The Latest Developments in ESG

Increasingly, shareholders and stakeholders want to know that the companies they are investing in share their values of sustainability and equity, and do not have ties to corruption, environmental destruction, or human rights abuses.  These are not only ethical and humanitarian issues but pose financial risks as well.  In this podcast, E3 dives into the context and anticipated regulatory changes in this area, with Carol Ho, E3’s environmental engineer.  

One of the most compelling developments is the movement toward standardizing ESG metrics, which will be further solidified by the release of proposed rules from the Securities and Exchange Commission (SEC) regarding climate disclosures from public companies.  Listen as Carol and Ginger discuss the SEC rules, reaction to the proposed rules, and ESG trends in other parts of the world. 

Transcript

Ginger Elbaum (9s):
Welcome to The Top Three by E3 a monthly podcast about the intersection between engineering energy and project finance. My name is Ginger Elbaum, managing director at E3 and I'll be your host today. So increasingly shareholders and stakeholders want to know that the companies they're investing in share their values of sustainability and equity, and don't have ties to corruption, environmental destruction, or human rights abuses. These are not only ethical and humanitarian issues, but also pose financial risk as well. So in this podcast, we'll dive into the context and anticipated regulatory changes in this area with Carol Ho, an environmental engineer. Hi Carol.

Carol Ho (48s):
Hi Ginger.

Ginger Elbaum (49s):
Carol, ESG has become more mainstream in the world of finance and investing. Can you just provide some background on ESG?

Carol Ho (56s):
Sure. Sounds good. Thanks for having me. How about business manages environmental social and corporate governance or ESG is coming into focus throughout the economy, including the energy industry. A company's commitment to ESG values is becoming an increasingly important factor to investors on March 21st, 2022, just a few weeks ago, the securities and exchange commission sec issued a proposed rule for climate related disclosures as significant milestone that has the attention of the finance community. But to back up a little, the term ESG covers a broad range of issues that have been making headlines over the years, that relate to how we do business, how business decisions might be impacting the environment and vulnerable people.

Carol Ho (1m 43s):
There are well-known issues in specific industries, such as seafood diamonds, clothing, manufacturing that have inspired, specific research and accountability in those areas. So in ways that consumers want to know whether the food or clothing that they are buying is sustainable. Investors want to know if what they're investing in is in line with their values, funds or companies may advertise themselves as sustainable. But what does that mean? Exactly. People are concerned about false or exaggerated claims, which has become known as greenwashing.

Ginger Elbaum (2m 19s):
I've heard of greenwashing. So how can that be identified or, or even prevented?

Carol Ho (2m 25s):
Well, people have been working on, on ESG metrics for a long time. Metrics and reporting will provide a way to standardize that information. So companies have a harder time showing only their good news and concealing other information. They may not want to share, but by evaluating sustainability practices, as a matter of course, and having a way to compare performance, the performance of companies, apples to apples investors can make more informed decisions. There are a number of voluntary reporting mechanisms that have been around for many years. Some well-known ones are the global initiative, the carbon disclosure project and the task force on climate related financial disclosures.

Carol Ho (3m 7s):
Although thousands of companies globally are participating in these, you can see the limitation has, these are voluntary and they don't have a requirement for third-party verification or assurance, but by codifying or regulating the metrics and reporting requirements. Now you have data that can be evenly compared several industry and government standard setting bodies and policy makers have been working in this field for many years and have recently consolidated. I won't go through that list because it's a lot of acronyms that basically several organizations are being merged into the international financial reporting standards. I F R S foundation to create one global body to oversee development of sustainability standards.

Carol Ho (3m 51s):
And one of those is the SEC rule that I just mentioned.

Ginger Elbaum (3m 55s):
So Carol, how will the SEC rule work?

Carol Ho (3m 58s):
Well, the SEC rule will require a publicly traded companies to address or disclose climate risks. First of all, companies will need to report their Scope one, two and three greenhouse gas emissions. Scope one and two emissions are those emitted directly by company facilities, as well as those emissions from a company's electricity use. So they're fairly easy to measure. Scope three emissions can be very hard to calculate. These are the emissions from up and down the supply chain of a company, such as emissions from manufacturing of components for your product or disposal of a product at the end of its life, but not just related to products. The Scope three emissions include vehicle emissions of employees commuting to work.

