ESG – How the private sector can support the achievements of COP26

The motto for COP26, “keeping 1.5 degrees alive”, was in line with the Paris Climate Agreement adopted at COP21 in December 2015. There, 196 parties pledged to limit global temperature rises to 1,5 degrees Celsius and keep them below the 2.0 of the pre-industrial period.

But as the conference started in Glasgow, Scotland late last year, the reality of the viability of keeping warming to 1.5 degrees looked increasingly unlikely as countries that had adopted the Paris Climate Agreement changed their levels of commitment to reduce emissions.

In a May 2021 report, the International Energy Agency (IEA) noted that “the number of countries announcing pledges to achieve net-zero emissions over the coming decades continues to grow. But the pledges by governments to date – even if fully achieved – fall well short of what is required to bring global energy-related carbon dioxide emissions to net zero by 2050 and give the world an even chance of limiting the global temperature rise to 1.5 degrees Celsius.”

Even so, although COP26 did not result in significant levels of progress on keeping warming beneath 1.5 degrees above pre-industrial levels, the conference did see a number of agreements signed. These included pledges by several countries and multinational companies. The first, signed by more than 100 countries, looks to reduce methane emissions by 30% by 2030. The second, signed by more than 100 countries, seeks to end deforestation by 2030. The deforestation pledge also includes $12 billion to help developing countries reduce deforestation.

However, some of the world’s largest methane emitters (Australia, China, India and Russia) are not party to the methane pledge. Additionally, questions around how the deforestation pledge will be effectively enforced within countries reduces some of the excitement.

In spite of this, private companies should not lose sight of the role they must play in keeping alive the objectives of the Paris Climate Accords, because their future profitability depends on the environmental survival of the planet. Equally, private companies are significant contributors to both greenhouse emissions and deforestation. One hundred companies contribute approximately 71% of global emissions, while companies such as McDonalds, Starbucks and IKEA have products made from the results of  deforestation within their supply chains.

These shifts and changes necessary to keep in line with the Paris Accords, and the recent pledges on methane emissions and deforestation. will have implications for the social and governance responsibilities of company processes.

Environmental, social and governance (ESG) is the inclusion of non-financial factors in the analysis that companies use in identifying risks and growth opportunities.  Including these factors in their risk analysis also helps companies to identify how resilient and sustainable they are.

ESG has the potential to play an important role in ensuring the Paris Accords and other climate pledges succeed. ESG challenges the traditional idea that the only purpose of business is to make profits and increase shareholder value. Instead, ESG suggests that, in addition to the creation of shareholder value, it is essential for businesses to recognise that they have other responsibilities and duties. ESG opens the door to capital markets playing an active role in promoting the world’s climate ambitions.

Equally, an understanding of the way companies perform in line with these factors produces data that helps with investment decisions. Environmental factors speak to a company’s energy usage, its carbon emissions and offsetting, waste management and energy usage. Social factors speak to the relationship between companies and labour within the supply chain and its commitment to human rights.This approach also creates an environment for companies to obtain the social licence to operate from local communities affected by their presence.

Governance refers to the rules and procedures of corporate governance that define the matrix of rights, expectations and responsibilities between different stakeholders. It is worth noting that the metrics defining ESG performance are both self-reported and voluntary.

Critics such as Tariq Fancy (see video below), the former Chief Investment Officer for Sustainable Investing at the New York-based multinational investment corporation Black Rock Asset Management, and Robert Armstrong of the Financial Times, argue that the lack of regulation defining ESG-related disclosures and metrics provides room for companies to use the language of ESG without fulfilling any substantial responsibilities implicit in the process. In spite of this, efforts are ongoing to create a voluntary standard of disclosures used to analyse a company’s ESG performance. Examples include the European Financial Reporting Advisory Group (EFRAG)’s efforts at standardising ESG disclosures. Similarly, the United States Securities and Exchange Commission (SEC) is working on a framework to include climate risk disclosures.

BlackRock Asset Management, for example, has been a driving force behind the incorporation of ESG metrics and sustainability in the investing discourse. This is no small part due to its role as the world’s largest asset manager, with approximately $9.5 trillion under management. Indeed, BlackRock views the integration of ESG in investment decision-making processes as an important element in assisting portfolio managers to better manage risks in investment decisions.

What does ESG have to do with COP26? In many ways, the concerns of COP26, the Paris Climate Agreement, the Sixth Intergovernmental Panel on Climate Change (IPCC) report and the International Energy Agency (IEA)’s Net-Zero by 2050 report all speak to the “E”, or environmental factors, of ESG.

Climate change presents a series of systemic risks to companies – be that in terms of access to resources such as water in the production of silicon chips or damage to physical infrastructure because of flooding.

Equally, the metrics emerging from the “E” factors are relatively easy to analyse compared to the “S” and “G” criteria. However, the “S” and “G” factors are significantly important to COP26. This is because the shift towards a net-zero emission world will have numerous social and governance implications. Among these are the impact on those employed in the fossil fuel industries, the potential for deforestation as the need for critical minerals increases, and the need for climate adaptation processes for communities impacted by the energy transition.

The importance of these “S” and “G” factors is demonstrated by the recent pledges to end deforestation and reducing methane emissions, in addressing climate change and building resilience. These pledges open opportunities to address these pressing issues in a manner that includes the private sector understanding its role in the current climate crisis, as well as the mitigation processes that must be pursued to address it.

As momentum towards the net-zero revolution increases, countries where fossil fuels play a major role in their economies and in their energy supply will be faced with difficult decisions. Developing countries, such as India, point out that pursuing the net-zero targets could result in a slowdown of their developmental objectives, as they have not yet reached a level of development that would enable them to move towards renewable resources.

Questions around the reliability and energy density of renewables compound these issues. Similarly, countries such as Nigeria and Saudi Arabia will be confronted with the challenge of abandoning their fossil fuel assets if the goals and objectives of the Paris Climate Agreement and the net-zero by 2050 proposal are to be achieved.

But through ESG integration in the pursuit of net-zero, and adherence to the pledges countries made at COP26, there is the potential to bring together what seem to be the irreconcilable goals of development and energy security for developing countries and the energy transition and development of climate change mitigation.

By integrating ESG principles into some of the timelines presented by countries, companies as well as countries will be better able to understand the risks and opportunities they face. Developing countries would also be able secure investment for projects to boost their climate resilience.

Doing this requires a marriage of ESG principles with a country’s roadmap to net-zero and its commitment to reducing emissions. The development of an effective carbon market, in which carbon is well priced, opens a number of doors for companies, and investors, to support these ambitions.

Lastly, regulation must play a role in the marrying of ESG with the pledges mentioned, to promote private sector accountability in the implementation of the objectives of COP26 and a low carbon future.

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