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Take Five: The Waiting is Almost Over

A selection of the week’s major stories impacting ESG investors, in five easy pieces.

The US and UK saw movement on two long-awaited fronts, while Europe felt the force of electoral anxiety.

Clearing’s present danger – Financial market infrastructures are waking up to climate risks, even as some central banks are scaling back their work in this area. The Eurex Derivatives Forum, held this week in Frankfurt, even dedicated a plenary discussion to the environmental risks to clearing houses – the entities that sit between buyers and sellers of financial instruments, guaranteeing liquidity and anticipating trouble. As noted by Markus Mueller, Chief Investment Officer for ESG at Deutsche Bank’s private bank, financial market participants go bust in much the same way as individuals: “gradually, and then suddenly”. But abrupt collapses are more likely to catch clearing houses off guard if they stem from a combination of unmodelled climate- or nature-related factors, causing risks to ripple unpredictably through the financial system. Mueller worried about our lack of understanding of the ecosystem impacts when a keystone species falls under threat of extinction. “Too many see it as fantasy, but when it happens, it will be sudden and irreversible,” he said. Innovations such as smart contracts tied to data on key metrics, like temperature rises, could provide early warnings and protect the financial ecosystem, Mueller suggested – if not the natural ones.

Good day, sunshine – This week, the US Securities and Exchange Commission (SEC) confirmed that it will finalise rules on climate risk disclosures next Wednesday. Having delayed publication multiple times, it seems the SEC’s hand was finally forced by the threat of a government shutdown. Much attention will be focused on the extent of Scope 3 requirements, given the difficulties of reporting emissions along the value chain. But opponents and potential litigants will also scrutinise the minutiae of the rules regarding timing, board oversight and liability. California’s disclosure rules – something of a forerunner for the SEC – have inevitably run into legal and budgetary difficulties, so might the SEC have avoided controversy through its stalling tactics? After all, many of the largest US firms are already well on their way to quantifying their climate risks in line with internationally agreed standards, due to pressure from investors at home and regulators abroad. Further, investor network Ceres recently found that the number of North American firms in the food sector reporting Scope 3 emissions had doubled. With the Swiss Re Institute naming the US as the second hardest-hit country by climate change globally in terms of annual economic losses, firms across the country have plenty of incentives to address this material risk.

Done deal? – The Nature Restoration Law (NRL) was passed by the European Parliament on Tuesday, but recent legislative developments suggest formal adoption by member states via the European Council is far from certain. The NRL sets progressively higher targets for the percentage of land and sea habitats to be protected and restored by member states, providing a framework for the European Union to meet its obligations under the Global Biodiversity Framework. The many implications for the agriculture sector led the Parliament’s main conservative bloc to vote against the NRL, mindful of recent farmer protests and upcoming elections, but the law passed more comfortably than some expected. With the EU’s three institutions having provisionally agreed the terms of the NRL last November, the rest should be a formality. But this has been thrown into considerable doubt after the Council failed this week to achieve a qualified majority in favour of the EU Corporate Sustainability Due Diligence Directive. Having fallen at this final hurdle, the future of the directive – which would have given investors greater transparency on environmental and human rights risks at investee firms – is now highly uncertain.

Evolution or revolution? – Another long-awaited announcement came from the UK’s Financial Reporting Council (FRC), which confirmed the start of its Stewardship Code 2020 review. The terms of reference for the review seem intentionally broad, emphasising “long-term value creation” and seeking to avoid reporting burdens and unintended consequences. Similarly, the review process seems highly deliberate, with two phases of consultation to ensure the full range of issues are covered, and a nod to the work and role of other authorities – including the Financial Conduct Authority, The Pensions Regulator and the Department for Work and Pensions. In light of recent developments at Climate Action 100+ and elsewhere, it will be interesting to see the time and space devoted to issues such as collaboration, universal ownership and system stewardship. FRC Head of Stewardship Andrea Tweedie’s keynote speech at the Stewardship Summit 2024 should shed further light on this.

Progress on plastics – Today sees the close of the sixth session of the United Nations Environment Assembly (UNEA), the world’s top decision-making body on the environment. Much of the emphasis has been on greater collaboration on a range of well-established risks and concerns, rather than new initiatives. This will not make too many headlines, perhaps, but a reminder of the power of this summit can be seen in the progress made since UNEA-5 backed the creation of a binding legal instrument on plastic pollution. The fourth session of the Intergovernmental Negotiating Committee will meet towards the end of April, and both corporates and investors should be alert to consequences for existing business models.


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