Responsible investment quarterly update | Insight Investment

G7 countries commit to major sustainability goals

The Group of Seven (G7) gathered in the UK in June, and announced several major commitments, reflecting a broad focus on sustainability factors.¹ They included commitments to provide one billion doses of the COVID-19 vaccine globally; to seek to limit the impact of climate change to 1.5 degrees Celsius; to halve emissions over 2010-2030 and to reach net zero carbon emissions by 2050; to halt and reverse biodiversity loss by 2030; and to tackle the growing problem of debris in space.

Notably, the leaders declared support for mandatory climate-related financial disclosures based on the Taskforce on Climate-related Financial Disclosures (TCFD) framework, and added that they “look forward” to the establishment of the Taskforce on Nature-related Financial Disclosures and its recommendations².

In a communique before the summit, G7 climate and environment ministers committed to “an absolute end to new direct government support for unabated international thermal coal power generation by the end of 2021”.³

Net Zero Asset Managers initiative grows to 87 investors managing $37 trillion

The Net Zero Asset Managers initiative is a group of international asset managers committed to supporting the goal of net zero greenhouse gas emissions by 2050 or sooner, in line with global efforts to limit warming to 1.5°C. The group is also committed to supporting investing aligned with net zero emissions by 2050 or sooner.

Launched in December 2020 with 30 signatories, the initiative has grown to include 87 signatories with nearly $37 trillion in assets under management (AUM), representing nearly 40 percent of the total assets under around the globe⁴.

Global asset managers with $41 trillion urge governments to adapt climate policy

A joint statement by 457 investors managing more than $41 trillion in assets, amounting to around 37% of all global assets under management, urges a global “race-to-the-top” on climate policy⁶.

Issued ahead of the G7 summit, the letter calls for governments to strengthen commitments and policies with regard to achieving net-zero emissions targets, and to implement mandatory reporting on climate risks in line with TCFD recommendations.

Pressure on energy sector intensifies

The International Energy Agency (IEA) called for an end to fossil-fuel expansion and investment as it published an extensive report with over 400 ‘milestones’, declaring that current climate targets require “nothing short of a total transformation of the energy systems that underpin our economies”.⁷

Separately, all on the same day, big oil companies Exxon, Chevron and Shell each faced significant challenges regarding their approach to climate change. Exxon shareholders voted in activist board members, partly in response to the criticisms over the company’s approach to energy transition⁸; a court in the Netherlands ordered Shell to increase planned cuts to greenhouse gas emissions⁹; and the majority of shareholders supported a call for Chevron to target reduced emissions, including those of its customers (known as Scope 3 emissions)¹⁰.

New initiative, ‘ASCOR’, to assess sovereign climate risks launched by major bodies

Asset owners, industry bodies and global initiatives have jointly announced the ASCOR (Assessing Sovereign Climate-related Opportunities and Risks) project¹¹.

Asset owners the BT Pension Scheme and the Church of England Pensions Board; the UN-convened Net-Zero Asset Owner Alliance; the Coalition for Environmentally Responsible Economies (Ceres); the Institutional Investors Group on Climate Change (IIGCC); the Principles for Responsible Investment (PRI); and the Transition Pathway Initiative (TPI) are “joining forces to create a practical tool to support investors in their assessment of sovereign climate-related risks and opportunities”.

They aim to develop a framework that will ultimately result in annual assessments that investors can use in research, decision-making and engagement with sovereigns on climate change.

Research suggests ESG factors have a much stronger impact on corporate funding costs in Europe relative to the US

The funding differential between the best and worst-in-class companies, when compared with regard to their ESG risks, is significant for European investment grade corporate debt post the Paris Climate Agreement, and more recently for European high yield issuers, according to research from JPMorgan¹³.

However, US investment grade and high yield spreads show low signs of ESG risk awareness. Within emerging markets, the researchers only found statistically significant results for Asia ex-China issuers.

According to their analysis, investors appeared to reward higher-ranked issuers (according to ESG scores) from ‘good’ sectors more than higher-ranked issuers from ‘poor’ sectors.

President Biden signs executive order focusing on climate-related financial risks

The Executive Order on Climate-Related Financial Risk encourages financial regulators to assess climate-related financial risks to the stability of federal government and the US financial system.

Alongside other measures, it explicitly calls on the Labor Secretary to “consider suspending, revising, or rescinding any rules from the prior administration that would have barred investment firms from considering [ESG] factors, including climate-related risks, in their investment decisions related to workers’ pensions”¹⁴. This came after the US committed to curb carbon emissions by 50-52% below 2005 levels by 2030¹⁵.

US budget proposal emphasises climate and other sustainable initiatives:

President Biden’s proposed 2022 budget, amounting to $6 trillion of spending in total, includes a wide range of climate and sustainability proposals¹⁷.

