Analysis

ESG Insights: January

As we enter 2022, ESG continues its rise in prominence in the minds of company shareholders and broader stakeholders. In particular, the increasing strain on the global supply chain is sharpening the focus of management teams on how it manages ESG related risks. In this latest iteration of MHP Mischief’s quarterly ESG newsletter, we cover the growing spectre of Scope 3 emissions, provide an update on the primary challenges for corporates relating to ESG reporting, and discuss the ongoing trend of shareholder activism and divestment. We also provide a brief overview of some key developments from last year and highlight Shaftesbury as our Client in Focus.

KEY THEMES

1. The challenge of decarbonisation: Scope 3 emissions
2. Effective ESG reporting: the biggest challenges facing corporates
3. Engage or Divest: the rise of shareholder activism and fund divestment

1. The challenge of decarbonisation: Scope 3 emissions

Scope 3 emissions – the greenhouse gases created indirectly by a business beyond its control, most commonly through its supply chain – will dominate this year’s focus on corporate climate responsibility. This differs from the more familiar Scope 1 and 2 emissions, the former directly generated from a company’s core business and the latter indirectly produced by energy bought by a company. But too much focus on Scope 1 and 2 emissions risks becoming another, often inadvertent way of greenwashing, particularly as public and private vigilance can be overwhelmed by carbon neutral and net-zero pledges publicised constantly across all industries.

For most, Scope 3 emissions unlock the real climate impact of a business. On average, they are 11.4 times higher than operational emissions and account for more than 70% of a corporate’s carbon footprint. If you strip out the Utilities sector, that figure is much higher:

2021 saw increasing awareness of how Scope 3 is key to any serious corporate climate commitment. IKEA set a benchmark for Scope 3 awareness in retail last year with a report that focused on their planned value chain emissions reductions by 2030. They found that it would be “the equivalent to cutting the average climate footprint per product by an estimated 70%”. IKEA isn’t alone. Maersk, the world’s second-largest container company, took unprecedented steps for the shipping industry last week by accelerating plans to achieve net zero emissions in its business by 2040, a decade earlier than previously planned.

According to the CDP (Carbon Disclosure Project), only 37% of suppliers in 2020 said they were taking action and engaging with their own stakeholders on Scope 3, even lower than the previous year. For far too long there has been a worrying misconception that businesses have no control over Scope 3 emissions. They do, and there are several steps that corporates can take to demonstrate this.

1. Digitise your supply chain

This is the most straightforward method for cutting Scope 3 emissions. There are plenty of tools available to help drive sustainability performance and enhance the visibility and traceability of your product. A recent report by Schneider Electric highlighted the value of incorporating AI and blockchain technologies to reduce carbon footprints, and hinted at the growing influence of these technologies in operations and supply chain management. Morrison’s created a stir last month by pledging to reduce carbon emissions across parts of the supply chain out of its control by 30% within the decade, offering 400 suppliers free access to software analytics so they can manage operational carbon emissions effectively.

2. Leverage supplier relationships

Do not underestimate your clout with partners in your supply chain. As of this year, Tesco will be introducing fully electric HGV’s to serve its Welsh distribution centre, initiating the process of switching to a new provider with fleet-wide zero-emissions transport operations by 2025. Leverage your relationships with suppliers and agree on carbon footprint reporting parameters and reforms. As the case of Morrison’s shows, shared supply chain analytics are a practical way to get started.

3. Innovate

Interrogate your product or service’s development to find inefficiencies that can be eradicated from the decision-making and logistics process. Weir Group announced its commitment to a Science-Based Targets initiative last month, recognising its carbon footprint is “dominated” by emissions beyond their own facilities, namely, by the customer’s use of their products. Weir’s commitment to accelerate Scope 3 reduction depends upon conscious innovation: engineering products and solutions that shrink emissions output. The announcement confirmed that some of Weir’s technologies were “already offer[ing] energy savings of up to 40%”.

2. Effective ESG reporting: the biggest challenges facing corporates

ESG reporting is a challenging endeavour, with a multitude of differing frameworks, evolving regulation and – at present – limitations to the comparability of relevant data. To understand the various challenges facing corporates who are keen to meet best practice, and initial steps that can be taken to help address these challenges, the Financial Reporting Council’s ESG paper is a sensible starting point.

The FRC has identified and grouped the main ESG challenges within six stages: Production, Audit and assurance, Distribution, Consumption, Supervision and Regulation.

  1. Production – Companies face challenges in how they measure, manage, control and assure ESG data, with reporting often aspirational and high level but without providing users information about progress or whether financial data is aligned with the commitment.
  2. Audit and assurance – There can be a lack of credibility in ESG information, and independent assurance may be insufficient to meet expectations given the current level of data maturity.
  3. Distribution – ESG information is often located in separate places, reports and media, and often not in an accessible or reusable format.
  4. Consumption – Users often have difficulty obtaining ESG data, and where it does exist it is often based on differing methodologies with limited comparability.
  5. Supervision – With increasing expectations of more and better ESG reporting, there is a need to supervise whether companies, auditors and assurance providers meet appropriate standards.
  6. Regulation – Different countries, organisations and markets are responding to ESG challenges at differing speeds and depths, making international comparability and coordination difficult.