Carol Ho (4m 42s):
So these can be very moving fuzzy targets to try to even add up. Whether or not to include Scope three has been a controversial issue during the SECs first request for comment. But the proposed rule does include a safe Harbor for Scope three legally, meaning that the SEC will not hold companies liable for Scope three estimates that are provided in good faith, but it remains to be seen if those will be left in the final rule. The other aspect of reporting will be narrative companies need to disclose actual or likely material impacts that climate-related risks will have on their business strategy and outlook, including physical risks to actual manufacturing plants, for example, as well as transition risks, which is how they will be impacted by the energy transition.

Carol Ho (5m 32s):
This can include disclosure of actual costs that companies have incurred due to extreme weather events. The information is to be included in registration statements and periodic reports, but the rule is over 500 pages long. So these are just some of the highlights. One other important highlight is that if a company has publicly announced a climate-related target or goal, they are required to report details on how they are achieving their stated goals. Investors want to know, for example, if a company is planning to use carbon offsets, or if they are actively reducing their own carbon footprint, this is another way of preventing greenwashing. Finally, I'll mention that critics of the rule consider this regulatory overreach.  Changes to the rule are anticipated before it's finalized based on opposition expressed during the comment period. There is one now after the proposed rule and lawsuits are expected. Nonetheless, even the proposed rules set a new bar.  The law firm Kirkland and Ellis calls this arguably 'one of the most sweeping changes to public company's disclosure obligations in recent memory.'

Ginger Elbaum (6m 42s):
So Carol are companies ready to report under the new SEC rules?

Carol Ho (6m 47s):
Well, the timeline for the rule, which could be delayed is to have a final rule by the end of this year and the reporting requirements starting in the fiscal year 2023, which are then filed in 2024, even. So the SEC rule will cause a flurry of activity for some companies who've been ignoring ESG issues and are not prepared. Many companies though are already creating sustainability reports. Our parent company, ITOCHU, is one that is highlighting their changes and efforts. One clue as to how serious the company is, is whether their boards are engaged with the company's sustainability agenda. Another is whether they are collaborating with other organizations on sustainability matters because sustainability can not happen in a bubble.

Carol Ho (7m 29s):
But in addition to the voluntary reporting discussed earlier, there are several environmental regulations that will contribute data to ESG and have some overlapping requirements with the sec rule, California Senate Bill 260 referred to as the Climate Corporate Accountability Act, which is going through the legislative process now would require US-based companies doing business in California that have annual revenue of $1 billion to report Scope one, two and three greenhouse gas emissions. And that's expected to be over 5,200 large corporations reporting would begin for 2024. And then in 2025, the corporations would have to begin publishing science-based targets.

Carol Ho (8m 12s):
So that's already on the horizon and many are already doing that. There's also the Greenhouse Gas Mandatory Reporting Rule, which requires sources that admit over 25,000 metric tons or more annually of Scope One emissions to report to the EPA, which applies to most of the utility-scale power plants, which we at E3 are very familiar with in the reports and websites. So we are seeing trends toward companies estimating their carbon footprints and announcing goals to reduce carbon emissions. Although reduction requirements are not part of the SEC rule. You hear a lot about net-zero carbon goals. These companies are already navigating how to measure their impact and may already be reporting under one of the voluntary frameworks are out there and they will have a leg up on new regulatory requirements.

Carol Ho (8m 59s):
I'll just add there are some flags to look out for when you're reviewing the company's sustainability reports. For example, right now, if a large multinational sells off a carbon-intensive business segment and say they have a petrochemicals business, they might take credit for the emissions reductions in their sustainability reporting, but those emissions are still occurring. So anyway, standardized protocols for disclosure and reporting will clarify issues like this.

Ginger Elbaum (9m 25s):
So Carol, you know, what about worldwide? Can you tell us a bit about what is happening with ESG regulations in other parts of the world?

