While many companies voluntarily disclose environmental, social, and governance (ESG) data, there is a lack of reporting regulations to define the metrics employed. This can make it difficult to evaluate them – and the targets that companies are meant to be hitting – against peers. Increasing the availability of comparable and meaningful ESG information, or ‘democratising ESG data’, – is essential to assess whether companies’ sustainability strategies and initiatives are effective. It will also help investors make better-informed decisions about which companies to support.
The year ahead will see increased availability of freely accessible resources that will help us evaluate companies’ sustainability performance. A good example is the Transition Pathway Initiative (TPI), which provides assessments of companies’ transitions to net-zero. The TPI’s new Global Climate Transition Centre, set to open in 2022, will expand the number of companies assessed from 400 to 10,000, a 25-fold increase.
Regulation also has a role to play as it can ensure the process of reporting ESG data is simplified, streamlined, and standardised. For example, the EU introduced the Non-Financial Reporting Directive in 2014, requiring around 6,000 large companies to publish standardised reports on the ESG policies they implement. In April 2021, the initiative was expanded to nearly 50,000 companies via the Corporate Sustainability Reporting Directive, with the first set of standards to be adopted by October 2022.
2. Holistic Decarbonization to become the priority
The past twelve months has seen a growing number of companies set carbon reduction targets and make commitments alongside improvements in sustainability governance, transparency, and reporting mechanisms. Building on this foundation, 2022 is likely to see entire value chains play a more pivotal role within transition strategies.
We’ll see further pressure on companies to reduce greenhouse gas emissions in line with the science-based targets and report on their progress. Wherever firms are unable to target all of their Scope 3 emissions (indirect greenhouse gas emissions within a company’s value chain), they’ll increasingly be expected to implement targets for their most material activities.
As companies seek to address Scope 3 emissions, the ability to engage with supply chains in emerging markets to reduce emissions is likely to present challenges. We expect companies to rely on partnerships across sectors to deliver on broader decarbonisation targets.
3. Green and social taxonomies will move to the fore
From 2022, the EU Taxonomy Regulation will oblige companies to report on their alignment with climate change mitigation and adaptation objectives. Alignment criteria for the remaining four categories (sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems) will be outlined in 2022 and enforced from January 2023.
In addition to the 'Green' Taxonomy, the EU has signalled its potential expansion to include social factors. Further details about the development of a Social Taxonomy are expected in 2022 and as a result, stakeholder pressure to account for social aspects will increase.
Taxonomies of sustainable activities aren’t exclusive to the EU. As part of its 'Build Back Better' report in July, the UK government announced its intention to produce its own green taxonomy.
The development and application of sustainable taxonomies in 2022 will increase firms’ reporting obligations and result in ESG criteria being further embedded in financing activities. Taxonomies will also provide an additional benchmark for investors and other stakeholders to assess corporate performance against, and lead to higher quality and more consistent reporting.
4. Scrutiny of greenwashing will intensify
ESG markets have come under intensifying scrutiny in recent times, not least because of a series of high-profile whistle-blowers providing details about questionable practices in organisations that claim to adopt a sustainable approach.
With awareness of greenwashing on the rise, we expect investors to analyse corporate disclosures in greater depth and breadth in 2022. We also expect healthy scepticism from various stakeholders – not just investors – about companies’ ESG claims and targets.
“Additionality” – the positive net-benefit associated with an activity or project – is therefore expected to remain high on investors’ wish-lists, with corporates able to use labelled financing to bring the biggest impact, whether targeting benefits to society or the environment. This is likely to sharpen the focus on companies, activities, projects, and expenditures, to ensure they can evidence the real-world impact of their claims
5. Private ESG funding markets to take off
Sustainable finance first emerged within public funding market – the first labelled ESG instruments were bonds issued by multinational organisations. The concept is now gaining traction in private markets, with around €2 billion of ESG-labelled private debt transactions in 2021 according to Bloomberg.
A key driver of this trend is that improved ESG disclosures and data are enabling investors to evaluate the sustainability characteristics of private assets. Companies seeking to issue a sustainable private placement (PP) can now use a sustainability-linked structure, and US-domiciled investors – which are among the largest investors in PPs – are under increasing pressure to incorporate sustainability into their mandates.
Sustainability looks set to drive execution dynamics in the private markets in 2022, and issuers with strong ESG narratives or those introducing ESG structures are likely to prove attractive to a broader investor base and, in certain cases, secure a greenium (more attractive pricing).
6. Carbon markets transparency will improve
About one fifth of the world’s largest companies have set out a net-zero or carbon-neutral pledge. With a wave of commitments in 2020 and 2021, attention has now turned to how firms are using voluntary carbon markets and buying carbon credits and offset emissions to achieve these goals. Companies will need to be more transparent in the use case of carbon credits, either to offset residual emissions, compensate for emissions in the value chain (Scope 3), or pursue “negative emissions. Nascent but fast-developing industry platforms like Project Carbon are helping to accelerate this trend.
With an agreement for implementing Article 6 cast at COP26, we expect the transparency of carbon offset projects to improve in the near to medium term, as companies will want to understand what the return on each credit looks like (particularly as they seek to avoid accusations of greenwashing. This will help carbon to be accurately priced on a company’s or lender’s balance sheet, and in turn, help develop the liquidity of carbon as an asset class.
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