Governments as well as investors and companies will continue to actively address environmental, social, and governance issues this year.
By Paul A. Davies, James R. Barrett, Michael D. Green, Aaron E. Franklin, and Kristina S. Wyatt
Environmental, social, and governance (ESG) was more prominent than ever in 2019, as issues such as climate change and corporate responsibility regularly appeared in news cycles worldwide. This year, observers can expect even more focus on this area, with public awareness of ESG at an all-time high, and major ESG-related events set to take place.
Whilst the nature of ESG means that significant issues and events can arise at any time, this blog post highlights 10 trends to watch in 2020.
- International Response to Climate Change
Recent events, such as the fires that have affected Australia in late 2019 and early 2020, show how ESG matters have never before received such continuous international news coverage. Significant concern has been generated amongst the general public globally, leading to increasing scrutiny on governments’ climate policies.
This scrutiny is making an impact. Most notably, as of 5 January 2020, 25 countries (and over 1,250 local governments) have officially declared the existence of a climate emergency. This declaration is often accompanied by new or revised climate-related policies, including promises and measures to reduce greenhouse gas (GHG) emissions.
Given the broadly accepted view that measures to address climate change will be more effective if implemented internationally, 2020 is likely to bring further scrutiny on the cooperation among nations in these matters. In particular, the EU’s Green Deal, which launched in December 2019, places explicit focus on such cooperation, highlighting the 2020 EU-China summits and the 2020 African Union–EU summit as opportunities to reinforce partnerships on climate and environmental issues (see EU Commission Formally Announces European Green Deal).
- COP 26 in Glasgow
Linked to the international response on climate change, the 26th Conference of Parties (COP 26) to the UN Framework Convention on Climate Change, in Glasgow, Scotland in November 2020, will be an important event. Last year’s 25th Conference of Parties (COP 25), held in Madrid, aimed to provide an opportunity for participants to provide direction and clarity on their climate change commitments, and for the conference to continue to pave the way for international action on climate change. However, despite the record-setting length of talks, UN Secretary-General António Guterres described the outcome of COP 25 as “disappointing”, noting that a number of key decisions (such as establishing rules on international carbon markets) were delayed.
As a result, this year brings increased focus on COP 26. Key topics of discussion are likely to include how to get more nations to enhance their national GHG commitments, how to attract global climate finance, and further work on international carbon markets.
- Climate Change Litigation
Last year saw the continued expansion of climate change litigation worldwide. Whilst the majority of cases are still US-focused, a significant number of claims are now being brought in other jurisdictions, and 2020 is likely to see a continuation in this trend.
Of particular note was the Dutch Supreme Court’s December 2019 decision upholding previous decisions in favour of the NGO Urgenda Foundation, finding that the Dutch government has obligations to urgently and significantly reduce GHG emissions in line with human rights obligations (see Dutch Supreme Court Confirms Government’s Obligation to Reduce Emissions). The government was unable to amend the target — a 25% reduction, compared with 1990 levels, by the end of 2020 — as it had intended to do.
- ESG Innovation
Given ESG’s increasing impact on the market, the large amount of ESG-driven innovation over the course of 2019 was not surprising — and more such innovation is expected this year.
Electric vehicles are continuing to grow in number and technological advancement. The transition to a low-carbon economy will likely see an increasing need for not only electric vehicles themselves, but also the associated infrastructure (e.g., charging points), leading to opportunities for manufacturers and investors alike.
Further, as research continues to demonstrate the carbon footprint of meat products, a widespread shift in eating habits is taking place, with a transition to non-meat substitutes leading to industry-wide consideration of existing menus and products. Technology has advanced to the point where fast-food chains and supermarkets are beginning to offer a range of credible meat-free alternatives, a pattern that is likely to continue into 2020.
- Biodiversity COP in Kunming
The 15th meeting of the Conference of Parties to the Convention on Biological Diversity, commonly known as the 2020 UN Biodiversity Conference, is due to take place in the final quarter of 2020 in Kunming, China. The theme of the conference will be “Ecological civilization: Building a shared future for all life on Earth”, and the focus will be on setting the course for global biodiversity for the next 10 years through a new biodiversity framework. Negotiations for this framework began in August 2019 with a session in Nairobi, Kenya. A further two sessions will take place ahead of the conference, and their outcomes will go a long way toward determining the success of the parties at Kunming.
