Because we are in a position to hold financial institutions to account for their commitments to the environment and our societies, it’s only right we should also hold ourselves to account for the work we create. As promised last year, Capital Monitor has reviewed our 12 “big ESG calls” for 2022 to see how our predictions faired. We won’t lie, this was a nerve-wracking experience, but also a very useful one. Below is our report on the findings.
Prediction: The SEC pressured to climb down on double materiality
Already embedded into the incoming European Commission proposed Corporate Sustainability Reporting Directive, and to be included in the UK’s equivalent legislation, Capital Monitor predicted the US Securities and Exchange Commission (SEC) would not choose to pursue double materiality reporting after significant pressure from US lawmakers, notably Republicans.
Outcome: Looks like we were on the money. Announced in late March last year, the SEC did not propose including double materiality into its plans to enhance climate-related disclosures for investors. As was reported at the time, US regulators seemed focused on improving the quality of reports on single materiality – that of the impact climate change will have on the reporting company – by, for example, requiring publicly traded companies to detail their costs from extreme weather events or capital investments to help reduce emissions.
In a nod to regulators the other side of the Atlantic, the SEC said in May 2022 its aim was “to achieve as much interoperability” as possible between what the SEC could require and global standards.
Prediction: Inflation will stall carbon tax ambitions
Even before Russia invaded Ukraine, inflation had already reached or surpassed 5% in many regions including the UK, US and Eurozone, with rising gas and energy prices fuelling a large part of the rise. Capital Monitor said world-wide inflation would stall the conversation on carbon taxes throughout 2022 for fear of adding to prices pressures.
Outcome: Any multilateral progress concerning carbon taxes was limited to non-existent. On the eve of Cop27, the head of the International Monetary Fund, Kristalina Georgieva, said the price of carbon needs to average at least $75 a tonne globally by 2030 for global climate goals to succeed. Presumably anticipating some progress at Cop27, Geogieva would have been disappointed; no significant updates on carbon tax were made at the event held in Egypt.
Whether rapid inflation was a primary driver for a lack of momentum is hard to tell. No doubt Putin’s war has had an impact on inflation and re-focused political attention to more pressing matters. But to a greater degree, getting countries to align on carbon tax has always been seen like wishful thinking, regardless of macro-economic headwinds.
Prediction: More bank climate stress tests in the offing
Banks will be under greater scrutiny from regulators and supervisors to meet their expectations on climate. In November 2021, the European Central Bank (ECB) said that none of the 112 banks it supervises is close to meeting all its expectations on climate and environmental risks. While almost all banks developed plans to improve ESG-related practices, less than a third have policies in place the central bank deems “broadly adequate”.
Outcome: The subject of climate stress testing has become something of a political hot potato; certainly since the US Federal Reserve Chairman, Jerome Powell, made clear in January that unless given the authority from Congress, its job is not to be a climate regulator. Although, that’s not the same thing as climate stress testing, it shows just how sensitive the subject is within the world’s wealthiest nation.
Other banks are less concerned about the appearance of neutrality. The Bank of England has signalled it will consider the UK government’s environmental goals in buying assets in financial markets, while the ECB is already active in managing its own bond portfolio in favour of issuers that pollute less. Both have conducted stress tests.
Prediction: Investors will acquire voting rights within more pooled funds
On the back of news that BlackRock was intending to do something about it, we said it was likely that more pooled/commingled funds that allow clients to vote with their shares will be launched in 2022, driving an increase in support for ESG proposals. We based this on the fact that the UK government felt it necessary to wade in on the subject after much push back from asset managers claiming it’s too complicated to handle. A government-backed UK taskforce warned that legislation would be tabled if the industry resists.
Outcome: Well, some of the biggest managers out there have certainly moved on this. In June, BlackRock said it was planning to expand its programme to allow proxy voting where possible. Vanguard also announced the launch of pilot programmes to increase investor input on proxy voting. The governance initiatives from the two largest asset managers firms come as companies have been lambasted for their ESG products and portfolios by politicians and other managers. In addition, Charles Schwab said in October it will “poll fund shareholders to understand their overarching preferences regarding key proxy issues”.
Prediction: Watch out for the fossil fuel divestment fallout
Capital Monitor expected the divestment of fossil fuels to hit a tipping point in 2022, forcing those still invested to closely monitor how engagement on the energy transition is effective. Douglas Flint, chairman of UK fund house Abrdn, aired the same view – stressing the necessity for a robust impact measurement system to assess the effectiveness of engaging with carbon-intensive companies.