It includes over $800bn over the next decade in new spending and tax breaks to tackle climate change, including efforts to accelerate the use of clean-energy technologies. The budget also targets tax provisions that benefit the fossil fuel industry, projected to raise over $35bn by 2032. The budget would first need to pass through Congress.

SEC official challenges “myths and misconceptions” about ESG disclosures and materiality

In a speech interpreted as setting out the likely path for SEC rule proposals on climate and ESG disclosures, SEC Commissioner Allison Herren Lee challenged “myths” about the concept of materiality and how it applies to climate and ESG disclosures¹⁸. Lee said that “disclosure is only required when a specific duty to disclose exists” – meaning that some ESG factors material to investors are not already required to be disclosed under securities law.

Lee also highlighted examples of managers and their advisers incorrectly determining what information is material, meaning investors cannot be assured appropriate disclosures are being made – and that “a disclosure system that lacks sufficient specificity and relies too heavily on a broad-based concept of materiality will fall short of eliciting information material to reasonable investors”.

Other myths challenged by Lee were that SEC disclosure requirements must only be limited to ‘material’ information, and that climate and ESG factors are not material to investment or voting decisions.

SEC issues risk alert to investment adviser and funds focusing on ESG investing practices

The SEC’s Division of Examinations issued a risk alert offering “observations of deficiencies and internal control weaknesses from examinations of investment advisers and funds regarding ESG investing”, noting it had seen “potentially misleading statements” and either absent, poorly designed, unimplemented or unclear policies and procedures on ESG investing²⁰.

The alert also highlighted positive examples of clear disclosures that align well with a firm’s stated policies, and compliance departments with the knowledge to evaluate and advise on ESG-related policies and procedures.

European Climate Law achieves provisional approval

The European Parliament and Council have reached a provisional agreement on the Climate Law Regulation, which is now being prepared for formal adoption21.

It proposes a legally binding target of net-zero greenhouse gas emissions by 2050, with measures to track progress and adjust actions over time. It also requires EU member states to develop and implement “adaptation strategies to strengthen resilience and reduce vulnerability of the effects of climate change”.

European Union carbon border adjustment mechanism (CBAM) details emerge

The EU will apply tariffs linked with carbon emissions on imports of steel, iron, cement, fertilisers, aluminium and electricity, according to leaked documents.²² The proposals have been expected for some time as part of the EU Emissions Trading System²³, and are intended to put companies in the EU on an equal footing with those in other countries with weaker policies on carbon. The measures are set to come into force by the end of 2022.

The details are of particular interest to the UK: around one third of all UK goods exported to the EU could be affected, according to LSE research.²⁴ The EU is set to announce full details of the CBAM, alongside other initiatives in its ‘Fit for 55’ package, on 14 July.²⁵

Germany launches sustainable finance strategy

The German government published a new strategy to guide capital towards environmental projects and to address “climate risks that are increasingly relevant to the “financial system”²⁶. The government plans to issue green bonds with longer tenors to “establish a green bond yield curve that will become a benchmark in the eurozone’s green capital market”, introduce a traffic-light system to help investors identify green investment opportunities, and impose mandatory sustainability reports for corporate reporting.

Separately, Germany’s cabinet approved a surprise move to become carbon neutral by 2045, following in the wake of a ruling by the German Constitutional Court that elements of Germany’s Climate Action Law – which included a target to become carbon-neutral by 2050 – were insufficient.²⁷

European Central Bank (ECB) analysis highlights large share of bank loan exposure to climate risk

The European Central Bank found that a “significant” portion of bank loans to companies could “be subject to a high level of climate-related physical risk”, affecting either company operations or the physical assets used to support loans.

The review suggested enhanced climate-related disclosure requirements and more effective green financing are “essential steps in a smooth transition towards a sustainable economy and a general reduction of climate-related vulnerabilities” – but noted the risks from data gaps and greenwashing.²⁸

UPDATE: EU publishes its sustainable finance strategy including a European Green Bond Standard

On 6 July, the European Commission adopted measures to “help improve the flow of money towards financing the transition to a sustainable economy”. Alongside a range of actions, the EU proposed a European Green Bond Standard, a voluntary standard available to all debt issuers to help finance sustainable investments.²⁹

UPDATE: European Commission delays introduction of next phase in Sustainable Finance Disclosure Regulation (SFDR) rules

The “length and technical detail” of regulatory technical standards associated with SFDR were cited, among other reasons, for the European Commissions’ decision to delay the application of associated measures from 1 January 2022 to 1 July 2022.³⁰

DWP pushes on with climate disclosure rules for larger pension schemes

The Department for Work and Pensions (DWP) has published a response to its consultation on climate risk governance and reporting³¹, and issued its guidance for pension scheme trustees on the governance and reporting of climate-related risks³². The rules, subject to Parliamentary debate, will require pension schemes with over £5bn of assets to publish TCFD reports from October 2021.

