Investor Stewardship at a Crossroads

Rickard Nilsson, Head of Stewardship Success at Esgaia, considers how asset owners can maximise long-term impact at a time of regulatory uncertainty.

Capital markets play a key role in influencing resource mobilisation. At a time when political division is delaying needed policy action, investors find themselves at a crossroads over how to act amid regulatory uncertainty.

Capitalism is governed by existing hard and soft law. As intermediaries with obligations to clients and end-beneficiaries, institutional investors are bound to play by those rules. Trying to play a more ethical game in anticipation of a developing rule book will put an organisation’s competitiveness at risk.

How can investors position against this, and implement a stewardship strategy that maximises impact over the long term for both clients and society at large?

The purpose of investor stewardship

The investment stewardship ecosystem reflects a complex web of stakeholder relationships and interests. From the underlying assets and the institutions owning them to clients, civil society, and the public sector, a myriad of actors influence industry practices, norms and policies.

From an investor perspective, the stewarding of assets generally entails selecting a board of directors who in turn assign and oversee management for the strategy and daily running of the asset. Investors can then choose to monitor and engage the asset, e.g. to build trust and align on longer-term plans. Engagement dialogues also play an important role in setting expectations and as an accountability mechanism when performance is lacking.

As evidenced in literature, and by the experience of many investors, good management practices are not adopted by many organisations because of cognitive, knowledge, incentive and capability barriers. Unsurprisingly then, research suggests that successful investment stewardship can increase returns, lower risks, and empower real-world outcomes – but needs to become more effective to have the intended impact.

The current state

Historically, investment stewardship has focused on individual company performance, generally perceived as high-cost monitoring. Normally only investors with large stakes would have sufficient ‘skin in the game’ to engage with a firm and undertake restructurings that truly increase productivity and investment efficiency. Today, practices are changing with institutional investors representing the single largest category of investors in public equity markets, and with the majority of portfolio performance due to overall economic development.

Most institutional investors’ portfolios now consist of hundreds, if not thousands, of holdings. Therefore, it seems obvious that investment stewardship should focus on reducing non-diversifiable/ market-wide

Net Zero is Bringing Business Back to Britain

Graham Upton, Chief Architect – Intelligent Industry, Capgemini UK, explains how climate goals are driving UK firms to reindustrialise.

The UK has recently been accused of watering down its net zero ambitions, with a report from the Climate Change Committee suggesting that the UK is on course to miss meeting the pledges it made at COP28.

Despite this, new data indicates UK businesses are taking decarbonisation efforts seriously, increasingly bringing their manufacturing back home to shorten supply chains and cut emissions. According to a new report by the Capgemini Research Institute, UK organisations are investing £338.5 billion into reindustrialisation over the next three years, an increase of £57.8 billion on the previous three years.

Sustainability is a driver of reindustrialisation

Reindustrialisation, or the act of moving manufacturing operations closer to home, is emerging as a key strategy to decrease a company’s greenhouse gas (GHG) emissions. Responsible for 54% of the world’s energy consumption, manufacturing has a massive carbon footprint, and is a key concern for any business considering how they can balance economic growth with a responsibility to work towards net zero.

Ensuring that a business has a strong ESG strategy adherence is also attractive to investors. Companies committed to ESG are often at less risk of exposure to accidents or lawsuits, and so offer better returns. Data from credit ratings agency and index provider Standard & Poor’s show that its ESG index has outpaced the S&P 500 in recent years.

As UK manufacturing has shrunk over the past 50 years, the proportion of emissions produced beyond its borders has ballooned. Today, around half of the UK’s carbon footprint is found abroad. However, companies are now increasingly aware of their indirect Scope 2 and 3 emissions, both because of increased corporate social responsibility, and because the regulatory environment grows more stringent. For example, UK companies trading in the US and the EU now need to comply with regulations like the EU’s Corporate Sustainability Due Diligence Directive, its Circular Economy Action Plan, and the US’s Uyghur Forced Labor Prevention Act.