Outcome: That tipping may not have come in 2022, but the debate on how to treat fossil fuel investments rages on. The ability to measure effective engagement still seems far off, with investors still struggling to know how to do it in the first place, let alone report on it or prove impact – at least on any scale worth noting.
That said, the power of the people to enforce change should never be in doubt. Late last year, the number of UK universities committing to fossil fuel divestment reached 100 – well over half the UK sector. The signatories include Edinburgh, Manchester and King’s College London, and multiple colleges of Oxford and Cambridge. If more follow suit, this will make the passive investment houses think more carefully about their product offerings.
Prediction: Net zero lawsuits will jump
Given 2021 proved a bonanza year for issuing net zero targets, it seemed sensible to assume 2022 would give rise to increased scrutiny over their credibility. Litigation has become an increasingly popular tool for campaigners to hold the powerful to account. Globally, climate cases have more than doubled since 2015, and more climate litigation on both sides of the energy transition and the Atlantic is almost certain in 2022
Outcome: It’s a stretch to say there was a “jump” on legal proceedings, but the trend is clear: the law courts will be a prime venue to conclude net zero disputes.
According to research conducted by Grantham Research Institute in May 2022, court cases are becoming increasingly commonplace and NGOs are bringing highly credible legal challenges to bear. A headline case includes the legal action started by British charity ClientEarth in March against 13 directors at oil major Shell, claiming they had breached their duty to adequately prepare the company for the energy transition, which could prove a watershed case.
Prediction: Investors to scrutinise SLBs more seriously
Capital Monitor is a fan of sustainability-linked finance. However, despite its healthy progress, we warned of rather evident weaknesses within the asset class: a lack of product standardisation, penalties for missing the KPIs weren’t meaningful, and issuers shouldn’t be allowed to redeem debt if KPIs were going to be missed. As such, we predicted much bigger scrutiny of the emerging instrument by investors, thanks to greater engagement from the public about transition issues in general.
Outcome: The jury is out on this one. It’s been a tough-ish year for green and sustainability-linked finance, although much of that follows the overall characteristics of the primary debt markets in general. That said, the market has grown and should continue to thrive in 2023. Moody’s Investor Services forecasts issuance levels will hit a record $1.35trn this year.
However, the success of sustainability-linked bonds has certainly attracted political scrutiny, notably in the EU. As we predicted, there are concerns KPIs are too easy to meet and investors need to push issuers a little harder. Eila Kreivi, chief advisor on sustainable finance at the European Investment Bank (EIB) said as much late last year:
“This is the same logic that we have seen in the [sustainable finance] taxonomy: in order to be green, you need to make a substantial contribution” to the EU’s wider environmental objectives, she said. “A small contribution is fine, but it’s not enough…I think it would be helpful if the market were to self-organise a little bit better.”
Prediction: The emergence of the two-faced board director
CEOs of high profile companies know full well what can happen if they fail to perform financially. Emmanuel Faber’s downfall was a warning to many. He put ESG at the heart of Danone’s strategy, created a carbon-adjusted earnings per share indicator, and turned the business into the French equivalent of a B-Corp, Faber was ousted in 2021 because the group’s performance lagged behind peers.
Capital Monitor expected to see the C-suite struggle to manage the balance between future-proofing companies, making them more sustainable and handling shorter-term financial pressures and increasingly hostile anti-ESG political pressure and press attention.
Outcome: Well, if Larry Fink is anything to go by then the situation has only deteriorated since we first flagged this issue. Seemingly both devil and angel, the CEO of BlackRock has taken considerable flak for the fund manager's approach to ESG – considered both a climate laggard and a zealot in the same breadth.
In December, London-based Bluebell Capital Partners, a $250m hedge fund, criticised Fink for being inconsistent on ESG and said that he had “alienated clients and attracted an undesired level of negative publicity”.
“The contradictions and apparent hypocrisy of BlackRock’s actions have…politicised the ESG debate,” Bluebell wrote in a letter. “The reputational damage of being dragged into this politically charged debate, in our view, is very significant because it calls into question the independence of BlackRock as an asset manager.”
Fink has since said publicly that ESG debate has becoming ugly and personal. Sadly, he’s not wrong.
