ESG+ Newsletter – 28 March 2024

This week’s newsletter covers a number of EU-related developments, with back and forth on the merits of defence funding through an ESG lens, the EU Nature Law hitting a significant roadblock, and details on ESMA’s intention to publish its final greenwashing report this summer. Outside of the EU, we look at the shareholder proposal landscape in the US, analyse potential areas of scrutiny at French AGMs and detail FTI’s own research, which finds that one in three senior executives believe CISOs are ineffective in communicating cybersecurity risk.

ESG Regulatory Update

As ESG regulations rapidly develop, FTI Consulting is providing a quick summary of need-to-know updates from around the globe. This month we cover the United States’ final climate disclosure rules, movement on corporate sustainability due diligence and forced labor legislation in the EU, as well as ISSB-based climate reporting standards in Singapore and Canada. https://fticommunications.com/esg-regulations-global-update-march-2024/

EU Nature Restoration Law hits major stumbling block

Despite being adopted by the European Parliament in February, as reported by this newsletter, the EU’s ambitious nature restoration plan may be on the brink of failure after multiple member states withdrew their support for the law. The Nature Restoration Law aimed to restore at least 20% of the EU’s land and sea areas by 2030; however, it has hit a major roadblock with Hungary, Italy, the Netherlands, Sweden, Poland, and Finland withholding their support in a critical vote, according to ESG News. Justifications for the withdrawal of support were varied, including the Netherlands citing issues with binding restoration targets for 2040 and 2050 and Hungary expressing concerns about the impact on agriculture and food security. This reversal was unexpected and has drawn some criticism on the credibility of EU institutions. Given that EU elections are scheduled for later this year, the likelihood of reaching a compromise before the end of the current parliament is low. Since the Nature Restoration Law is foundational to the EU Green Deal, the latest development represents a major blow to the EU’s green agenda. These challenges also potentially compromise the EU’s credibility in the upcoming international negotiations on global nature restoration that will take place at COP16 in October. The Irish Environment Minister, Eamon Ryan, was scathing in his message to an EU Council of environment ministers on Monday, stating that going into the next European elections without this law agreed upon “would be a disgrace”. 

Heat remains on companies from climate-related shareholder proposals

A recent analysis by the sustainability nonprofit Ceres shows that a record 263 climate-related shareholder proposals have already been filed at annual meetings of US companies, surpassing the record 259 resolutions filed in 2023. Despite the increase in the number of climate-related shareholder proposals year-on-year, the drop in support for these proposals in recent years has raised questions about both their effectiveness and the evolution of investors’ expectations. This year however, a proposal demanding that one company reports scope 1 and 2 emissions and its plans to reduce them has received majority support from shareholders, highlighting that some “investors continue to be discerning and willing to support some resolutions”, as noted by a senior researcher for The Conference Board in a recent Reuters article. Alongside the focus on climate-related proposals, Ceres’ analysis also found a growing number of proposals related to biodiversity loss, particularly on topics related to plastics and water use. Investors, such as Fidelity, who has recently published its Nature Roadmap, said in an Environmental Finance article, that it will consider “lending its support” to these resolutions as it envisages an increasing number of nature related resolutions. Ultimately, as the scrutiny on the merits of shareholder proposals grows, the most effective means of pressurising companies will be grounded in constructive engagement and voting, with consideration to the specific structures and strategy of each company. In response, companies should put in place preparedness plans for ESG-related activists, with a focus on material sustainability issues a meaningful place to start. 

Trust gap persists between C-Suite and CISO despite push for cybersecurity oversight

New research this week from our own teams at FTI Consulting has revealed that one in three senior executives believe Chief Information Security Officers (CISOs) are both ineffectively and inaccurately communicating cybersecurity risk. The research was based on a survey of 787 C-suite executives at organisations with more than 500 employees and explored the communications challenges that persist at the top levels of businesses when it comes to cybersecurity. Despite almost nine in ten organisations increasing their CISOs’ decision-making responsibilities, many senior leaders doubt their CISOs’ ability to communicate with other stakeholders, indicating a lack of trust between executives and security teams that could ultimately leave organisations vulnerable to attack and potential regulatory enforcement. In this sense, the challenges are similar to those faced by heads of sustainability, where communicating with internal and external stakeholders is paramount to genuine business transformation.

The study’s findings highlight the challenges organisations face, as governments and regulators seek to standardise the management of cybersecurity risk and push for organisations to demonstrate a top-down approach to cybersecurity. The EU’s upcoming Network and Information Security Directive (NIS2) will impose management accountability for non-compliance with cybersecurity obligations, while the widely-adopted US National Institute of Standards and Technology’s (NIST) Cybersecurity Framework was recently updated to include a governance function, stipulating how cybersecurity should be integrated into an organisation’s broader risk management strategy. Regulators and other stakeholders want to see robust engagement and trust between senior leaders and CISOs which can be achieved through regular cybersecurity briefings, clear roles and procedures around incident response, combined with robust testing of response plans.

