In this month’s ESG Market Alert, we cover:

• The FCA and other market regulators’ criticism of ESG benchmarking;

• The European Commission’s ban on goods being produced using forced labour;

• Anti-ESG backlash; and

• What’s new in market practice: the practical ESG steps being taken by corporates and central banks.

FCA and other market regulators criticise ESG benchmarking

Despite the prevalence of ESG efforts and with more than half of FTSE 100 companies having dedicated ESG committees, regulators are questioning the credibility of investment firms’ ESG benchmarking practices due to lack of standardised methodologies of measuring and reporting. In a portfolio letter published on 8^th September 2022, the FCA warned that the “subjective nature of ESG factors” give rise to an “increased risk for poor disclosures” in relation to ESG.

This stance echoes the underlying concern expressed by the EU authorities, who published their own benchmarking rules for ESG that were subsequently adopted by the European Commission in April 2022. Notable concerns include companies ‘cherry-picking’ how they assess themselves on an ESG basis (commonly known as ‘greenwashing’) or investment firms developing and using their own ESG rating systems to assess their funds.

Across the Atlantic, regulators are taking similar action, with the U.S. Securities and Exchange Commission having enhanced its scrutiny of ESG funds and practices earlier this year. The SEC’s proposal requires more detailed disclosures in prospectuses and extends its Name Rules and the 80% investment policy to require, respectively, ESG funds to define the terms in its name in plain English and to have a minimum of 80% of a fund’s assets being consistent with its name. For example, a fund that considers ESG factors alongside but not more centrally than other, non-ESG factors in its investment decision-making would not be permitted to use ESG or similar terminology in its name.

European Commission bans goods produced using forced labour

The European Commission has made a proposal to prohibit products made with forced labour being sold in the EU- a stance which will be discussed by the European Parliament and the Council of the EU. If passed, the new regulation would apply to both imported goods and goods produced within the EU. The proposal is based on definitions and standards established by the International Labour Organisation (ILO) and, if enacted as law, would apply to products for which forced labour has been used at any stage of production by all “economic operators”, making it one of the broadest product-related forced labour bans in the world.

As part of the regulation, each EU Member State would have to designate national authorities who would be responsible for enforcing the regulation. These authorities would conduct investigations across multiple phases, with a ban being implemented on any products within the EU market that were determined to have been made using forced labour. It is expected that, if the regulation were to be enacted, it would take effect in 2025 at the earliest.

This proposal is part of a general global trend towards policing forced labour issues, as evidenced by the Uyghur Forced Labour Prevention Act passed in the United States in June 2022. The legislation presumes that any product originating from the Xinjiang Uygur Autonomous Region is a product of forced labour, and unless contrary evidence is provided at border control, such products are not be allowed to enter the United States.

Anti-ESG backlash

Despite increasing focus on ESG driven by the United Nations’ Sustainable Development Goals, an anti-ESG exchange traded fund (ETF) has attracted over US$300 million in funds in less than a month. The ETF in question, Strive Asset Management’s US Energy ETF “DRLL”, is listed on the New York Stock Exchange. Launched in August by Vivek Ramaswamy, Strive Asset Management’s co-founder and Executive Chairman, this ETF aims to refocus companies on delivering shareholder returns rather than setting social, political, cultural and environmental goals.

In this new ETF, Ramaswamy has called on energy companies to reduce their focus on cutting carbon emissions unless doing so can be proven to increase shareholder value.

The launch of Ramaswamy’s ETF comes in light of increasing anti-ESG sentiment in certain political spheres in the United States. The state of Florida has passed a resolution barring its pension funds from using ESG factors in decision-making. Glenn Hegar, the comptroller for Texas, has targeted ESG investing by blacklisting ten financial groups for "boycotting energy companies" in their investment strategies. Under a law passed by the Texas administration in 2021, state pension and school funds may be forced to divest shares they hold in financial groups that appear on this list.

What’s new in market practice: Practical ESG steps being taken by corporates and central banks

At a minimum, the UK Corporate Governance Code requires companies with a premium listing in the UK to have in place audit, remuneration and nomination committees. However, 54% of FTSE 100 companies have now taken the additional step of putting in place a committee dedicated to focusing on ESG issues. By contrast, analysis from 2020-2021 in the United States has shown only 13% of S&P 500 companies had assigned responsibility to an ESG or sustainability committee.

This practical shift from the leading UK companies is particularly prevalent in the oil, gas and mining sectors, where a number of the big energy giants have a dedicated ESG committee. This step demonstrates a recognition that a dedicated ESG committee can enhance a company's ability to meet its sustainability and net-zero goals, with better ESG credentials also supporting share price and improving eligibility for ESG-focused funds.

At the European level, following an announcement in July 2022 of its intention to incorporate climate change considerations into its monetary policy framework, the European Central Bank (the ECB) has revealed its commitment to decarbonising its approximately €385 billion of corporate bond holdings. This move by the ECB aims to reduce the Eurosystem's exposure to climate-related financial risk and to support a green transition of the economy in line with the EU's climate neutrality objectives.

The ECB's plan includes decarbonising its corporate bond holdings portfolio as well as the introduction of new climate scores (assessed in terms of greenhouse gas emissions, carbon reduction targets, and climate-related disclosures), which will be taken into account in all Eurosystem corporate bond purchases. The ECB also intends to start publishing climate-related information on its corporate bond holdings during the first quarter of 2023 and will regularly report on its progress in aligning with the EU's climate neutrality objectives.