As the host country, China will likely look to showcase the green transformation already underway in many sectors of its economy and seek to demonstrate a commitment to leading on biodiversity and other aspects of global sustainability, something it appears increasingly interested in doing (see Environmental and Social Policy in China: What Will 2020 Hold?).
- Sustainable Finance — EU and Elsewhere
Last year saw the continued expansion of the global green finance market, as demand for products such as green bonds and sustainability-linked loans continued to outpace global supply. As a result of this excess demand, new and innovative financial products are being developed, particularly in what is becoming known as the “olive” space.
“Olive” marks the intersection between green and brown finance, and provides an opportunity for companies to engage with investors and/or lenders in the sustainable finance market, even if those companies do not have a business model generally accepted as environmentally friendly (e.g., conventional power companies that want to invest in improving their energy efficiency).
Two examples of financial products supporting the olive space are “transition” bonds and sustainability-linked bonds. Transition bonds tie the use of proceeds to expenditures related to sustainability transition (e.g., investing in more sustainable cattle-ranching practices). Sustainability-linked bonds take a different approach: rather than focus on expenditures, they focus on outcomes and reward companies that meet agreed sustainability performance targets (such as renewable-power-generation capacity) or punish companies that fail to meet their sustainability targets. The rewards or punishments are administered through interest rate adjustments. These two products are examples of the “50 shades of green” in sustainable finance identified as necessary by the outgoing governor of the Bank of England, Mark Carney.
- Converging Standards
This year is likely to see further convergence of standards in the ESG reporting space. Investors continue to identify inconsistent and difficult-to-compare information as one of the primary hurdles for investing in ESG, and as a result, regulators are trying to provide a platform to facilitate the production of better and more comparable data.
The EU Sustainable Finance Action Plan is in the process of introducing measures that seek to improve the consistency of information — whether through a green taxonomy or disclosure regulation — on which further technical guidance will be produced in 2020. Additionally, a revised version of the Sustainable Finance Action Plan is expected in the third quarter of 2020, and it will be interesting to see what changes have been made.
These mandated standards as well as voluntary standards (such as the Green Bond Principles), are likely to feature in the market even more heavily in 2020, and given investor demand, further convergence between global standards is likely to take place.
- Supply Chains
The ESG performance of companies’ supply chains, and not just the companies themselves, is likely to see increased focus in 2020. Acknowledging that ethical conduct at the company level does not mean much if ESG issues are present elsewhere in the production process, investors are likely to continue to focus on transparency and disclosure relating to a broader range of processes in companies’ supply chains.
This area is especially relevant for the advancement of ESG-related technology, as recent years have seen the production of innovative solutions to track supply chain performance (especially in the minerals and metals sectors). Expect this innovation to continue into 2020, as companies respond to stakeholder demand and government regulation to monitor ESG performance at all levels.
- China and the Social Credit System
China has made significant strides in integrating ESG into its regulatory framework in recent years, and 2019 was no different, with a number of new measures, including a revised soil pollution law, entering into force.
This year promises to follow that trend, notably with the continued rollout of the Social Credit System (SCS). In some ways, the SCS resembles the most complete attempt at a corporate ESG monitoring system — including significant consequences for poor performance — that has been seen in any jurisdiction.
The SCS provides both opportunities and risks for companies operating in China. Under the SCS, a company’s performance in a range of underlying environmental categories (such as compliance with permits) will be monitored, and a “credit score” will be given to the company based on its achievements. That score will then affect a variety of aspects of the company’s business, such as the granting of licences, the regularity of inspections, and access to subsidies and support.
Whilst many governments worldwide are actively addressing ESG issues, some jurisdictions (such as the United States) have been more subdued in this regard. Leadership in governance has been driven by investors and corporations, who are playing an ever-increasing role in the incorporation of ESG in business strategies. Last year, the Business Roundtable redefined the purpose of a corporation to accommodate a broader group of stakeholders, demonstrating the impact that private actors can have in this area.
This year will likely see boards place further focus on the ESG issues that are material to their businesses, addressing the risks and opportunities those issues pose as part of corporate strategy. A good understanding of a company’s ESG performance and strategy will become essential knowledge to directors across all industries and impact their decision-making as a matter of good business.
This blog post was prepared with the assistance of James Bee in the London office of Latham & Watkins.
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