Thu. Jan 27th, 2022


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Greetings from Denver, where I have unexpectedly been forced to relocate for a while due to a family health issue. Such micro-level surprises have (sadly) become part of the wider zeitgeist in the past year, amid Covid-19. And Denver has unexpectedly provided a glimpse of another set of shocks: last week, freak winter wildfires in the region consumed hundreds of homes, in (yet) another sign of peculiar weather.

So will 2022 be the year that these types of climate and pandemic surprises concentrate corporate minds around ESG? Maybe. In 2021, many corporate boards and investment committees increased their commitment to sustainability goals. Thus in 2022 the debate is no longer about “why” sustainability is needed — but “how” to pursue it in a practical, effective manner. This means tackling issues such as: how do you measure carbon emissions? Interpret ESG ratings? Track supply chains? And these debates are not just occurring inside public companies in Europe (where they have rumbled for some time), but increasingly in the US and Asia regions too — and the private capital sphere.

It is still unclear, however, whether this shift in corporate zeitgeist is occurring fast enough to prevent disastrous levels of global warming, let alone address rising social challenges. While governments have unveiled some striking policy initiatives — such as the new European green taxonomy — public sector support for sustainability remains patchy, at best. The bottom line? The sustainability fight has rarely been more important, nor more uncertain. In today’s edition we detail the top eight ESG themes for 2022. — Gillian Tett

1. Scope 3 emissions: focusing on transparency and reduction

If there is one phrase that every corporate executive and investor needs to know in 2022 it is “Scope 3 emissions”. For the uninitiated: Scope 1 emissions are those directly generated from a company’s core business; Scope 2 are those indirectly generated by energy bought by a company; Scope 3 are those indirectly created by its supply chain — and which represent 65-90 per cent of all emissions at many companies, according to Carbon Trust.

This might sound technical. But Scope 3 is built on a radical idea: corporate boards and investors need to adopt a sense of lateral vision in how they look at a company’s footprint on the world, rather than clinging to a tunnel vision perspective on what a company does. Scope 3 principles are thus diametrically opposed to the concept of shareholder capitalism championed by Milton Friedman.

Some corporate leaders (unsurprisingly) hate this shift, since it is hard for corporate boards to track what is happening in far-flung supply chains — let alone control it. In 2022, however, there will be rising pressure for companies to track Scope 3 emissions. That’s partly because new digital tools, such as the launched Climate TRACE system backed by Al Gore, are creating so-called “radical transparency” about the source of global emissions. It is also because the so-called Gfanz agreement (Glasgow Financial Alliance for Net Zero) launched at the COP26 talks in November potentially leaves financiers on the hook for the Scope 3 emissions of their clients. And since some companies, such as Walmart, are already flaunting their Scope 3 credentials, this is raising pressure on others. Rising transparency, in other words, is creating a cascading effect that no corporate board can ignore – and rising demands for data. (Gillian Tett)

2. Private capital: ‘A paradigm shift is taking place’ amid hunt for climate deals

© Bloomberg/Getty Images

After a bumper 2021 for private capital, more records are likely to be shattered in the new year. Blackstone could raise up to $30bn for a flagship fund this year, while Carlyle and Apollo could raise $27bn and $25bn for each of their big 2022 funds, according to PitchBook.

Given the cash already surging into climate finance, the big private equity companies will surely want to get in on the game.

“A paradigm shift is taking place, wherein private capital sees climate technology as a promising investment opportunity,” PitchBook said in a December 15 report. Indeed, for the year through November 2021, venture capital funds had invested $34.2bn in climate tech, PitchBook said.

Private equity funds have plenty of room to grow their environmental portfolios. Only 20 per cent of the biggest PE groups’ holdings include renewable energy, according to the Private Equity Stakeholder Project.

Environmental data for private investments remains limited. This is a top concern for BlackRock’s Larry Fink who has warned “more hydrocarbons moving away from public entities to private entities.” Though the Securities and Exchange Commission is considering requiring private companies to disclose more environmental information, those rules are unlikely to be implemented until 2023. For now, competitive pressure within the private equity sector — the first-mover advantage — will do the most to drive transparency. (Patrick Temple-West)

3. Green bonds: growth to the moon, but is it credible?

One of the safer predictions for 2022 is that the green bond market will continue to grow. Sustainable bond deals totalled $991.7bn globally in 2021, an all-time high and up 45 per cent from 2020, according to Refinitiv. HSBC estimates that green bond supply will be about $800bn in 2022, and that sustainability-linked bonds will grow 70 per cent to $170bn.

As the market accelerates, investors are getting increasingly discerning about what qualifies as green. For example, bond giant Pimco wants issuers to include goals that get progressively harder to hit over the life of a bond. Sustainability-linked bonds should include interim performance targets tied to coupons rather than the redemption of a bond at maturity. Pimco says it shuns sustainability-linked bonds that do not have interim steps.

In 2022, investors are likely to demand more environmental progress from companies hoping to issue sustainable debt. A survey from the European Leveraged Finance Association in 2021 found that investors do not believe the typical 25 basis point relief for hitting environmental targets is high enough, suggesting that investors believe companies can achieve more debt savings if they make more ambitious climate promises.

The green bond market has established itself as a core component of the fixed-income universe. But in 2022, we will see a battle fought over the true impact of green debt. (Patrick Temple-West)

4. Carbon markets: more growth ahead, amid rising scrutiny of offset quality

Economists have long warned that effective carbon markets will be essential to any successful response to climate change. This year should offer a clearer sense of the prospects in that field.

Expect a continued boom in voluntary carbon offsets, where issuance hit a record $1bn last year. But concerns about quality in the market have also been rising. Look out for a major publication this year from Mark Carney’s Taskforce on Scaling Voluntary Carbon Markets, which aims to establish global standards for offsets.