As a result of this and other concerns about supply chain resiliency and geopolitics, 78% of UK execs have a reindustrialisation strategy or are currently developing their strategies, and around two thirds are banking on reindustrialisation to help their organisation meet its climate ambitions in the next three years. According to our data, reindustrialisation is expected to drive on average

Weak Carbon Pricing Stalls Energy Transition

Low and patchy carbon prices will delay the transition to a clean economy but present political advantages, says the Institute of International Finance.  The sluggish spread of carbon pricing around the world risks holding back the urgent transition to a low-carbon economy, a leading financial industry bodies has warned. In…

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Property Possibilities are Running Wild

Farrer & Co Senior Associate Rebecca Standing considers the options for investors and developers facing the UK’s biodiversity net gain rules.

The requirement to provide 10% biodiversity net gain (BNG) became mandatory in England when Part 6 of the Environment Act 2021 (2021 Act) came into force on 12 February 2024, or 2 April 2024 for small sites – developments with nine houses or fewer on a site of less than one hectare. From this date, all planning permissions issued in England are subject to a deemed condition that the development for which permission is sought must meet the BNG objective.

The UK government guidance describes the aim of the BNG objective as “habitats for wildlife are left in a measurably better state than they were before the development” – which translates into a requirement that the post-development site achieves a net increase in biodiversity of at least 10%, compared to the biodiversity value of the site pre-development. The associated habitat creation or enhancements must then be maintained for 30 years.

BNG metrics and methods

In order to ensure that the biodiversity value of a site is calculated in a standardised way, Natural England has published the statutory biodiversity metric. This is a calculation tool which, with the help of an ecologist, enables developers to calculate the present and projected future biodiversity value of a site, before and after development. It can also predict how much biodiversity value certain habitat creation or enhancement works will create and, as such, is a helpful planning tool.

Examples of BNG delivery are diverse and can include both larger-scale elements – including the creation of dedicated habitat areas, such as wildflower meadows, wetlands, and orchards – and smaller scale elements, such as bird boxes, bee bricks and hedgehog highways. BNG delivery can also be achieved in the construction of the built environment itself, through the inclusion of infrastructure like solar slate, green walls, ground source heat pumps, and rainwater collection.

The required 10% gain can be achieved in one of three ways, or a combination of them, by:

carrying out habitat creation or enhancement works on the development site itself – i.e. onsite creating or enhancing habitats in offsite locations buying statutory credits Offsite or onsite?

When considering which of the three methods to use, it should be noted that the government has made it clear that statutory credits are to be

Industry Split on SFDR Outcome

Consultation results reveal investors and industry networks undecided on whether to leave Articles 8 and 9 behind.  

The European Commission has published a summary report outlining feedback to its consultation on the future of its flagship sustainable finance disclosure regime, having found no clear consensus on how to improve the framework. 

The Sustainable Finance Disclosure Regulation (SFDR) first came into effect in March 2021, introducing disclosure requirements for fund managers to report at the entity- and product-level on how and to what extent their funds align with Article 8 and 9 fund categories. 

In the three years since, compliance with SFDR has been fraught with challenges, prompting the commission to run a three-month consultation last year proposing changes to existing disclosure requirements and questioning whether the regulation was still relevant. 

With the results now visible, it appears that while most respondents agreed that SFDR’s purpose remains valid, they question its current effectiveness, with 62% noting that SFDR has not sufficiently strengthened protection for end investors and 52% claiming it has not successfully directed capital towards sustainable and transition investments. In addition, 84% of respondents said SFDR disclosures were not useful to investors. 

Meanwhile, seventy-seven percent of respondents highlighted additional limitations within the framework, such as a lack of legal clarity on key concepts, limited relevance of certain disclosure requirements, and ongoing issues with data availability.  

A large majority of respondents called for disclosure requirements such as adverse sustainability impacts to be simplified and streamlined across the EU’s sustainable finance framework. 

“Support for SFDR remains strong, demonstrating its positive effect on improving the transparency of sustainable investments,” Pierre Garrault, Senior Policy Adviser at pan-European sustainable investment organisation Eurosif, told ESG Investor. “But many respondents – including Eurosif – find it insufficiently clear in defining key terms and acknowledge it is used as a de facto labelling regime.” 

The commission also noted “no clear preference” for either of its two proposed approaches to a potential EU fund labelling system.  

