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Recent Buzz from the editor

(https://blogs.cfainstitute.org/investor/2022/11/30/esg-fixed-income-exposure-index-providers-respond-to-asset-manager-demand/)

What does the latest Index Industry Association (IIA) global membership survey reveal about current trends in indexes and benchmarks?

Chief among the key data points is that the rapid expansion of environmental, social, and governance (ESG) indexes continues to gain momentum and diversify across asset classes.

The 2022 survey found the number of ESG indexes grew by 55%, with fixed-income–focused ESG indexes and benchmarks taking the lead in driving that growth.

(https://www.unpri.org/download?ac=17824)

Highlights from the report:

  • The scene is set for major countries - in addition to China - to build clean energy capacity at scale. The EU and US are primed to race to the top of clean technology, much of which is now manufactured by China. To do this, the US is using industrial policy with protectionist elements.
  • The EU is likely to follow with its own subsidy playbook. An instigator of this moment is China’s dominance in multiple areas of renewable manufacturing and critical raw material (CRM) refining.
  • Current western policy responses to this situation reveal the tension between being unable to live without China if energy transition goals are to be met and being unable to completely live with China when it comes to survival of domestic industries.
  • A primary rationale for America’s new industrial policy is not commonly appreciated; the Biden Administration views it as a means to it protect democracy in America. The industrial strategy involves incentivising global companies to locate manufacturing of clean energy in the US, exploiting the huge job creation potential of the industry.
  • Seen from this standpoint, the US administration is unlikely to backslide on its industrial and trade agenda. The US expects and welcomes the prospect that the Inflation Reduction Act (IRA) will elicit a chain reaction of similar subsidies among its allies. This policy is likely to stick even in a post-Biden world.
  • The EU must now contend with unabashed subsidy regimes from two of its primary global trading partners in clean energy, China, and the US. Current EU tools are not fit for purpose; the bloc has some ammunition to use for business support, but comprehensive action is constrained by unique factors and much of the support is being directed to cushioning business and individuals from high energy prices.

(https://pages.marketintelligence.spglobal.com/Big-Picture-Reports-2022-EYP-ESG-Request.html?utm_source=google&utm_medium=cpc&utm_campaign=Expand_Your_Perspective_Rem_Display_Google&utm_term=&utm_content=640136019040&_bt=640136019040&_bk=&_bm=&_bn=d&_bg=143700655865&gclid=EAIaIQobChMI45KK47ri_AIVgadxCh2xYAHjEAEYASAAEgL_jfD_BwE)

The Big Picture 2023 - Sustainability 

A look ahead to the key strategic trends and opportunities expected to drive sustainability narrative through 2023 and beyond.

Following the unprecedented market and policy momentum behind environmental, social and governance in 2021, investors, corporate boards, and government leaders raised their expectations for companies to progress on climate pledges in 2022.

Alongside climate, biodiversity and other environmental concerns, social issues remained in the spotlight in 2022. Rising demands for action have led to increasing pressure for more accountability, greater regulatory scrutiny and credible disclosure backed by better data.

 

 

ESG-linked pay: value driver or peril?

  • "Properly structured ESG-linked pay can enhance company value; but concerns over 'ESG-washing' are evident 
  • We explain our assessment framework to help investors spot 'red flags' in pay disclosures and improve their analysis 
  • We also review policies of FTSE 350 travel & leisure firms and provide questions to assist investors in their engagement

This report is part of our regular publication, Governance in Focus, which provides guidance on the assessment of qualitative and forward-looking aspects of corporate governance practices. This note focuses on one of the 12 elements of our framework (see page 2). To receive future editions via email, click here to subscribe.

ESG pay metrics can drive company value and lead to better ESG performance... Research suggests that firms that use ESG pay metrics achieve enhanced shareholder returns, increased long-term operating profit and better social and environmental outcomes. It also shows that companies experience better innovation and growth opportunities when there is a higher extent of integration of non-financial performance measures in pay.

...but poorly structured and implemented ESG-linked pay may lead to 'ESG-washing'. Although companies are increasingly linking executive pay to ESG metrics, evidence suggests that they represented only 1.5% to 3% of total CEO 2020 compensation in large companies in the US. In addition, the actual economic significance of ESG-based pay sometimes may be as low as 1%, when long-term incentive plans (LTIPs) from prior years are considered. In addition, companies may set ESG targets that are easily achievable, giving limited insight into their actual ESG performance and impact. In our view, only ESG incentives with clear targets and higher weightings can ensure the successful delivery of corporate strategy and enhance company value.