To address the above challenges is not a quick fix. The FRC has proposed three modes of action as being most helpful in addressing these challenges:

  1. Co-ordinating – Further coordination is needed within the UK and internationally across reporting, markets and regulation;
  2. Connecting – Whilst the UK can, and already has, made progress, connecting with others internationally will be a more effective longer term outcome; this can be achieved by leveraging partnerships in order to provide leadership, guidance and support, along with a commitment to drive change;
  3. Contributing – All interested parties must contribute collectively to the broader discussion on these matters, if ESG is to work effectively across multiple markets.

Following the publication of the FRC’s paper, in November the International Financial Reporting Standards Foundation (IFRS) announced the formation of the International Sustainability Standards Board (ISSB), aiming to establish a global consensus for climate and sustainability disclosures. The ISSB will consolidate with the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF) by June 2022, resulting in the formation of a new global standards setter. The ISSB is expected to come out with a first set of ‘baseline’ global standards on climate-related disclosures in mid-2022.

In the meantime, we have identified factors that corporates should prioritise to ensure their own ESG data is accessible and credible, and move their own ESG reporting forward in line with the direction of travel:

  • Available – Make your ESG data accessible not only to your shareholders but broader stakeholders.
  • Digitisation – Consider electronic distribution of ESG data and a digital tagging system to make it easily identifiable.
  • Prioritisation – Speak with shareholders and your broader stakeholders such as suppliers, customers and employees to understand their priorities when it comes to your ESG data and reporting.
  • Verification – Consider engaging with an external third party to validate the quality of your ESG data.

For a more detailed discussion on the FRC’s ESG paper, please click here to watch our video with the FRC’s Executive Director of Regulatory Standards, Mark Babington.

3. Engage or Divest: the rise of shareholder activism and fund divestment

It’s nothing new that businesses are increasingly focused on developing and communicating effective ESG strategies to shareholders and stakeholders alike, with poor ESG credentials now a veritable risk to accessing capital. This is increasingly critical as investors look to ‘Engage or Divest’; they either engage in ESG-related activism, or divest holdings in those companies which don’t meet specfic ESG thresholds.

In recent months large shareholders have actively engaged with investments, using their influence to engender change and force companies to improve their ESG credentials, as well as divesting away from those holdings which are in traditionally ‘ESG-unfriendly’ industries or where performance is lagging.

For example, Nest, the £20bn state-backed workplace pension scheme, in December announced plans to reduce its portfolio emissions by 30% by 2025 and disposed of holdings worth £40m in ExxonMobil, among other oil and utility companies, citing lack of progress on managing climate change risks. Similarly, Dutch civil service pension fund ABP confirmed it will stop investing in fossil fuel producers and sell the majority of such holdings, which account for 3% (€15bn) of its total assets, by Q1 2023.

Despite growing levels of ESG-related investor activism, management teams need to remain focused on their responsibilities to shareholders in terms of value creation and returns. Unilever recently came under fire from Terry Smith of Fundsmith, amongst other investors, who believes it has become obsessed with ESG at the expense of business fundamentals; in his view, this has been the cause of the share price decline over the last 2-3 years.

Total ESG assets are predicted to reach USD$53trn by 2025. It remains to be seen as to whether more shareholders will look to divest of ESG-unfriendly assets, or if they will be emboldened by 2021’s victories and look to take a more active role across the corporate landscape to push for greater ESG performance. Either way, this underlines the importance of effective ESG performance and communication.

RECOMMENDATIONS

In recent months we have been working with a number of clients on interesting issues related to ESG. Taking these into consideration – along with the key themes discussed in this newsletter – we have collated some recommendations corporates should consider with regards to their ESG communications:

  • Focus on reducing Scope 3 emissions to get ahead of the curve and ensure your ESG credentials don’t fall below investor ESG thresholds.
  • Make your ESG data readily available, engaging, easy to digest and ideally verified by a third party to showcase quality of data and transparency.
  • When communicating ESG-related commitments such as net zero carbon strategies, consider hosting a dedicated capital markets event.
  • Who you are is as important as what you do; ensure that your corporate purpose is intertwined with your sustainability strategy.

CLIENT IN FOCUS

Shaftesbury PLC is a Real Estate Investment Trust which owns a 16-acre portfolio based in the heart of London’s West End. It has a portfolio of around 600 buildings, clustered in high profile locations, many of which make a significant contribution to the heritage of this historic part of London. Shaftesbury’s portfolio is focused around five iconic villages: Carnaby, Covent Garden, Chinatown, Soho and Fitzrovia; across the estate there are over 600 businesses, including retailers, restaurateurs, cafés, bars and office occupiers, as well as residential properties.