One of these options would involve designing and implementing new criteria that would more closely align with the UK’s Sustainability Disclosure Requirements (SDR), whereas the other would formalise Article 8 and 9 as

UK Needs Heat and Transport Emissions Pricing

The government is under legal pressure to tighten its climate policies, and pricing the fossil fuels used to heat homes and power cars could be part of the answer.

At a time when the UK government faces legal pressure to ramp up its climate policies, a new report has found that the UK could cut its carbon emissions by as much as 26% by pricing those generated by heating and road transport fuels.

Conducted by the London School of Economics and Political Science’s (LSE) Grantham Research Institute on Climate Change, the research found that extending the UK’s Emissions Trading Scheme (ETS) to heating and transport fuels could produce a “double dividend” by cutting emissions and expanding the economy by as much as 0.3% through the redistribution of the revenue raised to households and businesses.

The report followed a High Court ruling last week, which found that the UK government’s existing climate action plans were unlawful as they failed to demonstrate how they would meet legally binding targets under the Climate Change Act. The ruling underscored that courts take the legislated climate targets and obligations seriously, meaning the government must find new ways to reduce emissions beyond the power sector.

The heat and transport sectors present an obvious opportunity. Both are major contributors to global warming, accounting for 18% and 23% respectively of the UK’s total greenhouse gas emissions, the report found. But so far, the government has not put a price on emissions from these sectors in the way it has for industrial and power sector emissions.

Extending the ETS to heat and transport  would help push households to lower carbon alternatives to gas boilers such as heat pumps, while addressing tax breaks that make gas artificially cheaper than electricity, according to the LSE report. It would also increase take-up of electric vehicles and use of public transport.

With a carbon price on heat and transport fuels starting at £0 per tonne and rising to £80 by 2040, UK emissions across the economy could fall by an extra 26% by that date, the report said. If the price reached £40, emissions would fall by 16%, which would help the government meet the legally binding goal of net zero emissions by 2050.

“Our modelling shows that extending the UK ETS to transport and heating will lower greenhouse gas emissions and boost the economy,” Josh Burke, report co-author and Senior Policy Fellow

Take Five: Coal in the Whole

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

This week’s G7 commitment on coal will have insufficient impact without a global response.

Coal in the whole – The Group of Seven committed to phasing out unabated coal by 2035, but was criticised for allowing continued use of the fuel in power plants that deploy carbon capture technology, as well as for the flexible deadlines it gave to Japan and Germany. The announcement came in response to the COP28 pledge for all parties to transition away from fossil fuel usage. G7 countries said they would submit nationally determined contributions (NDCs) that “demonstrate progression and the highest possible ambition”, including 2030 targets and demonstrating alignment with net zero by 2050 goals. But the Turin communiqué offered precious little detail on the elimination of oil and gas from the energy systems of G7 countries. There has been some action at the individual country level, admittedly, with the US Environmental Protection Agency last week outlining requirements for coal and gas-fuelled plants to capture 90% of emissions, among other measures. While the G7 stressed its adherence to the International Energy Agency’s Net Zero by 2050 scenario, members are not fully aligned with its ban on new oil and gas exploration or development. G7 environment ministers also encouraged other countries to follow their lead on NDCs, and stressed their continued support for Just Energy Transition Partnerships. Given the latter are focused on effecting the clean energy transition of intensive coal users such as South Africa and Indonesia, it is likely that getting these stalled decommissioning initiatives back on track will have more impact on the decarbonisation trajectory than the domestic actions of leading economies. China, it should be noted, added the most coal capacity last year, followed by Indonesia and India.

Plastic progress? – The fourth round of UN-sponsored negotiations on the Global Plastics Treaty were hampered by an inability to agree on all-important production cuts. As a result, “intersessional work” will be needed if a final draft text is to be ready ahead of the last planned round of discussions in Busan in November. Most progress was made on developing a global approach to extended producer responsibility, but reports suggested developed countries fought shy of committing to binding targets for lower production levels. Prior to the talks, 160 financial institutions called for binding rules and obligations to address plastics’

Diversify for a Just Transition

Anita Dorett, Director of the Investor Alliance for Human Rights, warns of the pitfalls of relying on social audits to address state-sponsored forced labour risks.

