Investors, regulators and stakeholders in capital markets are paying increasing attention to social issues and this ESG theme will rise in prominence over 2022, Sustainable Fitch says in a new report. In conjunction, the nexus between environmental and social issues will become stronger as ESG integration becomes more sophisticated as more disclosures and data become available.
This can manifest in various ways, be it a greater importance placed on just transition issues and the impact of investment strategies, supply-chain evaluations, or the issuance of sustainability bonds that include social and environmental goals.
We expect to see a rising level of issuance of sustainability and sustainability-linked debt as investors combine climate and social objectives under single mandates. The release of the EU’s draft Social Taxonomy in 2022 will reflect a growing demand to consider the ‘S’ in ESG integration and evaluation, and a need for guidance on how to capture and address wide-ranging social issues.
Adaptation Financing Gap To the Fore
At the core of the social and environmental nexus is the issue of financing a just transition to a low-carbon economy for populations most at risk from adverse socio-economic impacts. Related to this is the focus on the emerging market financing gap at COP26 and ways to incentivise lending for mitigation and adaptation projects.
Of significant importance to investors and reporting entities in 2022 will be the new ESG disclosures that can affect a plethora of market participants and jurisdictions, bringing much-need consistency and harmonisation. Areas to watch are the development of the ISSB under the auspices of the IFRS, the updated climate risk disclosures from the US SEC and work in the EU on the SFRD regulatory technical standards.
Resilience, Responsibility in Supply Chains
Increasing regulatory attention on environment and social risks, and shifting consumer preferences for sustainable products have emphasised the importance of sustainable, resilient, ethical and transparent supply chains. ESG considerations will mean a longer-lasting structural shift in how companies consider supply and value chains.
ESG Disclosures Enter Operational Phases
Major ESG disclosures that can affect multiple market participants and jurisdictions will move from the drawing board to fuller implementation over 2022 bringing much-needed consistency and harmonisation.
Sector in Focus: Technology
Technology firms have increased their activity on the social side of the sustainable bond market. Following Alphabet Inc.’s landmark $5.75 billion sustainability issuance in 2020 – the largest ever from a corporate – HP Inc., Baidu, Inc., Alibaba Group Holding Limited and salesforce.com Inc are among global tech sector firms that launched their own sustainability bonds in 2021. This has occurred in the backdrop of an increased focus on the social effects of technology products and platforms.
A California law passed in September will raise standards for worker safety and wellbeing, following increased demands placed on warehouse and logistics workers at internet retailers and report of elevated injury rates. China introduced a series of technology sector regulations in areas including internet content for children and working conditions for e-commerce delivery drivers. This led Fitch to assign ESG Relevance Scores of ‘4’ in Labour Relations & Practices and Exposure to Social Impacts to several Chinese issuers subject to the new laws.
The growth of artificial intelligence and algorithm-based analysis has the potential to create unforeseen issues related to access and affordability, bias and discrimination, and privacy. These systems are in use in financial services, social media, advertising, and human resources and could have enormous impacts if more widely adopted without consideration of these unintended consequences. For example, a 2017 Princeton University study found that a commercial AI software programme rated European names more highly than African-American names, and linked female names with family characteristics over professional ones. Fitch’s ESG Relevance Score framework could capture these risks under one of three social general issues – Human Rights & Community Relations, Customer Welfare, Employee Wellbeing, or Exposure to Social Impacts.
Sustainability Disclosures: From Drawing Board to Reality
Evolving efforts to establish more standardised reporting requirements will take shape next year and their impact on ESG data and reporting will begin to become more tangible. This is a continuation of one of the themes that Sustainable Fitch highlighted for 2021 (ESG Data Deluge), but they expect to see in 2022 the contours of what more standardised disclosures, especially around climate, look like in major jurisdictions. Investors and regulators have called for a higher degree of standardisation and harmonisation in ESG data and disclosures from corporates and financial institutions. This has also been one of the most often cited sources of frustration and inconsistencies for ESG integration strategies among asset owners and managers and investors.
The objective of more standardised forms of reporting on various facets of sustainability is to allow for greater transparency, less scope for greenwashing from reporting entities due to asymmetric reporting. More standardised reporting can also create a more harmonised set of decision-useful data, which investors, regulators and other stakeholders can use to scrutinise and compare financially material sustainability risks, as well as – mainly in the case of the EU’s double materiality principle – adverse sustainability impacts of operations or investments.
ESG Risks Matter to Supply-Chain Management
Supply chains have been a pressing issue throughout the Covid-19 pandemic and will remain pertinent in 2022. Resilient, responsible value chains will become a structural feature of supply chains as they relate to ESG considerations and how investors, policy makers and regulators scrutinise supply chains. Physical climate and transition risks are potential threats, as are social issues around employment and labour practices. Sectors from global retailers, such as food and beverage, apparel and textiles, electronics, automobiles, agriculture, and natural resources and industrials are at higher risk.
Heightening regulatory pressure to consider environmental and social risks as well as shifting consumer preferences for sustainable products have underscored the importance of sustainable, resilient, ethical and transparent supply chains. Failure to ensure proper oversight and management of supply chain risks can result in significant financial and reputational losses, as regulatory scrutiny rises.
Geopolitical Pressures on Supply Chains Persist
Persistent global trade tension was prompting corporates to rethink the need for diverse sourcing options before the pandemic. Global supply chains have gone through tremendous disruption, particularly at the beginning of Covid-19 for companies with direct exposure to outbreaks. In a report examining the future of trade and supply chains, Fitch noted that trade disputes and protectionism will continue to present risks on supply chains in the post-pandemic years an assessment.
Volatile political environment and weaker macroeconomic conditions will test corporates’ ability to diversify and execute alternative sourcing options and generate profitability. The continuous trade tension between China and the US has heightened pressure on global business, and risks for relying on single suppliers. Global manufacturers are expected reconsider the critical functions and resilience of supply chains by managing alternative resourcing strategies. Corporates might assess broader implications of supply-chain resilience as a core component of governance and management strategy as investors and stakeholders seek more transparency and accountability in value chains.