Defence funding, ESG and the European Investment Bank

On the back of geopolitical tensions driven by the war in Ukraine and conflict in the Middle East, global defence spending has increased over the past year. In Europe, defence funding has come sharply into focus with growing pressure to provide more funding to support the region’s military capability and security. Both the EU Commission and member states have recently been placing pressure on the European Investment Bank (EIB) – the lending arm of the EU – to end its near-total ban on weapons funding to help strengthen Europe’s defence industry. However, a recent Reuters article highlighted the problem that this change in funding allocation could have on the EIB’s ratings. The EIB’s primary investing remit is to focus on environmental and social projects, and a departure from this has been met with scepticism from both investors and ESG rating agencies, who believe that it would materially impact the EIB’s ESG score and result in higher borrowing costs. 

Integration of ESG in pay presents opportunities and risks

Executive compensation is increasingly tied to ESG, a trend noted by Bloomberg, as a third of the top 1,000 US companies are doing so – double that of 2016. However, there is a level of concern from investors that it is not always translating to desired outcomes. Ambiguous language as part of the bonus criteria, and a lack of clear KPIs and potentially easy-to-clear thresholds can lead to inflated pay without substantial ESG progress. And even on more quantifiable data, companies have been criticised for paying ESG bonuses despite rising CO2 emissions. The use of such measures – and their lack of transparency – run the risk of attracting negative scrutiny, with activist shareholders using the link between higher pay and ESG as a means to attack investee companies. 

As investors recognise ESG as an investment risk, it emphasises CEO accountability beyond delegating to sustainability officers. Linking compensation to material issues can be a positive; however, such measures need to be demonstrably linked to long-term strategy and value creation, while also being quantifiable, to allow for shareholders to assess their efficacy. Ultimately, ESG integration into executive compensation needs to reflect a genuine commitment by the company, which can be supported by transparent progress reports and evidence of how it links to meaningful sustainability improvements.

Source confirms updated ESMA greenwashing guidance

An EU regulatory source has confirmed to Responsible Investor that the European Securities and Markets Authority (ESMA) will publish its final greenwashing report this summer, building on its previous progress report for addressing the challenges that national competent authorities (NCAs) face with oversight.

The guidance is reported to relate to the supervision of the watershed Corporate Sustainability Reporting Directive, which requires companies with significant activities in the EU to undertake and publish double materiality assessments and dial in more generally on the issue of materiality in reporting, and the oversight of sustainable investment principles. The latter issue has been cited consistently by the European Commission as a core need in the ongoing battle to combat greenwashing at the asset manager level. Within this, the relatively new phenomenon of engagement washing is a notable focus area. Active participation by shareholders in steering companies to stronger material ESG performance is a core principle of contemporary sustainable investing, in part driven by the consistent strong financial profiles of hard-to-abate sectors and valuations of clean energy stocks, which once prioritised complete divestment. As covered by Responsible Investor, it is an aspect of stewardship that is of increasing awareness in the market, with a recent publication by PGIM noting the degree to which effective engagement can become influential on a macro-level by “mitigating negative impacts of certain economic activities on our environment and society“. While it can be costly for businesses to implement requisite changes to achieve this, PGIM views engagement as a key fiduciary duty. 

Key areas of focus – French 2024 AGM season

Last week, FTI published our French Governance Snapshot, setting out considerations on the areas most likely to draw scrutiny from the market in 2024. The note digs into executive remuneration; director accountability; growth in ‘pass-through voting’; ESG; and shareholder activism. Despite differences in shareholder structures and registers in comparison to the UK and US, French companies have not been immune from significant opposition as the focus on governance, remuneration and ESG has grown globally. For 2024, remuneration structures and clarity of disclosure are expected to remain the main sources of opposition at AGMs; however, new guidelines from proxy advisors on director accountability, the disclosure of climate-related information, the management of cyber security incidents and the use of capital structures with unequal voting rights, may spur greater opposition for those viewed as lagging market practice. Alongside rising governance and ESG expectations, French boards must also cope with a surge in traditional (financial) shareholder activism across Europe, while recent recommendations from the legal expert group, ‘Haut Comité Juridique de la Place Financière de Paris’, may possibly pave the way for an increase in shareholder resolutions. While the number of issues facing companies grows, asset managers have simultaneously been rolling out ‘pass-through’ voting solutions, allowing asset owners to cast their votes either in alignment with the asset manager’s approach or according to different guidelines, perhaps presenting challenges for companies in anticipating, or understanding, vote results. Regardless of sector or issue, as the majority of French AGMs take place over the coming months, those that place a focus on relationships with shareholders – through engagement and meaningful communication – will stand to benefit in terms of stronger support at the AGM.

ICYMI 

• Vietnam Could Earn $200 Million Annually From Carbon Credit Trades. The country has signed an emissions reduction purchase agreement with Emergent, a non-profit intermediary engaging between tropical forest countries and the private sector, to mobilise finance to support emissions reductions in deforestation.
• MSCI Study Reveals Heavier Net Zero Transition Opportunities Exposure for Private vs Public Climate Funds. MSCI’s report revealed private markets funds are focusing on areas within carbon-intensive sectors positioned to benefit from the net zero transition, compared to public funds investing heavily in areas with already-reduced carbon footprints.
• AMF resources for CSRD supervision are ‘extremely constrained’. The French financial watchdog is experiencing budget and staffing difficulties amid new CSRD requirements, amidst other EU regulators recently announcing plans to assess their resources.