In our view, there is an opportunity for investors to enhance their analysis of ESG-linked pay to spot 'red flags'. In this report, we explain our framework, which can be incorporated into investment analysis as a standalone tool or as part of ESG integration analysis (see Spotting good governance... and red flags, 28 April 2022).

We have reviewed disclosures of the five largest FTSE 350 travel & leisure firms - insights into ESG measures remain fragmented. All the companies we reviewed use ESG criteria in annual bonuses and explain what those metrics are. There is some insight on target setting and methodologies used. We think investors should ask companies for more clarity on how these measures have been identified, the rationale for inclusion and why they are best suited to promote right behaviours.

We present a list of 10 questions to assist investors in their engagement with companies."

HSBC: European Green Deal

CBAM: A clear signal to decarbonise. The rest is noise

  • "High-stakes EU Carbon Border Adjustment Mechanism (CBAM) set to go ahead, ruffling many feathers
  • Cutting through the noise, the material issue for CBAM covered sectors is the loss of free emissions allowances
  • Our view is this will drive clean investment and accelerate structural change on the path to net zero 2050

Europe looks set to formally adopt a Carbon Border Adjustment Mechanism (CBAM). The CBAM will ensure that certain goods (including iron & steel, aluminium, cement, fertiliser, electricity and hydrogen) face the same carbon price whether they are imported or produced in the European Union (EU).

CBAM in, free allocation out. The CBAM aims to reduce the risk of emissions leakage, replacing the previous leakage policy of free European Union Allowance (EUA) allocation. Free allowances will be phased out from 2026 as CBAM is phased in, with the phase out process complete by 2034.

Free allocation phase-out is the key material issue. CBAM covered sectors currently receive an emissions subsidy of around EUR20 billion a year that will be removed completely by 2034. This will strengthen the carbon price signal, accelerating investment in decarbonisation and driving significant clean structural change in CBAM covered sectors. Our case study on the cement industry shows that CRH and Holcim are comparatively well placed.

Other key issues to watch. These include: measures to prevent export leakage; responses from trading partners including formation of climate clubs; WTO complaints from developing countries; and reshuffling of global trade flows.

How to prepare? Investors should monitor company CBAM reporting preparation and encourage strong decarbonisation plans. We provide questions for investor engagement on these issues.”

 

 

 

(https://www.newtonim.com/uk-institutional/insights/articles/finding-opportunities-for-positive-change-and-sustainable-growth-in-emerging-markets/)

Newton IM: Finding Opportunities for Positive Change and Sustainable Growth in EMs

Lower and middle-income countries are home to four out of every five people on the planet, and account for over half of the world’s economic activity, as measured by PPP-adjusted GDP. Newton believe their global relevance will continue to grow, in large part owing to their needs, wants and resource intensity.

It is in emerging markets where the deployment of large-scale solutions most urgently needs to be funded, and yet these countries remain vastly underrepresented in terms of global capital flows today. Around 88% of ESG or sustainable investment funds today are global or developed-market focused, while emerging markets represent little more than 10% of global-equity indices…

 

(https://www.newtonim.com/uk-institutional/responsible-investment/responsible-investment-quarterly-report/)

Highlights

Engaged with 44 issuers for the purpose of raising ESG concerns or seeking further information

Voted at 156 Annual General Meetings + 134 Extraordinary General Meetings on behalf of clients

 

 

(https://foodfoundation.org.uk/publication/investor-briefing-what-do-investors-need-monitor-ensure-food-industry-net-zero)

The Food Foundation: Investor Briefing - What do investors need to monitor to ensure food industry net zero commitments are credible?

This investor briefing looks at current climate change commitments by major UK-operating food retailers, restaurant chains and caterers given a third of UK food businesses don't have a Net Zero target and only half are reporting detailed food emissions data.

It aims to help investors understand the credibility of these pledges and proposes a strategy to accelerate progress in the industry.

The world will not be able to bring global warming within 1.5 degrees unless food system related greenhouse gas emissions are reduced. Data on emissions for individual foods remains unreliable, with generic datasets on emissions not capturing the wide ranges in emissions between and within food products.