In November 2021, Shaftesbury launched its Sustainability commitment, complete with net zero carbon roadmap and an ambition to reach net zero by 2030. An accompanying launch event for Shaftesbury’s stakeholders, including shareholders, partners and advisors, was seen as an effective way for the REIT to lay out its ambitious strategy, together with how it plans to achieve it. The event also provided an opportunity for discussion with stakeholders, a reflection of Shaftesbury’s collaborative approach.

For any corporates considering a commitment of this nature, below are some takeaways from Shaftesbury as to how you can make your communications particularly effective:

Stay aligned to your corporate values – Shaftesbury’s purpose is to contribute to the success of London’s West End by curating lively and thriving villages where people live, work, and visit. It has a proven management strategy to create and foster distinctive, attractive and prosperous locations, led by an experienced management team focused on delivering these long-term strategic objectives and staying aligned to its five core values:

  1. being human in how we operate
  2. original in how we nurture talent and think
  3. community minded in our approach to the West End
  4. being responsible, and
  5. long term in our approach to everything

The above values are engrained within everything Shaftesbury does, including its newly announced Sustainability commitment.

Talk about your approach – Shaftesbury was keen to emphasise its strategic approach; that is, to carefully manage, re-use and adapt its portfolio of mostly smaller, mixed-use and heritage buildings, all of which are in conservation areas and in many cases of listed status. Through refurbishment, reconfiguration and change of use – as opposed to demolition – Shaftesbury’s strategy avoids the high levels of carbon emissions and waste that are inherent in demolition and new construction projects, whilst also protecting the unique heritage of its West End location. Shaftesbury’s approach is also very collaborative, and its commitment to reach net zero carbon will involve working closely with partners, occupiers and broader stakeholders.

Utilise appropriate governance – When developing its sustainability commitment, Shaftesbury put in place governance processes to provide accountability and reinforce its commitment to reach net zero carbon by 2030, and carbon neutral for its own operations by 2025. A Board-level Sustainability Committee has been established – in addition to the existing Executive Sustainability Committee – to review progress and ensure specific deliverables are met as Shaftesbury moves towards its net zero carbon target. Additionally, Shaftesbury discloses climate risks in line with the requirements of the Task Force on Climate-related Financial Disclosures (TCFD), the details of which can be found in its Annual Report, as well as publishing an Annual Sustainability Report. Shaftesbury is also a member of the Better Buildings Partnership, a collaboration of the UK’s leading commercial property owners who are working together to improve the sustainability of existing commercial building stock.

Publicise your commitment – Shaftesbury was keen to host a capital markets event to ensure all stakeholders were well informed about its pledge. This provided Shaftesbury CEO, Brian Bickell, and Head of Sustainability, Matt Smith, to talk through the commitment and provide clear details of how they will approach what is an ambitious target. This interactive event was a great opportunity to not only raise awareness of the commitment, but also provided credibility and weight behind Shaftesbury’s plans, as well as an opportunity for open discussion with stakeholders, to both reassure and gain feedback for further consideration.

OTHER DEVELOPMENTS

  1. The Financial Conduct Authority’s (FCA) new rules and guidance came into effect on 1 January 2022, requiring all publicly-listed companies to declare whether they meet TCFD recommendations in their financial reporting, and FCA-regulated asset managers to disclose how they incorporate climate-related risk into their investment decisions.
  2. The Institute of Directors has demanded public companies improve the ethnic diversity of their boards, after many FTSE 100 companies failed to meet the 31 December 2021 deadline.
  3. The International Financial Reporting Standards Foundation (IFRS) announced the International Sustainability Standards Board (ISSB) on 3 November 2021, aiming to establish a global consensus for climate and sustainability disclosures.
  4. The ISSB will consolidate with the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF) by June 2022, resulting in the formation of a new global standards setter.
  5. The ISSB is expected to come out with a first set of ‘baseline’ global standards on climate-related disclosures in mid-2022.
  6. Analysis from the CFA Institute found that the correlation between MSCI’s ranking system with S&P and Sustainalytics was below 50%, which can be confusing for fund managers and companies.
  7. Oil and gas shares and energy equity funds outperformed ESG-aligned companies and funds in 2022, according to Morningstar data.
  8. ESG ratings provider Sustainalytics launched its ‘Corporate Supply Chain ESG Solutions’ to help companies assess and manage ESG risks within their supply chains.

UPCOMING KEY EVENTS

Get in touch

MHP Mischief’s Capital Markets team provide strategic financial communications advice to private and public companies across a range of sectors. We advise companies on all aspects of their engagement with the capital markets, from financial reporting, M&A, IPOs and fundraisings to corporate profile raising activity, ESG communications and reputation management. For any questions or feedback please do get in touch.