Climate change targets will only be achieved if both developed and emerging markets work together, as we will see at Sharm el-Sheikh
Notwithstanding the threat of an economic downturn, the momentum that drives the focus on ESG strategy is accelerating. The Financial Conduct Authority and the Financial Reporting Council recognised this trend in their assessments on the quality of first-year reporting of premium-listed companies by the Task Force on Climate-related Financial Disclosures. They found that companies are treating climate-related considerations as risks without adequately balancing such risks against the considerable opportunities.
Striking the appropriate balance is easier said than done, especially when directors feel much less confident in emerging areas, such as the requirements for climaterelated disclosures. It is natural and prudent to be averse to risk.
International regulators have pushed forward with mandating and standardising ESG disclosure, with the EU pressing ahead with the Non-Financial Reporting Directive, the Sustainable Finance Disclosure Regulation and the Climate Transition Benchmarks Regulation. There is also the EU Taxonomy Regulation, EU Green Bond Standards, the Corporate Sustainability Reporting Directive and EU ecolabel extension proposals.
The rapid strengthening of EU disclosure regimes is driven by policies to enhance investor comfort and encourage European businesses to improve ESG performance, both in their own operations and value chains.
On the flipside, there are no mandatory disclosure regimes in the US, and federal regulators have been hesitant to follow the EU's example. There has been considerable political pressure against pro-ESG investments. While the Securities and Exchange Commission has proposed climate disclosure rules, the risk is that adoption of such rules could lead to litigation that challenges the SEC's authority based on the "major questions doctrine", as recently seen in the West Virginia vs Environmental Protection Agency court case.
Emerging markets — with their perceived additional ESG-related risks — may in the short-term miss out on investment. However, the Paris Agreement targets and the Sustainable Development Goals can be achieved only if developed and emerging market stakeholders work together. This will be one of the headline topics to be addressed at COP27 in Sharm el-Sheikh, Egypt, in November.
Providing higher quality, reliable (and non-boilerplate) disclosure is critical to reducing the risks entailed in emerging markets investment. In parallel to regulatory risk, recent spates of naming-and-shaming press reports have increased reputational risk for companies who may "get it wrong" in their approach to ESG.
Investors may benefit from collaborating with external experts to develop knowledge and drive better-informed decisions on which projects are best aligned with commitments to internationally recognised principles and standards.
Investors can apply responsible investment approaches aided by increased regulatory intervention through the introduction of mandatory due diligence legislation. Examples are Germany and Norway and the EU's proposal for a directive on corporate sustainability due diligence. The draft directive ensures the effective prevention and mitigation of potentially adverse effects on human rights by placing companies under an obligation to prioritise engagement with suppliers and other business relationships throughout the value chain, instead of using termination as a last resort.
The hope is that once investors realise how they can mitigate the perception of ESG risk by applying responsible investment approaches to emerging market investments, they can reap the financial and reputational rewards of gaining exposure to growing economies. This will not only diversify their portfolios but create long-term impact too.
White & Case LLP has partnered with the Financial Times on the publication of its Moral Money Forum reports, which explore key issues from the ESG debate. This article has been reproduced with permission from the Financial Times.
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