While protocols and better datasets are being developed, investors ought to look for, and monitor, existing indications of progress within companies. Where food companies have net zero commitments, investors need to look for three things:

1. Are they removing deforestation and land-use conversion from businesses and supply chains,

2. Are they cutting food waste across their supply chain and not just in their own operations, and

3. Are they shifting sales away from animal-based foods and towards plant-based foods.

(https://www.rabobank.com/knowledge/d011340306-the-takeoff-of-the-passenger-electric-vehicle-market-a-pathway-toward-the-eus-2030-e-mobility-targets)

The passenger electric vehicle car is taking off in the EU thanks to extensive decarbonization policies. Rabobank analyze the role of GDP per capita, available charging infrastructure, and governmental incentives in achieving the EU 2030 targets.

  • The combination of a demand-driven appetite for carbon-free mobility with policy targets to phase out the EU’s fossil fuel dependency is the ‘perfect storm’ to reshape the EU’s mobility from now to 2030
  • In this article, Rabobank analyze electric vehicles’ market uptake, as well as the parallel deployment of public charging infrastructure across the EU
  • E-mobility is developing very differently across EU countries. The Netherlands leads the way in terms of market penetration of battery electric vehicles, and in terms of charging point density
  • Regarding the factors driving these developments, there is a strong correlation between GDP per capita and electric vehicles’ market penetration. The influence of charging network density across the EU is debatable and more difficult to establish. Finally, the various support schemes for electric vehicles do not have a consistent impact across the EU. Below a certain GPD per capita, they do not seem to be able to trigger market uptake
  • As a result, it can be concluded that reducing total cost of ownership for electric vehicles is likely to result in stronger market leverage than increasing charging infrastructure density

(https://www.research.hsbc.com/C/1/1/320/JWnDDkB)

Don’t look back: 2022 wasn’t a great year for global climate progress, and the political distractions from climate ambition remain in play now. 2023 should start to reveal whether energy security concerns will morph back into energy transition plans, with the IPCC Synthesis report in March acting as a reminder of the urgency. More frequent extreme climate events should also drive the message home, while the UN Secretary General will host another climate ambition summit in September 2023.

It’s trillions: In 2023, attention will turn to climate finance requirements – trillions, not billions – and probe why these flows aren’t happening faster. Calls to reform multi[1]lateral finance institutions will rise, given their key role in ‘de-risking’ investments; and focus will remain on concessional finance, given the poor fiscal outlook for many EMs.

The net-zero offset: Companies will face further scrutiny of net-zero plans, with a focus on the quality of offsets used. In our view, this could shift the focus back towards greater self (organic) decarbonisation. The tightening climate disclosures in, notably North America, the EU and Asia, will likely facilitate this closer examination.

Fit (or fall): The EU needs to finalise its Fit for 55 proposals this year to ensure these are enacted into law without further delay to meet 2030 targets. Its Carbon Border Adjustment Mechanism will ruffle a many feathers, in HSBC’s view. Elsewhere, HSBC expect India to continue moving steadily forward with its transition plans, and ASEAN to step up its efforts, despite its reliance on coal and oil.

The inaugural climate mark sheet: COP28 will take place in the UAE this year (30 November-12 December) and deliver the first global stocktake, which will likely show just how far we are from implementing the Paris Agreement and keeping 1.5°C alive

(https://www.unpri.org/inevitable-policy-response/ipr-forecast-policy-scenario--nature/10966.article)

PRI: IPR Forecast Policy Scenario + Nature

The IPR FPS + Nature is the first integrated nature and climate scenario for use by investors. It fills a crucial gap in risk assessments and provides financial institutions with an exploratory forward-looking view on how policy, technological and social trends could impact key land use and energy-related value drivers. It represents a ‘beta version’ scenario of what might happen when nature-related policy is incorporated into a climate-related scenario.

  • The decline of nature is beginning to lead to policy action, which could impact investors and financial institutions
  • Government action on nature is increasing and a range of policies and regulations are being introduced to accompany action on climate. Over 190 countries agreed to adopt a global biodiversity framework at the COP 15 summit in Montreal in December 2022. Policy action to achieve these commitments may create new risks but lead to new opportunities for companies and investors.

Companies and investors are being asked to understand their impacts on nature and disclose these. Emerging frameworks, such as the Taskforce on Nature-related Financial Disclosures (TNFD), will encourage investors to take a forward-looking view on nature-related risks and report on how they are exposed to nature and biodiversity