1. What New ESG Approach ‘Double Materiality’ Means — And Why JPMorgan is a Fan
What it means: ESG has been part of many contentious debates within the investing universe recently. One of the core issues that asset managers and others are wrestling with is determining which sustainability topics need to be disclosed. Many argue that investors should only care about the bottom line, while others argue that all stakeholders should be considered. Because of these additional considerations, regulators in places like Europe are increasing reporting requirements. At the heart of the debate is the discussion of “materiality.” When we say something is “material,” it means that it could impact a company’s financial performance. Double materiality considers how companies impact other stakeholders, including the environment. This concept has complicated the regulatory landscape for sustainable investing. The Sustainable Accounting Standards Board (SASB), which is now under the umbrella of the International Financial Reporting Standards (IFRS) Foundation and, more specifically, the International Sustainability Standards Board (ISSB), had pushed for a singular financial materiality lens; whereas the Global Reporting Initiative (GRI) had components of a double materiality angle (confused by all the acronyms yet?). Why is this important? While the ISSB is actively trying to codify a set of standards and ultimately gain global support for a single sustainable accounting system, they are torn between very ambitious stakeholders in Europe and the dissent-filled US landscape, where ESG has become a political weapon. And with the US Securities and Exchange Commission (SEC) working diligently trying to push forth some set of climate disclosure rules for publicly traded companies, the debate on how to look at various ESG issues is more important than ever.
Sage’s View: The ISSB is in the unenviable position of trying to define how investors and companies should view materiality. While it is certainly in the best long-term interest of companies to understand how they impact other stakeholders, setting too many restrictive and complicated reporting requirements seems problematic. The work of SASB gained a lot of US support by tackling the importance of financial materiality. Greenhouse gas (GHG) emissions reporting illustrates this debate. Some argue that all companies should be forced to report on Scope 1 (direct emissions) and Scope 2 (indirect emissions related to purchased energy) as indicated by the recent SEC Climate Disclosure rules. But what if it isn’t financially material, such as in the case of an asset management firm? A firm likely does not have much control in impacting Scope 1 and 2 emissions (maybe it can choose an electric company car or raise the thermostat a few degrees), but now the company is going to have to spend resources to accurately report and manage emissions and pay for assurance to independently verify those numbers? Is the benefit worth the costs? Forcing the utility company that the asset manager uses for power to report on emissions makes sense. And we haven’t even gotten into the debacle that is Scope 3 (all other indirect emissions throughout a company’s value chain) debate, which is a critical component of comprehensively assessing a company’s impact on emissions but difficult to agree upon from a methodology perspective. Our recommendation to all stakeholders is to keep it as simple and pragmatic as possible. If the recent Fundfire article on the draft ISSB standards is any indication, asset managers’ opinions are all over the place.
2. Deep-Sea Mining: Is It Worth the Cost?
What it means: For the first time since the 1970s, deep sea mining has been authorized to be tested in the Pacific Ocean. The Metals Co., a Canadian start-up, plans to explore the Clarion-CIipperton Zone, a 1.7-million-mile abyss between Mexico and Hawaii. The company is interested in nickel due to electric vehicle demand and hopes that its processes will be less impactful than traditional nickel ore mining. Greenpeace and other environmental activists aren’t so sure and voice strong objections to any future deep sea mining projects. As deep undersea habitats are not necessarily well understood, there are fears that direct or indirect damage from sediment being stirred up will be irreparable. The Metals Co.’s stance is that land-based mining also has the challenge of impacting biodiversity, and that many of the issues can be mitigated (i.e., sediment stirred by operations will subside relatively quickly). The current phase of the company’s operation is research only, so there will be time to further study the impacts.