It’s an important year, too, for regulated carbon markets. Prices in the EU cap and trade scheme rose above €90 a tonne late last year — a new record, though still well short of the level that will ultimately be needed globally, according to the International Energy Agency. Watch to see whether Germany’s green-minded new government succeeds in securing a new price floor to lock in those gains — and whether the scheme is expanded to road transport and buildings.

Also keep an eye on China’s new carbon market — launched only last year but already the biggest of its kind. It currently covers only the power industry, but could be rolled out to two or three more sectors this year, according to a senior market official. That could have meaningful implications for industry — especially if the price is allowed to rise beyond its current low level. (Simon Mundy)

5. Sustainability accounting: global standards start to take shape

Just a few days into the new year, we’ve already had a fresh burst of controversy around the vexed subject of sustainability accounting.

The latest row surrounds the EU’s taxonomy for sustainable finance — a labelling system that will be used in corporate sustainability disclosures. After pressure from various European states, the taxonomy’s current draft would classify nuclear power and some forms of natural gas as “green”. That idea is facing strong resistance from various European politicians and environmental groups.

The taxonomy is crucial given the EU’s role as a (relatively) early and energetic mover on sustainability disclosures. European authorities are this year drawing up a new Corporate Sustainability Reporting Directive, which will require about 50,000 companies to file reports. The CSRD is expected to emphasise “double materiality” — meaning companies will need to give details of their impacts on the environment, as well as climate-related risks that they face.

There is movement on the other side of the Atlantic, too. Analysts at Jefferies expect the Securities and Exchange Commission to unveil new rules on corporate climate disclosures later this year, after SEC chair Gary Gensler argued that only mandatory disclosure could deliver “consistency and comparability”.

These accelerating moves by various regulators raise the prospect of a fragmented world of disparate reporting standards. The International Sustainability Standards Board, announced by the IFRS Foundation late last year, aims to forestall that prospect by creating a basic sustainability disclosure framework for regulators worldwide. Under former Danone chief executive Emmanuel Faber, the ISSB aims to unveil its new guidelines before the year is out. (Simon Mundy)

6. The ‘S’ of ESG: employee activism soars

As the pandemic continues to expose labour issues from pay to safety risks, workers are increasingly demanding change. This has brought the ‘S’ in ESG — social issues — to the fore.

Last year, companies faced fresh pressure to replace rhetoric with action in boosting diversity among their ranks. Investors have often been more hesitant to use their votes on social issues, compared with environmental ones — but there have been signs of a shift in that trend, which may well continue in the coming year. Most recently, Goldman Sachs Asset Management said it would be voting against nominating committee members at companies where there are not two diverse candidates on the board.

Companies will face continued pressure for more flexible terms, from employees reluctant to return to the pre-pandemic model of rigid working hours spent entirely in the office. And they should expect more of the unionisation efforts that have recently hit corporations including Starbucks, John Deere and Amazon.

Many investors have welcomed the trend towards employee activism, reasoning that it signals a healthy workplace culture, according to Edelman’s 2021 investor trust survey. Yet even as investors pledge to pay greater attention to companies’ social impact, they face a dearth of reliable data on that score, in the absence of consistent assessment standards. That’s a challenge for investors who say employee activism is an asset, and yet are not clear on what exactly employees want. (Kristen Talman)

7. US-China relations: the green cold war

As the tension between the US and China grows, global corporations face a double-edged sword. If they condemn China’s human-rights violations, they become a target of wrath in the world’s most populous country. If they remain silent, they are called out by regulators, investors and consumers in the west. The Beijing Winter Olympics in February will be a big test of whether they can appease both sides.

One approach has been to diversify supply chains. But companies will encounter fresh risks in emerging markets outside of China, where even less is known about social and environmental threats. Meanwhile, China has amassed control of rare minerals from Africa to Latin America and Central Asia — deepening concerns over whether the west can achieve its green transformation without China.

Some argue that the west’s key to counter China is strengthening its alliance with India. COP26, however, showed that the task is not simple. At the global climate meeting, India teamed up with China to weaken a coal pledge, despite the nations’ historical frictions.

Geopolitical tension between China and the west will persist, but turning the divide between the global north and the south into an iron curtain is avoidable. The west should pay attention to how to make the global climate efforts “just and fair” to poorer nations. Otherwise, it risks losing potential allies to the other block. (Tamami Shimizuishi)

8. US climate policy: Biden confronts challenges at home as he tries to inspire global action

At COP26, US president Joe Biden pledged to “lead by example” in the fight for climate action. But the weeks following the summit highlighted the domestic political obstacles to that ambition.

Biden’s $1.75tn Build Back Better Act — which includes $555bn worth of climate-related initiatives — has been stalled by the opposition of West Virginia senator Joe Manchin, who holds a de facto casting vote in the Senate. Manchin has voiced concern about the inflationary risks of such heavy state spending. Democrats have vowed to continue efforts to pass key measures within the landmark bill, and a clearer sense of their prospects should emerge in the early part of this year.

There will be plenty more to watch out for on the US green policy and regulation front. As mentioned above, the SEC is preparing new rules around climate-related corporate disclosures. The Biden administration also faces lawsuits from environmentalists over the sale of oil and gas leases on federal lands, and from Republican lawmakers seeking to limit the Environmental Protection Agency’s ability to regulate carbon emissions. Meanwhile, the EPA is poised to tighten standards around water pollution.

Arguably the most important moment will come with the midterm elections in November. Biden has been struggling to pass green measures even with nominal control of Congress. The task could prove even harder in the second half of his term. (Kristen Talman)

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