Carol Ho (9m 32s):
Sure. So while the SEC rule is just for climate-related disclosures in the US, the European Union and the UK are leading the way with broader ESG rules. The EU recently issued a sustainable finance disclosure regulation, which was supposed to be phased in starting this year, but it was delayed, but the SFDR requires financial market participants and financial advisors to disclose their sustainability risk policy and how adverse impacts are considered disclosure on their websites. In addition to climate-related disclosures, this rule encompasses other ESG factors. These are referred to as indicators, and there are some that are mandatory, others that are optional, the mandatory indicators cover greenhouse gas, emissions, energy, performance, biodiversity, water, and waste issues.

Carol Ho (10m 23s):
Social indicators include employee factors, human rights anti-corruption, and anti-bribery matters. So it covers a lot more under one umbrella than any us regulation. At this point, there's also the taxonomy regulation, which is also an EU regulation. It establishes a definition and criteria for environmental, environmentally-sustainable investments. This is what I would compare to the organic label. So now people can feel more assured that saying something is environmentally sustainable actually has substance and meaning behind it. The criteria are an overview, they're very detailed, but here's the list of the highlights.

Carol Ho (11m 7s):
One, it contributes substantially to any of a list of defined environmental objectives to doesn't significantly harm any of the environmental objectives, three complies with the minimum social safeguards, and lastly complies with specified performance thresholds known as technical screening criteria, which are still to be defined and will probably be, you know, activity or sector-specific. There are other regulations happening elsewhere, but those are a couple of the key ones that are impacting our clients with offices in Europe.

Ginger Elbaum (11m 40s):
It sounds like climate-related disclosures are taking center stage, which is the E and the ESG metrics. Can you talk a bit about the social and governance parts?

Carol Ho (11m 52s):
Yes, sure. This social part of ESG revolves around the people that make up and interact with the business. This includes how employees, customers, and community members are treated and how diversity, equity, and inclusion are part of the company's culture. In an article on the website, ESG clarity, a contributor from Europe spent a few weeks in the U.S. interviewing sustainability leaders. And she reflected that the U.S. is leading the way in this area. Social movements, such as Black Lives Matter have caused us to do some self-reflection.  

Words or checking boxes for diversity are no longer enough. I think the pandemic has caused a lot of questioning of the status quo in many areas.

How will our society change now that we know we are capable of changing and adapting, can we envision a future that we want and then work our way to make it happen? This might be a silver lining to the last couple of very difficult years. 

And then for the governance part, transparency and corporate governance get to the heart of pay equity. How board members are nominated or appointed reporting systems anti-corruption and anti-bribery policies. We've heard a lot about that in the media these last couple of years as well. Although several of those are often already regulated on some level.

Ginger Elbaum (13m 12s):
So here at E3, what trends are we specifically seeing in this area, in your workstream?

Carol Ho (13m 18s):
Well, the move toward environmental sustainability is certainly being reflected in the types of projects that E3 has been engaged with in the past several years. For example, interest in renewable energy and hydrogen fuel are a direct result of the energy transition, which is now in full swing. We all know that, but even other projects show the movement towards sustainability and reducing carbon footprint projects that have come across my desk have involved CO2 capture technology, district energy, using sewer heat, recovery, and even processing cardboard to enhance recycling all of these show, the current and increasing appetite for investments in sustainability.

Ginger Elbaum (13m 59s):
So good. Carol, I love this topic so important. So as I, you know, as the top three at E3, we'd like to provide three key takeaways for our listeners. So what would you like for our listeners to walk away with today?

Carol Ho (14m 12s):
All right. Well, first, just on a high level, recognizing that the importance of sustainability and business is a trend, a good trend, or even a culture shift that's happening. Secondly, ESG needs to be incorporated into a company strategy because shareholders are asking for it, stakeholders, lenders, and customers are demanding it. And three, there are many resources. I didn't really talk about this, but there are a lot of resources to help a company identify which ESG issues are material to their activities. Certainly, on the energy side, E3 could be a resource.

Ginger Elbaum (14m 46s):
Great, Carol, again, this is such an important topic. This has been an excellent podcast, and thank you so much. We appreciate your putting this together for us, and to our listeners thank you for joining our discussion on ESG. If you have any questions for Carol or any suggested topics for our podcasts, please reach out to us at e3@e3co.com. And thanks again for listening and thanks again, Carol.

Carol Ho (15m 12s):
You're welcome. Thanks Ginger.