The New Global Baseline?

With updates announced for several major ESG frameworks and standards, in an effort to streamline and simplify the corporate disclosure process, 2022 marked a year of development across the corporate sustainability reporting landscape.

This article provides an overview of key developments in ESG frameworks and standards over the past year and discusses some of the trends that will shape the terrain in the years to come.

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Closing the climate data gap

In 2022, the European Central Bank (ECB) pioneered a climate risk stress test carried out among the
most significant financial institutions in Europe as part of its annual stress testing exercise. Building on the test’s findings, the ECB launched last month a set of climate-related statistical indicators. The announcement forms part of the ECB’s mandate to incorporate climate change considerations into its monetary policy framework, which includes transitioning nearly €350 billion in corporate bond portfolios towards issuers with improved climate performance, according to ECB’s Climate Action Plan.

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The Global Regulation Race

2022 was a make-or-break year for ESG – what was once a buzzword is now a siren signalling the end of business as usual. Regulators began the year with lofty aspirations that were put to the test amid turbulent geopolitical events.

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As we start 2023 and look ahead to the COP28 summit in the United Arab Emirates later this year, here are some of the key takeaways from COP27.

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Over the last three decades, the United Nations has brought nearly every country on the planet together for global climate summits known as the Conference of Parties (COP). The COP is the highest decision- making body for climate action, where country representatives discuss, deliberate, and negotiate climate- related mechanisms, instruments, and actions. The United Nations Climate Change Conference of 2021, also known as COP26, was the 26th such conference held in Glasgow, Scotland, United Kingdom, between 30 October to 12 November 2021.

The UN Environment Programme’s (UNEP) Emissions Gap Report 2021: The Heat is On, released prior to COP26, noted an increase in the number of countries pledging net-zero commitments around 2050. Despite the spike, experts believed that the commitments lacked a clear pathway.

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Mind the carbon gap

“There are as many frameworks as there are disclosures” is a common phrase at ESG Book. It’s not without reason; the number of climate-related regulations and frameworks that companies and investors are expected to adhere to seems to grow by the day. Greenhouse gas (GHG) emissions data is essential for financial market participants to understand corporate alignment to various climate pathways, stress-test climate scenarios to identify transition risks and opportunities, and to engage with and hold companies accountable on their progress to meet their net zero targets.

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Always check the label

Using ESG Book’s recently launched Fund ratings which are applied to over 4,000 ETFs and more than 32,000 mutual funds, we explore how marketing claims and the labelling of funds can be inconsistent with the actual data behind a fund’s investments. For this analysis, two groups of funds were selected. The first group contains any fund with ‘ESG’ in its name, and the second any fund with ‘climate’ within its name. These two groups contained 420 and 95 funds respectively, all of which have at least 68% market value coverage from ESG Book data.

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Uncharted waters

Water is a crucial part of Earth’s climate system and, as a result, is intrinsically linked to climate change. While water is a victim of climate change, the way we manage and use water can contribute to it. Climate change affects the availability, quality and quantity of water required to meet basic human needs and threatens our human right to access clean water and sanitation. Water-related risks are becoming more immediate and significant, potentially adversely affecting all water users across the globe¹. On the other hand, energy use and greenhouse gas emissions in water supply, treatment and desalination can be significant contributors to global warming.

Water is input to almost all production activities. While specific sectors have unique KPIs, dependency on water is universal. In this landscape, water-resilient investments will be vital, and water data will be necessary for decision-making. Water is an important area for impact investors because water delivers a positive, clear, measurable impact – the trade-off between the benefits and sustainability of water is unambiguous². Water extraction, consumption and discharge are all closely interlinked, and good practice will have a positive chain effect.

Despite its importance, water reporting lags behind carbon reporting with information deficit and disclosure insufficiency. Many companies are still new and ineffective in water management and reporting³. The proprietary ESG Book dataset shows that even the most frequently disclosed metric for water (Quantitative Water Data Disclosure) has a coverage of only 54.91% in 2020, lower than the 65.11% coverage for Scope 3 GHG emissions (Figure 1). Moreover, the carbon reporting paradigm may not apply to water reporting due to water’s multifaceted, unidirectional, and localised nature. Unlike carbon, which can transport and accumulate worldwide, water issues are confined to certain times and geographical areas.

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What’s your fund’s ESG strategy?

The U.S. Securities and Exchange Commission (SEC) has proposed changes to the ‘Investment Company Act,’ an umbrella fund labeling regulation that requires 80% of holdings to be invested in accordance with the fund’s suggested investment focus. Funds that deem themselves ‘ESG,’ ‘sustainable’ or ‘green’ would be required, under the ‘modernized’ regulation, to identify securities included in the 80% basket. The proposed rule seeks to enhance data comparability and help investors differentiate between investment strategies. Given the investment industry’s demand for quantitative data, the S.E.C. has also introduced a standardized methodology for reporting emissions metrics. The fund labeling rule will be opened for comment and subject to further amendments. If finalized, it would be enforced at the start of the upcoming fiscal year FY 2023. In its proposal, the S.E.C. notes the rapid expansion of the sustainable investment universe – a 25 times increase from $639 billion to $17.1 trillion. The regulator is presently undertaking multiple measures to protect investors from misleading or exaggerated ESG claims, including the recent climate disclosure rule. The S.E.C. is, however, facing backlash for extending its powers. Several republican treasurers are punishing big banks including Wells Fargo, JP Morgan, and Goldman Sachs for fossil fuel divestment and preventing them from obtaining government contracts. The governing landscape is undergoing a paradigm shift in the U.S. and progressive rulemaking is being blocked beyond the treasury in republican-led state legislatures.

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One Draft at a Time

In an increasingly complex reporting landscape, firms are faced with an overabundance of frameworks and standards against which they can report their sustainability credentials. As stakeholders progressively highlight the need for consistent and comparable data1, standard-setting bodies are taking note. Public consultations for the International Sustainability Standards Board (ISSB) General Sustainability and Climate exposure drafts (IFRS S1 and S2), and the European Financial Advisory Group (EFRAG) Draft European Sustainability Reporting Standards (ESRS) were both live in Q2, 2022. The introduction of two draft standards with a potentially wide reach signals a trend towards the standardization of ESG reporting across jurisdictions.

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