ESG Watch: Why this year could be a watershed moment for investors on nature-related risk

A resident walks along a flooded street, after rainstorms slammed northern California earlier this month. REUTERS/Carlos Barria

January 10 - Environmental, social and governance (ESG) issues were central to many of the biggest stories of 2022. Indeed, ESG investors frequently found themselves the story, particularly in the U.S., where figures such as Florida governor Ron DeSantis, as well as other states such as Texas and West Virginia, accused asset managers of pursuing ideological goals through their use of ESG to assess risks.

As index provider MSCI points out, regulators around the world have upped the ante “on everything from greenwashed fund names, to stricter climate target disclosures, while the very idea of ESG investing is increasingly politicised”.

These challenges are unlikely to go away in 2023. With the new year starting with record January temperatures in Europe and winter storms in almost all of the U.S., the impacts of climate change will continue to dominate the agenda over the next 12 months.

Yet there are signs of progress. Europe continues to rapidly wean itself off Russian fossil fuels and to increase its renewable energy capacity, in a bid to boost energy security as much as to reduce its emissions. The astonishing growth in renewable energy capacity looks set to continue in 2023. While the impacts of the energy crisis have been far-reaching, it has also accelerated the decarbonisation of the economy in Europe, and shown that a fossil fuel-free future could be closer than was previously thought possible.

Climate regulation is now top of mind not just in the EU, but increasingly in the United States and in the Asia Pacific region, according to MSCI, “from requirements for financial institutions to conduct climate stress tests, to deforestation-free market-access rules”.

Pressure to disclose climate risks will increase, with the U.S. Securities and Exchange Commission’s (SEC) proposed disclosure rules set to be published in April. The International Sustainability Standards Board’s sustainability disclosure standards are also set to launch in early 2023, adding to the impetus for firms to outline how they are dealing with climate impacts, and bringing a certain level of standardisation to the process.

The Saint-Nazaire offshore wind farm, off the coast of western France. Europe is increasing its renewable energy capacity as it weans itself off Russian fossil fuels. REUTERS/Stephane Mahe

The increased transparency this disclosure will bring will make it harder for companies to get away with greenwashing.

Edelman’s annual trust barometer is due to be published next week, but it is unlikely to show an improvement on last year’s survey, which found that almost half of people don’t trust business to tackle climate change, so regulators’ efforts to crack down on greenwash will be welcome.

But ESG-focused investment is set to rebound from last year, when inflation and higher interest rates weighed on sentiment and saw corporate ESG bond issuance fall by almost a quarter from the year before, according to Barclays. The bank predicts that ESG bond sales will almost equal 2021’s $461 billion this year, up from 2022’s $362 billion, with green bonds driving the market.

Nevertheless, inflation is set to remain a key concern in the coming months, and workers struggling with the cost of living will be a key social issue for many companies. At the same time, businesses will have to grapple with the higher cost of goods and services in their supply chains, not least those making and providing renewable energy. The high cost of energy will further drive efforts by businesses to improve efficiency and reduce demand.

The attacks on ESG by Republican lawmakers will continue, but the attacks should become harder to sustain as time goes on: ESG risks are not going away, and investors, companies and state pension funds that ignore them will underperform, highlighting the importance of these issues.

In a number of key markets, climate investment is set to return to centre stage. The U.S. passage of the Inflation Reduction Act, with its $369 billion of climate-related funding, is expected to turbocharge investment in technologies such as renewable energy, electric vehicles, heat pumps, carbon capture and storage, and hydrogen.

Dead fish float in the Oder River at the Polish border with Germany. U.N. statistics show that 80% of wastewater is released into the environment without being treated or reused. REUTERS/Lisi Niesner

A new administration in Australia is revitalising the clean energy sector there, while in Brazil, investors will be watching whether the new administration of Luiz Inacio Lula da Silva will be able to turn the tide on the rampant deforestation that occurred during Jair Bolsonaro’s tenure.

Lula’s appointment of Marina Silva as environment minister bodes well. Silva, the daughter of a destitute rubber tapper, cut Amazonian deforestation by up to 70% during the previous Lula government, but the challenge this time will be much greater, something that was forcefully underscored by the storming of the Brazilian Congress by Bolsonaro’s supporters.

While the COP15 biodiversity summit in Canada was fairly low key, it could have a big impact in 2023, with more businesses looking at their operations with a focus on biodiversity risks and opportunities.

Mark Gough, chief executive of the Capitals Coalition, said in a statement that the Global Biodiversity Framework, to protect 30% of the world’s land and oceans, which was agreed at COP15, would provide “new impetus and direction for ESG” in 2023, pushing business and financial institutions to assess and disclose their risks, impacts and dependencies on nature.

“Frameworks and tools such as the Natural Capital Protocol and those in development, such as the Taskforce on Nature-related Financial Disclosure (TNFD) and Science Based Targets for Nature (SBTN) will aid implementation (of the framework) in 2023 and beyond.”

Pressure will grow on companies to disclose these risks, particularly in key sectors such as food and beverages, mining, energy, infrastructure, pharmaceuticals and agriculture.

The need to build a more sustainable and resilient global food system is starting to get the urgent attention it requires, says Maria Lettini, executive director of the FAIRR Initiative. “The climate crisis, war in Ukraine and COVID-19 exposed how vulnerable our food system is to global shocks and placed our food system under the spotlight.”

Water, however, remains an under-appreciated risk, according to CDP. Despite United Nations’ statistics that 80% of wastewater is released into the environment without being treated or reused, and almost three-quarters of recent disasters are water-related, just 18% of financial institutions identified water-related issues as a risk to their portfolios in 2022, CDP said. Greater investor focus on water is expected this year, however, with the U.N. set to hold a dedicated water conference in March, for the first time in almost half a century.

“The U.N,’s recent biodiversity conference showed that investors are starting to recognise how the climate and nature crises are inextricably linked,” says Cate Lamb, CDP’s global director of water security.

“But we still have a long way to go before investors think, or value, water in the same way as climate. Financial institutions urgently need to stop pouring money into projects which are putting the world’s fragile water systems in grave danger.”

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Sustainable Business Review, a part of Reuters Professional, is owned by Thomson Reuters and operates independently of Reuters News.

Mike Scott is a former Financial Times journalist who is now a freelance writer specialising in business and sustainability. He has written for The Guardian, the Daily Telegraph, The Times, Forbes, Fortune and Bloomberg.