Mar 30, 2022

Key ESG Developments to Watch in 2022

Over the last few years, the term “ESG” has become more widely known. Investors hear the acronym which stands for environmental, social and governance during earnings calls, while related topics are likely coming up during conversation around your dinner table. In 2021, plenty of focus was on climate change (E) and diversity, equity and inclusion (S). While those two areas will remain topical, there is an increasing focus on governance (G) and additional ESG and responsible investment trends that are worth highlighting. Here are four that AIMCo’s Responsible Investment team is keeping an eye on.

1. Standards and Reporting Frameworks Come Together

Sustainability reporting frameworks are plentiful and often sound like alphabet soup, for example, TCFD, IIRC, GRI, SASB, CDSB. At times, reporting frameworks present a reporting burden for issuers, as it has not always been clear what is the best way to report their information. Additionally, unlike financial statements which are very standardized, the components of sustainability reporting, like measurement and progress on ESG, have largely been left to issuers.

In November 2021, during the UN global summit on climate change in Glasgow (COP26), the International Financial Reporting Standards (IFRS) launched the International Sustainability Standards Board (ISSB). The ISSB, whose formation was supported by AIMCo and some of its investment and finance industry peers, is meant “to develop — in the public interest — a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs.” The IRFS also announced that by June 2022, two other sustainability disclosure organizations, Climate Disclosure Standards Board and Value Reporting Foundation, will be consolidated into the ISSB.

For investors, the promise of sustainability information that is standardized, accurate, auditable and timely is welcome. And there is reason for optimism, as foundational groundwork has been laid by many of the organizations listed earlier. On one hand, this means that the ISSB will not be starting from scratch. On the other hand, there are concerns from others that with various governments mandating their own ESG disclosures with different requirements — European Union (EU) Sustainable Finance Disclosure Regulation (SFDR), U.S. Security Exchange Commission (SEC) — this process may not be completed for five or more years. AIMCo continues to watch this development closely and report as we learn more.

2. A Crackdown on Greenwashing

What is greenwashing? In simple terms, greenwashing is when a company spends more time on promoting items as green than they do on making them green.

As previously mentioned, the lack of standardization in sustainability reporting has led to numerous claims of greenwashing. Recently, a study published in the journal PLOS One, found that Chevron, ExxonMobil, BP and Shell used terms like "climate," "low-carbon" and "transition" more frequently in recent annual reports and devised strategies around decarbonization. However, these companies’ actions on clean energy were mostly pledges and the companies remain financially reliant on fossil fuels.

There are also concerns about greenwashing in the fixed income space. Some analysts report that sustainability-linked bonds, unlike green or social bonds, come with no restrictions on how the proceeds can be used, allowing more issuers to obtain sustainable financing but they may lack the capacity to effectively track or report practices required for such instruments. AIMCo’s Fixed Income team has expressed concern that companies are tying the use of proceeds of sustainability-linked bonds to initiatives that the company had already been doing in the past, but are now trying to gain a premium by putting this label on the bonds.

Standardized frameworks and reporting, the convergence of data and metrics, an increasing requirement that the information be auditable, and a focus on impact not just inputs, will go a long way to address concerns of greenwashing.

3. Climate Pledges Translate to Action

These days, it’s common for a new firm or government to pledge a commitment to net-zero emissions by 2050. However, an article by Bloomberg stated that when they evaluated the climate plans published by the world’s biggest companies, the result would only be a 40% reduction in average carbon emissions by 2050. Often, commitments to net zero lack short-term reduction plans or fail to curb emissions along the supply chain (i.e. scope 3 emissions). There is increasing pressure from stakeholders for governments and companies to provide credible, achievable near-term goals, or signposts, on their path to decarbonization and show that they have plans to manage exposure to physical climate risks.

Additionally, for financial institutions, climate stress testing will become increasingly important. Through the Network for Greening the Financial System, central banks are beginning to incorporate climate risk as a stress testing feature. At a recent webinar with the Bank of Canada and Office of the Superintendent of Financial Institutions (OSFI), the discussion centred around their newly launched climate scenarios and the expectations that climate will be a material risk by 2030. Read more about the Bank of Canada and how they are assessing climate change risks.

4. Increasing Focus on S

At the intersection of S and G we find discussions centred around human rights in the supply chain, especially with all the news in the last couple of years around forced labour (e.g. Uighurs). According to S&P, there is legislation in the works that will increase the importance of supply chain traceability and social risk management. The U.S. is expected to continue restricting imports where concerns of forced labour exist, pushing companies to better evidence how they are monitoring human rights in their supply chains.

Another issue spanning both E and S is the concept of a Just Transition — ensuring that as the world transitions to a lower carbon economy, there are plans to account for impacts on developing nations and vulnerable populations. AIMCo is an active contributor to Climate Action 100+ and the Just Transition is one of the 10 benchmarks that it discusses with companies during engagements.