The guidance incorporates some changes in response to industry concerns, including an acknowledgement that Scope 3 emissions may be “challenging” to obtain, so trustees will not be required to obtain data on these emissions in the first scheme year that the regulations apply for them. The guidance also explains that trustees must seek out relevant information “as far as they are able”, taking into account the costs and time required to obtain the information. It states that it may be challenging to quantify climate risks for “some sovereign bonds, relevant contracts of insurance, asset backed contribution structures and derivatives”.

For any data trustees are unable to obtain, they must explain why in their TCFD report. Subject to another consultation, the regulations will apply to smaller schemes from 2024.

The Pensions Regulator (TPR) outlines climate change strategy

The regulator’s climate change strategy outlines its objectives with regard to climate change³⁴. TPR is planning to publish guidance later this year to help schemes comply with relevant legislation and to consider climate change risks and opportunities part of governance approach.

David Fairs, TPR’s Executive Director of Regulatory Policy, Analysis and Advice, said: “Our strategy outlines how we will help trustees comply with the new rules for larger schemes, but it signals work on climate change needs to happen right across the pensions landscape – climate change is a risk for schemes whatever the size or investment strategy. It is clear that all schemes need to build their capacity in this area if they haven’t already.”³⁵

UPDATE: On 5 July, TPR launched its new guidance designed to help trustees meet tougher standards of governance in relation to climate change risks and opportunities. It is open for consultation until 31 August 2021.³⁶

Green financing framework published by government ahead of inaugural green gilt issuance

The government published its framework outlining how it will finance expenditures through issuing green gilts, and a new retail product, Green Savings Bonds. The framework explains the “basis for identification, selection, verification and reporting of the green projects” eligible for financing from the proceeds of these new issues.³⁸

Government introduces working group to advise on green taxonomy

The Green Technical Advisory Group (GTAG) will provide independent, non-binding advice to the government on developing and implementing a green taxonomy for the UK,⁴⁰ which will set out how to define investments as environmentally sustainable. It is intended to help tackle ‘greenwashing’, and to make it easier for investors and consumers to understand how a company is affecting their environment. Members of the GTAG include Ingrid Holmes of the Green Finance Institute (chair) and Faith Ward representing the Institutional Investors Group on Climate Change (IIGCC).⁴¹

The announcement of the GTAG follows in the wake of the EU’s SFDR, which applied from March 2021. The EU’s Taxonomy Regulation applies from January 2022. The Financial Conduct Authority (FCA) is expected to set out details of a UK version of SFDR in the near future.

FCA consults on ESG integration in capital markets and extension of climate reporting rules: The UK’s financial regulator has opened two consultations, each focusing on climate-related disclosures – one on equity issuers and ESG topics within capital markets⁴², and the other on rules and guidance for asset managers, life insurers, and FCA-regulated pension providers⁴³.

The first consultation seeks input on issues related to green, social or sustainability-labelled debt instruments, including how the ‘use of proceeds’ of a bond for sustainable purposes might be included in its prospectus, and the role of ESG data and rating providers in markets. The deadline for submissions to both consultations is 10 September 2021.

These consultations were issued after the FCA published its sustainable finance strategy, which focuses on promoting transparency and good disclosures “along the investment chain”; ensuring the market delivers investments that “genuinely meet investors’ sustainability preferences”; and collaboration between the government, regulators and industry to address the challenges of climate change.⁴⁴

Bank of England (BoE) sets out plans to ‘green’ its corporate bond portfolio

The BoE issued a discussion paper to help it consider how to use its £20bn of corporate bond holdings, which amount to about 6.5% of the sterling corporate bond market, to encourage companies to reduce greenhouse gas emissions.⁴⁵

Proposals include setting climate-related targets for the Corporate Bond Purchase Scheme (CBPS) portfolio, making CBPS eligibility conditional on climate-related actions by issuers, and tilting purchases of bonds towards issuers making more progress towards achieving net zero.⁴⁶

Climate Change Committee (CCC) calls for faster delivery of emission reduction initiatives

The CCC, an independent body which advises the government on emissions targets and publishes the influential UK Carbon Budgets⁴⁷, published its 2021 Progress Report to Parliament⁴⁸.

It commended the government for “historic” climate promises – in April, the government set a target to reduce carbon emissions 78% compared to 1990 levels by 2035⁴⁹ – but the CCC proposed more than 200 policy recommendations, referring to “uncertainty and delay to a host of new climate strategies…with every month of inaction, it is harder for the UK to get on track.”