Sustainability – Stakes are increasing as sustainability-related risks and opportunities face greater scrutiny
To misquote Mark Twain, ‘Reports of ESG’s death have been greatly exaggerated’. While 2023 saw the term ESG challenged, the environmental, social and governance challenges that this acronym represents will continue to shape the investment and regulatory landscape; in many cases exacerbated by geopolitics and physical impacts of climate change.
The disorderly transition
The stakes are increasing as both climate-related physical and transition risks are becoming more impactful. On the physical side, we are already seeing extreme weather events on a more regular basis, and these are expected to increase in frequency. Coupled with the El Niño, this could extend the already record-high temperatures we have seen towards the end of 2023 into 2024 – impacting agriculture and food supply, manufacturing, and human health – and increasing the focus on resilience and adaptation.
On the policy front, just 12 months on from the introduction of the US Inflation Reduction Act, it has reportedly created more than 170,000 clean energy jobs and led companies to announce over USD 110 billion in clean energy investment. The European Green Deal, with ambitious targets and measures such as the Carbon Border Adjustment Mechanism, regulating carbon-intensive products imported to the EU, such as cement, iron and steel, fertiliser and electricity, could have a significant impact on supply chains, pricing and where companies chose to locate.
The investment opportunities for the transition are evident in the acceleration of clean energy innovation. So too are the challenges, dependencies and potential trade-offs associated with, for example, the growing demand for critical minerals, grid infrastructure and connectivity. And the potential impact of transformative technologies, such as generative artificial intelligence (AI) and automation are all still to be fully understood.
The question is how these complex dynamics will play out – delayed or accelerated action, competition and innovation or friction in global trade? National policies, incentives and responses will need to be much more closely watched and, as we have seen from recent UK policy announcements, liable to change.
Our nature (inter)dependency
With over half the world’s GDP reliant on nature and with the huge potential of nature-based responses to provide cost-effective solutions on both climate mitigation and adaptation, our dependency on nature and the interdependency with addressing the climate challenge is increasingly understood.
Building on the Taskforce on Nature-related Financial Disclosures issued in September 2023, and the publication by the Network for Greening the Financial System, comprising over 100 central banks and supervisors globally, of a framework to assess the interactions between nature, the macroeconomy and the financial system, we expect to see a continued focus on nature from investors and regulators.
Progress in 2024 at COP16 on the Kunming-Montreal Global Biodiversity Framework and National Biodiversity Strategy and Actions Plans will be critical to determine the speed with which policy and finance will mobilise behind the target to halt and reverse nature loss by 2030 and plug the estimated annual USD 700 billion biodiversity finance gap.
Sustainability disclosure no longer optional
Up to 50,000 companies in the EU and non-EU companies with EU subsidiaries or regulated entities will be subject to mandatory sustainability reporting under the EU Corporate Sustainability Reporting Directive (CSRD), being introduced from 2024. This will include a requirement to disclose a climate transition plan. Set to work alongside this disclosure regulation, the proposed EU Corporate Sustainability Due Diligence Directive (CSDDD), once introduced, will also require companies to monitor their supply chains for the risk of violations of human rights and negative environmental impacts. We also expect developments in the US with proposals for the Securities and Exchange Commission (SEC) Climate Disclosures under consideration, and the SEC Human Capital Disclosures that require companies to disclose human capital measures.
This mandatory reporting will be supplemented with industry standards such as the IFRS sustainability and climate standards issued by the International Sustainability Standards Board (ISSB) and the UK Transition Plan Taskforce guidance.
Sustainability disclosure and labelling will also step up in 2024 with proposals from the European Securities and Markets Authority, Financial Conduct Authority and SEC all setting more detailed parameters for sustainability-related funds.
As regulators, supervisory authorities and investors seek greater transparency and accountability, we expect data and disclosures to face greater scrutiny as they are integrated into the investment process.
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