The Future of ESG

The future of Environmental, Social & Governance (ESG) looks bright as companies continue to increase their focus on ESG initiatives.  In particular, there are several key areas that companies need to focus on.

One of these is accelerated focus to align global capital markets with sustainability goals.  No longer a question of ‘if,’ ESG regulation is now ‘when’ and ‘to what extent.’  Sustainable Finance standards will continue to progress rapidly.  This will be led by the European Union (EU), which continues to be a leader in Sustainability Finance.  Most notably, this will include a continued focus on the Corporate Sustainability Reporting Directive (CSRD).  The CSRD dictates the reporting requirements for large and listed EU companies. It is expected to go beyond the International Sustainability Standards Board (ISSB) standards.

The UK is also continuing to implement its reporting requirement.  More specifically, the UK is adopting the Task Force on Climate-related Financial Disclosures (TCFD) and implementing broader sustainability reporting.  The UK is expected to lower its reporting thresholds in the coming years to capture more companies.

A similar approach to the UK/EU is being adopted in Asia, with several countries beginning to implement reporting requirements, including Japan, Singapore, India, Malaysia, Thailand, and Indonesia.

Finally, the Securities and Exchange Commission (SEC) is looking at establishing some climate reporting regulations in the US. Indeed, the trend in the US is that companies looking to raise capital need a dedicated ESG approach.

As well as climate change, the effects on biodiversity and other elements of natural capital (e.g., air, soil, and water) are also in crisis.  The risk facing biodiversity and the rapidly deteriorating state of additional natural capital creates an economic threat.  This is because companies face issues with the quality and availability of critical raw materials.  With over one-half of the world’s economy being dependent on natural capital, the risks to asset managers’ portfolios are significant.

The Task-force on Nature-related Financial Disclosures (TNFD) was launched in response to this risk. Initially with thirty-five financial services, professional and corporate services entities.  Similarly, the Taskforce on Climate-related Financial Disclosures (TCFD) focuses on climate change; the TNFD focuses on nature-related risks.  In January 2022, the TNFD announced it was partnering with some international organisations, in particular, the Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), and the World Business Council for Sustainable Development (WBCSD). 

Other countries are expected to align with the TNFD, particularly Australia with the Responsible Investment Association Australasia (RIAA).  This is developing several frameworks to support Australian and New Zealand investors with nature-positive investments.

In the future, there will be a greater focus on reporting emissions caused by a company’s supply chain (and not necessarily caused directly by the company itself).  Examples include commuting to work or purchasing goods and services.  Companies that fail to report this themselves may find others (rating agencies or investors) estimating it on their behalf.  Companies have already started to receive some backlash for failing to report this in their net-zero targets.  ExxonMobil and Saudi Aramco are estimated to have up to 90% emissions in their value chains.  Regulators in the EU and the UK are beginning to note that supply chain emission reporting is required for certain companies.

In a term known as ‘financed emissions,’ the financial sector also plays a role as it provides financing that makes companies’ operations possible.  Suppose the emissions resulting from the finance are excluded from the reporting. In that case, this can be seen as a misrepresentation of the financial sector’s role in generating emissions.

An example of financed emissions would be greenhouse gases associated with investments and lending activities.  Under the rules regarding carbon accounting models, investments and lending activities are considered part of a financial institution’s carbon footprint.  The scope will widen as the focus continues to grow on financed emissions.  Firms such as insurance underwriting could be included.  Finally, there is currently no universally accepted scope for these activities.  Expect to see some framework put in place.

In Australia, a lot of change has occurred in recent years, focusing on ESG.  Activities such as banks being challenged regarding their suitability of funding to companies in the fossil fuel sector being accused of greenwashing.  Following the government’s Net Zero 2050 target, environmentally conscious super fund members demand more transparency on ESG and investing. As a result, several super funds are taking the initiative to lower their portfolio exposures to greenhouse gas emissions. Furthermore, with litigation cases increasing, firms have to look a lot more closely at their ESG commitments, strategy, disclosure policies, and reporting accuracy.


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