Sage’s View: The deep sea mining debate is interesting on a variety of fronts. The only reason we are even talking about the need for it is how woefully inadequate the world’s investment in mining has been to date (the impending copper squeeze is just one of many examples). As we envision our clean energy future, mining and metals processing are two huge areas of weakness, with China arguably the only country having adequately invested in these areas. And since getting land-based mines online takes time (capital intensive with a variety of regulatory hurdles), people are looking elsewhere for solutions. But even though deep sea mining is intriguing, the industry’s outlook appears complicated. The New York Times did an expose՛ recently on this mining deal and the international body that approved it, the International Seabed Authority, and let’s just say the whole landscape is messy (5). The potential for corruption is clearly a fear, and who gets authorization for projects in international water could potentially shift the balance of geopolitical power. But since mining is so critical to our future, deep sea exploration is at least worth discussing as an option, especially since all land is already accounted for and water represents over two-thirds of the globe (the new Wild West!). Perhaps this dialogue will bring to light how damaging (both to humans and the environment) some mining practices are, especially since it may conveniently be out of sight and mind to many Americans.
3. Europe’s Appetite for LNG Leaves Developing Nations Starved of Gas
What it means: With all the shenanigans from Russia over supplying energy to Europe, many countries have been aggressive in seeking deals elsewhere. In the liquified natural gas (LNG) space, suppliers have essentially been able to name their price, as demand has skyrocketed in developed countries. Unfortunately, one of the unintended consequences has been that developing markets have been crowded out and are now facing energy dilemmas of their own. Pakistan has been forced to rely more heavily on oil and coal for power generation, relying heavily on Taliban-led Afghanistan for their coal exports. LNG demand is expected to remain tight for the next few years, and so expect this problem to continue, unless the Europeans can heavily cut their gas consumption.
Sage’s View: This dilemma highlights two important dynamics of the global energy picture. The first one is that no matter how hard they try, no country is completely immune to the interconnected nature of the global energy market. The second point, which does not get enough attention, is that the Western World’s willingness to pay essentially any price for cleaner energy options will force developing nations to rely more heavily on power sources like coal. The problem is that global warming doesn’t care where GHGs come from, so the world needs to pay attention to how we may be inefficiently allocating resources and shifting emissions from one country to another. When it comes to deploying renewable sources, this could be a missed opportunity for GHG reduction. Take solar power for example. We are seeing massive projects in some of the cloudiest places on the earth, whether it be certain parts of New York, the United Kingdom, or Germany. Some of these same projects could potentially provide upwards of twice as much power – and arguably displace more fossil fuels – if they were in more suitable locations. Solar and wind power are not a one-size-fits-all proposition, but government subsidies and a willingness by some to slash their own emissions at all costs create an inefficient allocation of limited resources. But that is the path we are on, as there are many in Europe and the US that are all-in on renewables. Since we are talking renewable energy, we would be remiss not to talk about the irony of how Europeans are hell bent on swapping out one autocracy for another, trading their reliance on Russia and fossil fuels for Chinese solar. Countries must all have wrongly bought into the messaging that renewable energy equals energy security. Unfortunately, with nationalist fervor sweeping across European governments, expect a disjointed effort for any sort of coordinated path forward, as countries start taking an “every man for himself” approach during these volatile times. Expect both global economies and the climate to suffer as a result.
4. Japan’s Restart of Nuclear Reactors Will Help Europe’s Winter Energy Supply – IEA Chief Says
What it means: Speaking of how the world’s power supply is interconnected, the surprise announcement in August that Japan would bring some of their nuclear reactors back online may bring some needed relief to Europe. As Japan is a huge importer of LNG, power from their nuclear plants will allow for Europe to receive more imports, hopefully lessening the chance that countries run out of reserves this winter. Not only is Japan turning the corner in the wake of the 2011 Fukushima disaster by opening old plants, but they are also shifting their strategy to support the development of next-generation reactors.
Sage’s View: Nuclear is back! No country has had to deal with some of the stigmas associated with nuclear energy like Japan has, and yet they are poised to make it a cornerstone of their energy future. Nuclear energy is a great equalizer for a resource-poor country like Japan and is one of the easiest ways to provide clean and continuous energy on a small footprint. For those that followed the Fukushima story, it was an unfortunate series of events, mired in some very questionable decisions that could have prevented disaster. But ever since the European energy debacle has unfolded, there has been a clear change on international sentiment. We would still like to see more details on Japan’s plan, including what role next-generation nuclear reactors will play. Perhaps their plans will lead to continued discussions in Europe, where support for nuclear is building but still has some roadblocks from dissenters. For those still on the fence in supporting nuclear, the Ted Talk from the world’s first nuclear energy influencer is a great place to start. (Also, for more information, read our 2019 Nuclear Report, which is still relevant today).
