskforce on Climate-related Financial Disclosures (TCFD), GRI, Greenhouse Gas (GHG) Protocol and UN Sustainability Goals. Native Energy works with organisations to find sustainable solutions to urgent challenges, including helping to build high impact carbon projects and developing renewable energy projects.
Moody’s ESG Solutions is looking for input from market participants on a number of proposed alterations to its ESG assessment methodology. Moody’s assessment process currently uses a double materiality approach, which looks at the impact of ESG on enterprise value as well as the social and environmental effects of the business. Proposed changes to the Methodology include: (i) inclusion of new assessment subcategories, such as physical climate risks, cyber and technology risks and responsible tax; (ii) increasing the number of industry frameworks from 40-51 to conduct more precise analysis; (iii) refinements to the double materiality approach; (iv) enhancements to the data structure and scoring methodology; and (v) addition of an overall ESG grade.
With an increased inflow of capital into ESG-labelled funds, the number of companies vying to provide advice to investors on environmental, social and governance issues – particularly in the form of rating and ranking how companies fare on such factors – has increased significantly. In October last year, EY identified 100 ESG Consultancy providers, twice the number present in 2020. The growth in number, and diversity, of these providers creates challenges for investors when evaluating the ESG performance of companies, where there are differences in criteria and ratings due to the lack of standardisation or transparency of rating methodologies. There are, however, a number of regulatory bodies that are placing an increased focus on ESG ratings – for example, ESMA, the EU’s securities market regulator has published a call for evidence on ratings with a view of making suggestions on regulation which makes them more transparent.
ESG regains momentum on the improved market tone: With market conditions improving towards the end of the month, the “greenium” has re-emerged in Euro executions. For example, the E.ON Green dual tranche was priced with a reduced spread level of about 3 bps. Furthermore, strong ESG ratings are gaining increasing importance in the execution of conventional bonds. This was illustrated by the Akzo Nobel dual tranche which benefitted from the participation of some ESG-focused accounts on the transaction. Lastly, the syndicate desk noted that companies with solid ESG rating profiles are not immune to negative ESG headlines. This is true in particular, but not only, for the execution of conventional bonds regardless of the NIP on offer.
E.ON Green Bond. E.ON is one of Europe’s largest distribution grid operators and a backbone of the European energy transition. Its Green Bond Framework (first used for an issuance in 2019 and updated in December 2021) positioned E.ON as amongst the first of German corporates to align activities to the EU Taxonomy.
Akzo Nobel, Conventional “ESG Marketed”. Akzo Nobel leveraged its very strong focus on sustainability, which has been validated by top ESG ratings such as MSCI and Sustainalytics. And, became the first paints and coatings company to have its GHG emissions targets validated by the Science Based Target initiative.
Pernod Ricard S.A., Sustainability-Linked Bond (SLB). The first SLB in the wines and spirits sector, which suggests openness from companies that are sometimes subject to investor exclusionary policies to consider ESG financing solutions – see recent issuances in the oil & gas, tobacco, mining. For the SLB the company selected two KPIs (1) GHG emissions Scope 1 and 2 and (2) water consumption while the framework also includes a longer-dated Scope 3 target, an area of increasing focus for the market.
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The European Securities and Market Authority (ESMA) has announced the release of its final report on reviewing and addressing the functioning of the EU carbon market. The report provides an in-depth analysis of the trading of emission allowances and emission allowance derivatives and includes recommendations from the regulator to improve market transparency and monitoring. ESMA also conducted analysis of the trading of emission allowances and observed various market characteristics, including a significant level of high-frequency and algorithmic trading. While the report did not find any major deficiencies in the EU carbon market, the regulator included several recommendations aimed at improving transparency and oversight; this included adapting position reporting, and providing ESMA with access to primary market transactions, among others.
Carbonplace, the new Voluntary Carbon Credit (VCC) settlement platform, and global carbon marketplace Climate Impact X (CIX), have teamed up on a pilot to lower the barriers for organisations seeking VCCs on the voluntary carbon market. The collaboration helps achieve a key milestone in the development of Carbonplace by bringing the strengths of both platforms together: Carbonplace’s unique settlement technology and wallet service to store and trade credits, will combine with CIX’s curated marketplace of VCCs, to give customers scaled access to the voluntary carbon market.
To date the market’s preferred mechanism for punitive fees when a company misses sustainability targets is a coupon step-up, most often set at 25 basis points. However, because the flat rate of 25bps doesn’t consider the scale of a business, the materiality of this as an incentive is inconsistent across companies, and thus undermines credibility of the market. To facilitate the growth and protect the health of the SLB market Federated Hermes suggests replacing the fixed 25bps step-up with a feature that flexes with the scale of the issuing company.
Amundi Asset Management said it is “false” to assert that there is an ESG asset ‘bubble’, despite sustainable assets facing a ‘crowding risk’ which could drive overvaluation. It is unlikely that ESG investors will revert to being business-as-usual investors in the future because this is more of a structural change in the financial market or a paradigm shift in the investment framework than a short-term trend. Nonetheless, this does not exclude the possibility of a rotation between ESG themes – for example, the preference towards social assets after the Covid-19 pandemic hit.
New research by the Impact Investing Institute has revealed the estimated size of the market in 2020 was £58 billion, representing an estimated 3.3-3.8% of the global market. Additionally, healthcare, affordable and clean energy, and sustainable cities and communities were found to be the top focus areas for investment. Other key findings from the research included the identification of social investors, private equity, and venture capital firms and foundations as the leading impact investors in the market today, and institutional investors as the “primary drivers of future growth”.
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