Climate Impacting Finance: Investors Demand Information in a New, Unyielding Approach
At the AHRI Leadership meeting, we explored the forthcoming U.S. bills related to ESG (with California leading the charge) and discussed ongoing practices in the EU. The panel conveyed a clear message: ESG means different things to different people. An attempt to clarify some of its most relevant aspects was successfully made. Environmental, Social, and Governance (ESG) investing considers non-financial factors in investment decisions. In theory, it offers investors the opportunity to support companies that align with their values. The push for sustainability disclosure requirements is driven by the Paris Climate Change Agreement’s priorities and the United Nations’ environmental initiatives, such as the annual UN Climate Change Conference (the next being COP28) and the UN Principles for Responsible Investing.
Jurisdictions are gradually adopting reporting standards to enhance clarity and accountability. In the meantime, the rise of ESG presents challenges for companies trying to meet fund managers’ and consumers’ demands while adhering to existing regulations. This is highlighted in Reuters’ article “Deutsche Bank’s DWS and Allegations of ‘Greenwashing'”. The standardization of reporting aims to mitigate greenwashing concerns and legal risks through clear guidelines. The European Union was the first major jurisdiction to adopt such a scheme. Marco Masini, ASERCOM President, spoke at the panel about the Corporate Sustainability Reporting Directive (CSRD), passed in November 2022. The CSRD, being implemented in phases, faced delays due to corporate concerns over unclear standards set by the European Financial Reporting Advisory Group—a common issue with ESG. The International Financial Reporting Standards Foundation (IFRSF) began developing its financial reporting standards, heavily influenced by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures.
The IFRS Standards comprise two reporting tiers, IFRS S1 and IFRS S2, effective from January 1, 2024. IFRS S1 establishes sustainability disclosure requirements, while IFRS S2 details specific climate-related disclosures. Both focus on a company’s governance, strategy, risk management, and metrics related to sustainability or climate. The most contentious standard lies within the climate-related disclosures. IFRS S2 mandates reporting greenhouse gas emissions, divided into three scopes. Scope 1 covers direct emissions from company-controlled sources. Scope 2 involves indirect emissions from purchased or acquired electricity, steam, heating, or cooling. Scope 3, with 15 categories, includes emissions from “purchased goods and services.”
The SEC (Securities and Exchange Commission) has faced significant pushback on its climate disclosures within Scope 3. Companies have objected to requirements for publicly traded entities to compel privately held companies in their supply chain to report climate emissions. The SEC may consider dropping the Scope 3 requirements, focusing solely on Scopes 1 and 2. The panel also discussed the risks of neglecting ESG reporting, highlighting legal, financial, and commercial implications. Legally, companies above a certain size (1 billion USD) are obligated to comply to protect investors. Commercially, alignment with compliant supply chain partners is crucial for business continuity. Climate risks can significantly impact material supply and production. A discerning investor seeks ESG information to safeguard investments. ESG’s permanence stems from its financial implications. As the saying goes, “Investors allocate capital based on financial risk, not politics!”
Effective ESG reporting reduces a company’s funding, capital, and banking risks. Environmental factors are increasingly pivotal in financial due diligence. In NYC, for example, a 40% emission reduction by 2030 and 80% by 2050 is mandated, with HVAC systems playing a significant role. This underscores the importance of understanding ESG parameters for marketing purposes. Marco Masini also mentioned upcoming regulations on the Carbon Border Adjustment Mechanism (CBAM), requiring ESG data for environmental impact assessment and compensation based on the Emission Trading System (ETS). However, as Masini noted, “The absence of established, globally accepted metrics for carbon emissions measurement and uncertainties in sourcing all materials and components (including Scope 3, where the SEC also faces challenges) leaves some risks unresolved.”