Given multinationals’ complex global supply chains and trading relationships, the vast majority of today’s goods are sourced and produced far from where they are sold and consumed. For this reason, to meet their responsibilities under the UN Guiding Principles on Business and Human Rights (UNGPs), companies must ‘know and show’ where human rights risks may be present at every link in their global supply chains.

To address supply chain risks, companies are expected to disclose all their suppliers and business relationships throughout the entire supply chain, develop stringent supplier codes of conduct, and implement robust monitoring systems to ensure their codes are being enforced on the ground. Third-party social and labour audits and related supplier certifications have long been the go-to method for supply chain monitoring, noting that there are significant shortcomings with these programmes. Where these programmes fail, however, is in geographies where state-imposed forced labour is prevalent. In these cases, even the best-intentioned of such risk-assessment schemes are rendered wholly unverifiable and, therefore, meaningless.

Prohibited practices

Distinct from forced labour imposed by private actors like companies or individuals, state-imposed forced labour is compulsory labour enforced by state or governmental authorities. According to Walk Free’s Global Slavery Index, in 2021, 3.9 million people were forced to work by state authorities.

The International Labour Organization’s (ILO) convention No 105 expressly prohibits state-imposed forced labour. State-imposed forced labour is often implemented as a means of political coercion or ‘re-education’ or as a punishment for expressing dissenting political views; as a method of mobilising labor for economic development; as a means of labour discipline; or as a means of racial, social, ethnic, or religious discrimination. State-imposed forced labour can be found in 17 countries including Uzbekistan, Turkmenistan, Eritrea, North Korea, and China.

Nowhere is this pernicious form of human rights abuse better illustrated than the Chinese government’s long-term repression and enslavement of people in the Xinjiang Province (Uyghur region). The pervasive use of state-imposed forced labour programmes, enforced through an extensive surveillance system in the Uyghur region, vividly illustrates the impossibility of conducting credible supply chain human rights due diligence where the state controls the outcome.

According to auditors, they are only given limited access to worksites, can only inspect a curated ‘snapshot’ of factory conditions,

EU Sparks Controversy on Energy Charter Treaty Drop

European Union will withdraw from ‘anti-green’ treaty on environmental grounds, but sources warn of impact on renewable investments.

The European Parliament’s vote last week to withdraw from the controversial Energy Charter Treaty has been interpreted as a near-certain ‘death blow’ to a decades-old agreement that is widely perceived as outdated and anti-green.

But the decision, which lawmakers say is necessary to protect the European Union’s climate policies against litigation from fossil fuel companies, may not be as positive for the energy transition as some believe.

James Rogers, an international arbitration lawyer and partner at law firm Jenner & Block, said the EU’s withdrawal – which he said left the treaty “dead” – could inadvertently harm the bloc’s green energy ambitions by reducing investor protections against policy changes.

Set up in 1994 in the aftermath of the fall of the Soviet Union, in part to open up gas imports from Russia and eastern Europe, the ECT provides energy investors with legal protection against the policy whims of national governments. Governments that expropriate assets or arbitrarily change rules may be taken to arbitration under the treaty. More than 50 countries across Europe and Asia have signed up to the treaty since, with Japan its easternmost member.

But as climate change became a key policy concern in Europe in subsequent years, the ECT progressively turned into a weapon for fossil fuel companies to fight against green policies that harmed their interests. It was under the ECT that German utilities RWE and Uniper, for example, sued the Dutch government for €2.4 billion over its plan to phase out coal-fired power back in 2021.

Critics say the threat of a legal challenge under the ECT alone has a “chilling effect” on green policy – which is real but difficult to quantify.

Some of its members pushed to modernise the framework. But these efforts largely failed, and a growing number of European signatories have already left or plan to leave the treaty, including the UK, France, Germany, Spain and Poland. The EU’s departure now turbo-charges that trend.

“Finally, the fossil dinosaur treaty is no longer standing in the way of consistent climate protection, as we no longer have to fear corporate lawsuits demanding billions of euro in compensation brought before private arbitration tribunals,” Anna Cavazzini, Member of the European Parliament and Rapporteur for the Trade Committee, said following the vote last week.

Not anti-green

According to