“Mind the gap: Companies need to spend much more on net zero” 

Fidelity’s third annual International ESG Analyst Survey has recently been published, revealing that companies are not doing enough to deliver net zero. 65% of the world’s 2,000 biggest publicly traded firms have net zero targets[i]. However, Fidelity has found that less than 60% of the companies surveyed are on track to reach net zero by 2050 and only 25% by 2030[ii]. This is said to be largely down to inadequate spending on net zero strategies. Europe is ahead, with 69% of companies allocating the required funding to hit net zero by 2050[iii].

 

Figure 1: Most companies aren’t spending enough to hit net zero

A hitch ⁱⁿ ESG reporting

The global economic situation worsened by the pandemic and the war in Ukraine has placed sustainability on the back-burner for many, while short-term financial metrics are the priority. There are other challenges that hinder the effective and widespread use of ESG reporting, such as changing ESG regulation, a lack of standardisation of ESG collation methods, insufficient testing of target setting and calibration methods, and few case studies of best practice[iv]. Fidelity’s report also found that ESG action tends to occur most in areas that are more feasible and easier to achieve. So, whilst corporate governance and greenhouse gas emissions are high on the agenda, biodiversity and a just transition are often sidelined to discussions rather than action. 

CDP was established in 2000 to ask companies to disclose their climate impact[v]. They have established a standard for transparent greenhouse gas reporting, and today, almost every Fortune 500 company reports to them[vi]. CDP found that last year, over 4000 (out of 18,600) companies disclosed that they had a climate transition plan[vii]. However, this climate transition plan was only credible for 81 (0.4%) companies that disclosed all 21 key indicators needed. Power generation and infrastructure companies were the most likely to disclose all 21 indicators at 2.2% and 1.7%, respectively, whilst only one company in the apparel, fossil fuels, and hospitality industries disclosed all indicators[viii]. This data shows that companies still have a long way to go to improve their ESG reporting.

Is regulation the answer?

Fidelity’s report argues that regulation is the most important driver of change to ESG practices.

Figure 2: Regulation and incentives among top drivers of change across ESG practices

One type of regulation strategy that they suggest could be implemented is requiring companies to measure and report on particular ESG criteria. Success within these criteria can then be linked to remuneration pay for the senior management team. At present, senior management pay is most often linked to greenhouse gas emissions, but there is ample scope for this to be linked to other sustainability criteria.

Research by the organisation Reward Value could help with making executive compensation based on firm sustainability easier. Reward Value is creating an ‘impact yardstick’, a database of monetised social and environmental impacts that allows stakeholders to assess the ‘net societal value added’ by firms[ix]. Executive compensation can be tied to this more transparent measure of sustainable value creation.

Within the senior management team, CEOs have the most responsibility for actions impacting climate change. Recent research has found that CEO risk preference is particularly impactful in terms of corporate greenhouse gas emissions behaviour[x]. CEOs that are risk-averse tend to engage more in unethical corporate behaviours, including those related to environmental degradation. Additionally, this research found that companies with higher CSR (corporate social responsibility) scores also tend to have higher greenhouse gas emissions, highlighting how CSR is often used as a tool for greenwashing.  

Taking notes from the EU

A range of new EU regulations have been introduced, including Sustainability Disclosure Requirements (SDR), the Sustainable Finance Disclosure Regulation (SFDR), the EU Taxonomy, and the Corporate Sustainability Due Diligence Directive (CSDDD). One of these regulations is the Corporate Sustainability Reporting Directive (CSRD) that came into force on the 5^th of January, 2023. The CSRD means that starting in the financial year 2024, 50,000 affected companies will need to report more broadly on environmental matters, social responsibility, human rights, anti-corruption measures, and board diversity[xi]. This aims to address the key structural weaknesses of ESG regulation and reporting and create more transparency regarding the impact of companies on people and the environment. 

The ‘Brussels Effect’ is the idea that EU regulation is exported through market mechanisms and can be used to model regulation in countries outside of the EU. Research by Alamillos and Mariz (2022) has found that EU ESG regulation influences regulation worldwide partly because of the scope of the regulation standards and the EU’s involvement in global institutions like the Task Force on Climate-related Financial Disclosures (TFCD)[xii]. Therefore, not only does the CSRD impact non-EU companies that have a considerable presence in the EU (those with a net revenue of $150 million in the EU for each of the last two consecutive years and a listed EU subsidiary that generated a net turnover greater than $40 million in the preceding year[xiii]), but we could see this type of ESG regulation being modelled in other parts of the world in the years to come.

References

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[i] Net Zero Tracker- Net Zero Targets Among World’s Largest Companies Double, but Credibility Gaps Undermine Progress 

[ii] Fidelity- ESG Analyst Survey 2023: Mind the Gap 

[iii] Ibid

[iv] Harvard Business Review- Linking Executive Pay to Sustainability Goals

[v] CDP- Who we are

[vi] Alamillos and Mariz- How Can European Regulation on ESG Impact Business Globally?

[vii] CPD- New CDP Data Shows Companies are Recognizing the Need for Climate Transition Plans but are not Moving Fast Enough Amidst Incoming Mandatory Disclosure

[viii] Ibid

[ix] Reward Value- Research Projects 

[x] Hossain, Saadi and Amin- Does CEO Risk-Aversion Affect Carbon Emission?

[xi] Sustainable Future News- ESG Regulation in 2023: Everything You Need to Know & European Commission- Corporate Sustainability Reporting

[xii] Alamillos and Mariz- How Can European Regulation on ESG Impact Business Globally?

[xiii] Grant Thornton- Impact of CSRD on Non-EU Entities& Greenomy- CSRD Reporting for Non-EU Companies: What You Need to Know