Golden chance to globalise ESG

What is happening?

A common gripe about environmental, social and governance (ESG) evaluation is that there are too many standards, guidelines and taxonomies. Most are voluntary, while many jurisdictions are pursuing their own initiatives. 

All this muddies the waters for financial firms trying to judge a corporate’s ESG credentials. It makes drawing comparisons between firms more difficult as well. 

The lack of commonly followed standards also allows ‘greenwashing’ to quietly thrive as firms can cherry-pick the lowest standards. 

However, that is changing — the EU is undoubtedly the global leader in this area and other jurisdictions are following its work. China also carries weight internationally in this field. Global initiatives, such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), is another influential initiative.

Why is it happening? 

Regulators recognise that ESG analysis could be jeopardised by both a lack of common and enforceable rules, and also by insufficient enforcement. That is beginning to change. 

This was partly the inspiration behind establishing the International Sustainability Standards Board (ISSB) late last year. Its mission is to work with global standard setters and regulators to forge common reporting standards — an absolute must if ESG is to ever have much meaning. Its creation was warmly welcomed by the financial services industry. 

The other big opportunity to drive global convergence around ESG rules and guidelines are consultations by three bodies, including the ISSB (which is running two feedback exercises). The other two are by the US Securities and Exchange Commission (SEC) and the European Commission. 

All these various consultations are an opportunity for global financial institutions, and in the case of the ISSB, to promote the formation of common ESG standards. 

Besides national politics, there are some natural hurdles standing in the way of forging common standards. Most notably, it is around the lack of data and methodologies to calculate the potential impact of climate change on finance. 

The SEC, for instance, is looking for US stock market-listed companies to report substantially more climate-related information for the benefit of investors, which will help. 

But one particularly tricky area is around calculating so-called ‘Scope 3’ carbon emissions, which cover emissions from the supply chain through to those generated by the use of the product or service. Industry sources warn that this is fiendishly difficult to work out, and there are several competing ideas floating around on how to do this.  

Yet Scope 3 is a critically important part of the puzzle. It is estimated that 99% of Apple’s carbon emissions are actually Scope 3, and for many other large companies it is around 90%. Scope 3 would create a massive trickle down and amplifying effect by driving the ‘greening’ of entire supply chains. But until there are widely accepted practices around measuring and reporting Scope 3 data, a major part of the puzzle will be missing. 

What do the bankers say? 

Bankers would be delighted if common ESG standards are agreed and enforced globally, similarly to say the Basel prudential framework, even if there are differences around the edges. 

It would create a more level and transparent playing field. This would put banks and institutional investors in a stronger position to promote ESG policies in the companies they are supporting. It would also spur competition and innovation around the creation of ESG-friendly financial products, which banks are very keen to develop.

Will it provide the incentives?  

Establishing common standards around measuring and reporting would go a long way towards driving ESG globally. That, in turn, should lead to lower carbon emissions. 

However, there is still a danger that the EU, China and the US — which is just getting on-board — will seek to promote their own ESG approaches and taxonomies. Though this would not necessarily stop carbon emissions being reduced — providing these standards are tough enough and actually enforced — it would create fragmentation. 

That fragmentation would, in turn, hinder the development of innovative and competitive ESG financial products. It would also create confusion and duplication for global companies impacted by these various regimes. 

However, there are reasons for optimism. The area of ESG has developed in leaps and bounds in the past few years and even the Covid-19 crisis has not managed to derail it. The formation of the TCFD, ISSB and UN’s Principles for Responsible Investment are all proof of that strong momentum.