Prediction: Banks to introduce oil and gas exclusion policies
Although it is easy to bash the banks for their involvement in financing fossil fuels, it is genuinely difficult to unwind exposure to it. It really comes down to commitment and a preparedness to take a financial and reputational hit.
As Capital Monitor reported last year, few banks have policies limiting exposure to conventional oil and gas, despite the International Energy Agency’s warning in 2021 there can be no new oil and gas projects heading in 2022. As far as we were aware, La Banque Postale became the first bank to commit to exiting all fossil fuels, including conventional oil and gas. We were confident more would follow.
Outcome: Umm… not great by most accounts. On the plus side, just ahead of Cop27, Lloyds Banking Group – the UK’s biggest domestic bank – announced it would no longer fund new oil and gas fields with project finance, placing in the top 10% of banks for oil and gas exclusion policies, based off the Oil and Gas Policy Tracker, compiled by the NGO Reclaim Finance.
Lloyds is the first UK-based bank to make such a commitment, although it doesn’t exclude the bank from using other alternative forms of finance. Based on Reclaim Finance data, the European banks are further ahead on restricting their exposure to oil and gas on the whole, but none share the same level of commitment as La Bank Postale. The less said about the US banks, the better.
Prediction: 2030 to become the new 2050
As do many, Capital Monitor believes 2050 net zero ambitions count for very little without the publication of interim targets. Our prediction therefore would be the number of companies signed up to the Science-Based Targets initiative, as well as the number with approved interim targets, will snowball, as will the number of members signed up to the Glasgow Financial Alliance for Net Zero (Gfanz).
In the coming months, signatories are expected to present plans for interim targets, for 2030 or sooner. Investors will be forced to come to a consensus on how to set targets for particular asset classes, like passively managed assets or hard-to-abate sectors.
Outcome: Based on data supplied by the UN, more than 3,000 businesses and financial institutions are working with the Science-Based Targets Initiative to reduce their emissions in line with climate science. And “more than 1,000 cities, over 1,000 educational institutions, and over 400 financial institutions have joined the Race to Zero,” a commitment to halve global emissions by 2030.
Without context, it's hard to know if these numbers are good, okay or deeply depressing. Unfortunately, it seems most experts agree that whatever commitments are put on the table, our current trajectory will see us easily exceed the 1.5C target by 2050 above pre-industrial levels.
Prediction: More thematic ESG funds will be launched
Given the huge regulatory developments coming from on high in Europe (think SFDR), Capital Monitor said it expected to see a move away from generic ESG funds, with more capital directed towards thematic ESG products, like those focused specifically on low-carbon assets or particular social themes.
Outcome: Tricky one to analyse. Despite the overall ETF market suffering net outflows of AUM, ESG ETFs gathered €14.9bn in the fourth quarter, pushing the annual total up to €51bn, accounting for 18.8% of total assets in ETFs and exchange-trade commodities in Europe, according to Morningstar analysis.
Thematic ETFs attracted €1.3bn of investments in 2022, but this data is not broken down into ESG and non-ESG themes. Either way, the annual figure was significantly down from €11.2bn from 2021.
Anecdotally, demand for ESG-thematic funds was positive. An October article published by the FT provided some evidence that, despite the overall downturn, investors still wanted to exposure to ESG in some way. The report read: “From clean energy funds, such as iShares Global Clean Energy ETF to gender equality funds such as Lyxor Global Gender Equality UCITS ETF, many of the new thematic portfolios can be viewed as increasingly specialised ESG investments — matching a trend towards a greater granularity in fund offerings, as seen in other thematic segments.”
Prediction: Social housing investment to ramp up
The Covid-19 pandemic highlighted financial and social inequalities worldwide. So, while we expected to see social investment themes attract more investor attention in 2022, we thought social housing looks nicely set to draw capital flows in the UK.
Outcome: It’s been hard to obtain overall investment figures into social housing in the UK for 2022, but anecdotally investors have committed capital to the sector.
Examples include the Pension Insurance Corporation’s £40m debt investment into Housing Solutions, a provider with around 7,500 homes. The Cornwall Pension Fund helped set up an impact fund that secured £65m of new affordable housing to be built in South West England.
The UK government and Big Society Capital announced in January a £20m investment to provide safe and affordable homes to families at risk of homelessness in England. The Department for Levelling Up, Housing and Communities is providing a £10m grant to match it.