5. Troubled Biodiversity Plan Gets Billion-Dollar Funding Boost
What it means: World leaders had been struggling to garner the financial support to tackle biodiversity at a global level. Germany may have tipped the pendulum by pledging $1.5 billion at a meeting last week during the UN General Assembly. The hope now is that December’s UN Biodiversity Conference in Montreal will be the stage where wealthier nations agree to support a new biodiversity agreement, known as the Post-2020 Global Biodiversity Framework. With experts estimating that $700 billion is needed annually to protect the environment, some countries are going to have to dig deep to up their support. Also revealed at this meeting was a 10-point plan to support financing for biodiversity efforts, which includes a range of initiatives that involves scrutiny over public finance, allocation of funds for biodiversity projects, and calling for development banks to get involved. Currently 15 countries are on board with the plan, including Canada, Norway, and Germany.
Sage’s View: Climate change and biodiversity are obviously linked, but the issue as a standalone concern is worth addressing. Governments clearly have their work cut out in dealing with a myriad of problems that exist, but what role should investors play? With Moody’s recently estimating that $1.9 billion is at is at risk as biodiversity losses exacerbate nature-related risks, it is not an insignificant concern (12). Clearly investors need to be cognizant of these risks within their portfolios, which is not an easy task. Fortunately, there is a Task Force on Nature-related Financial Disclosures coming our way to help. And there is also the opportunity to capture the thematic angle, as many funds popping up are aimed at tackling the world’s biodiversity problems. Either way, asset managers have a lot of work to do, as in 2020 none of the world’s largest asset managers had a dedicated policy on biodiversity, and only 11% had policies that forced portfolio companies to mitigate impacts on biodiversity. A work in progress for all of us, no doubt.
Sources
1) Schwartzkopff, Francis. What New ESG Approach ‘Double Materiality’ Means — And Why JPMorgan Is A Fan. Washington Post. September 21, 2022.
2) Hickey, Bridget. Big Managers Split on ISSB Draft Accounting Standards. Fundfire. September 27, 2022.
3) Thomson. Jess. Deep Sea Mining: Is It Worth The Cost? Newsweek. September 23, 2022.
4) Attwood, James. A Great Copper Squeeze Is Coming For the Global Economy. Bloomberg. September 21, 2022.
5) Lipton, Eric. Secret Data, Tiny Islands And A Quest For Treasure On the Open Floor. New York Times. August 30, 2022.
6) Tani, Shotaro et. al. Europe’s Appetite For LNG Leaves Developing Nations Starved Of Gas. Financial Times. September 23, 2022.
7) Hui, Mary. Europe Is Replacing Energy Dependence On Russia With Solar Reliance on China. Quartz. September 22, 2022.
8) Obayashi, Yuka. Japan’s Restart Of Nuclear Reactors Will Help Europe’s Winter Energy Supply — IEA Chief Says. Reuters. September 27, 2022.
9) Boehmeke, Isabelle. Nuclear Power Is Our Best Hope To Ditch Fossil Fuels. TED. September 22, 2022.
10) Poreda, Andrew et. al. Is There A Future For Nuclear Power In America? Sage Advisory. October 2019.
11) Gilbert, Natasha. Troubled Biodiversity Plan Gets Billion-Dollar Funding Boost. Nature. September 26, 2022.
12) Quinson, Tim. Moody’s Has A $1.9 Trillion Warning Over Biodiversity. Bloomberg. September 28, 2022.
13) Agnew, Harriet. Biodiversity Quickly Rises Up The ESG Investing Agenda. Financial Times. September 19, 2022.
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