Battleground ESG issues for 2023
Yarra Capital Management
As we look forward to the year ahead, we have been reflecting on where we are likely to see the most prominent sustainability issues (sometimes called 'ESG' or environmental, social and governance issues) surface for companies in the year ahead.
Our predictions include continuing to see the big issues, such as climate change, remain centre stage but shift from a conversation about disclosures and targets to issues of quality and substance. Alongside climate, we will see companies scrambling to make sense of an expanding environmental mandate to include understanding their implications on nature and biodiversity more broadly.
We see a big year ahead for social topics, including industrial relations and labour rights, as well as a resurgence of issues pertaining to social license to operate. And, as ever, good governance will continue to be a key driver of value, particularly with the continuing rise of cybersecurity issues and companies having to navigate an increasingly complex landscape of material issues.
Our predictions for the big battleground ESG issues for the year ahead are:
1. Climate change issues are evolving towards quality:
- Move toward the improved transparency, rigour, feasibility and quality of emissions reductions strategies, including a focus on more science-based targets and disclosures for scope 3 emissions.
- Push for reducing greenwashing and more scrutiny around credibility of targets and claims, as supported by the Treasurer recently putting greenwashing penalties into focus, and signals from ASIC and APRA over the last year that guidelines are moving toward increasing regulation and penalties. This is also supported by the establishment of the Australian Sustainable Finance Institute and their move to publish an Australian Sustainable Finance taxonomy.
- Negative emissions - taking carbon out of the atmosphere, not just avoidance and abatement-will become a hot topic.
2. Nature, food and water security and biodiversity will be the newest everywhere topic:
- 2023 will be a year of companies trying to establish their liabilities and obligations with the growth in nature-related disclosures.
- Beyond 2023, clearer standards and expectations will emerge in relation to the way companies are impacting vital resources, like water, soil and air, biodiversity. This will be underpinned by tightening Federal legislation (e.g. Our Nature Positive Plan) and increasing disclosure frameworks (e.g. TNFD (Taskforce for Nature Related Financial Disclosures)).
- We can expect more focus on water stress and food security, including on equity and pricing which will have implications on how companies consume, price and manage water assets. The tension between water as a commodity versus a resource as well as issues of access, affordability and sustainability across food supply chains will become increasingly apparent.
3. Industrial relations and labour rights and conditions will become increasingly material:
- Workplace issues will continue to make headlines, including companies that are failing to engage in appropriate cultural shifts to account for demands for diverse, fair and inclusive workplaces.
- Industrial Relations reforms (e.g. Secure Jobs, Better Pay 2022) have put rights for collective bargaining, flexible work, gender equity and zero tolerance on sexual harassment into the spotlight. We see increasing risks for companies with either no EBA (enterprise bargaining agreement) or an EBA set to expire, a low-paid workforce and high union membership, as well as companies with poor track records responding to inappropriate workplace incidents at risk.
- Best places to work studies starting to show that companies that rate highly are driving alpha.
4. Social license to operate makes a 'comeback':
- Greater regulatory pressure and scrutiny on social license when evaluating new approvals. Evidence is particularly prevalent in the mining, materials and energy sectors, with material financial impacts. We are also seeing companies with track records of breaches experiencing regulatory approval issues compared to peers (e.g. RIO v. BHP and FMG).
- Industries and companies with shaky license to operate are more at risk of stakeholder outrage and penalties, NGO engagement, increased scrutiny, regulatory intervention, litigation, and accountability on stakeholder management issues. Socially controversial sectors are likely to see more stakeholder backlash incidents in the years ahead.
- We are also likely to see this issue intersect with issues of equity, access and affordability. As rising cost of living fuels pressures on quality of life, there will be focus on accessibility and affordability as the socioeconomic divide widens, particularly for products and services that are considered 'rights' (e.g. pharma).
5. Data security and privacy evolves to include issues of data sovereignty:
- The conversation around privacy and data security will continue to escalate, alongside more sensitive data leaks and cyber security attacks. Reports of cybercrime were up 13% in 2022 led by the highest reporting sectors of government (healthcare, IT, and education and training).
- There will likely be pushes toward data sovereignty and people demanding ownership rights over their own data.
- With the rise of AI (Artificial Intelligence), a new suite of digital security challenges such as how data use is intersecting with issues of human rights is quickly surfacing. This is giving rise digital sovereignty issues, where companies will have to navigate geopolitical boundaries to comply with new regulations about data privacy and regulations.
6. The 'G' factor will drive corporate responses to an evolving landscape of material issues:
- While corporate governance has been the most steadfast in the ESG conversation, we will see the 'G' factors continue to be seen as critical (perhaps the most critical) in this evolving landscape of complex and material E and S challenges. How a company responds to any material issue always comes back to its governance.
Beyond the E, S, and G
Beyond the individual issues surfacing under the E, S, and G banners, we also see trends toward positive investment opportunities, including:
7. Scale will be the focus for the new wave of purpose driven capital:
- Purpose driven capital will move toward opportunities at scale commensurate with the size of the social and environmental challenges and the urgency and timelines of these challenges. Offshore wind, hydrogen, nuclear-what are the game changers that are going to help address the scale and urgency of the problems we are facing? This is where the ideal moves toward the pragmatic and money will follow, which is why we are seeing labelling shifts in the EU Taxonomy to allow for gas and nuclear.
- We will see the theme of 'transitions' extend beyond energy and climate. The trend of moving away from 'divestment' toward active engagement will start extending to other sectors including waste and toxic chemicals. This provides opportunities to look at positive screens and ESG improvers and leaders across all sectors, particularly those companies with entrenched social/environmental issues but which are societally necessary or difficult to replace.
- Collective action and collaborative engagement will be a feature for engaging in these strategies. We expect to see new innovative approaches toward collective action in the year ahead.
8. Sustainability, ESG and Impact are no longer distinct approaches to investing:
- Investors across all shades of responsible investment have been looking for the win-win solutions to back for decades, opportunities that deliver alpha and support the narrative of addressing our world's most pressing social and environmental challenges. Investors now seeking to align a values overlay with value considerations have to look beyond the thematic to the nuance of how companies are operating. This is forcing a "coming together" of ESG considerations with positive screens, thematic investing and impact investing. This is, in part, because value is not just driven by what a company produces but also by how it operates. This means that a lot of our distinct responsible investment approaches are blurring together, creating a greater need to help investors interrogate the different strategies of how managers are integrating these responsible investment considerations into investment decisions. This intersects with the moves toward a taxonomy, scrutiny around greenwashing, and greater requirements for transparency, disclosures, and language that helps investors understand the quality of disclosures and strategies.
Author: Dr Erin Kuo, Yarra's Chief Sustainability Officer