Corporate pledges to clean up operations are all well and good, but investors need to recognise whether ESG standards fall in line with global benchmarks or are leaning towards greenwashing.
One way is to look at that contribution to global temperature increases caused by companies going about their business.
As part of the Paris Agreement, 197 countries agreed that the global temperature could rise by a maximum of 2°C, with 1.5°C as a stretch target, to avoid irreversible damage to the Earth’s ecosystem and the subsequent economic risks.
However, the average temperature rise caused by companies worldwide is about 3°C, according to a study published last year, with only 6% of firms below 2°C and 4% below 1.5°C.
The research was based on 2,686 companies part of the I Care and Arvella’s climate alignment database, Climate SBAM, which included stocks part of MSCI’s flagship global equity index.
This may have huge consequences in the short-term: the price tag is expected to be US$1.7 trillion per year by 2025 if the world doesn’t take immediate action, according to a recent New York University survey of 738 economists.
Executives have long figured out the importance of setting up environmental goals to reduce financial risk, but they need to be detailed to show that it’s not just greenwashing, experts say.
When corporations announce their environmental targets, they often categorise them in three scopes.
Scope 1 covers direct emissions from owned or controlled sources, Scope 2 is about purchased electricity and heat and Scope 3 includes all other indirect emissions that are part of the value chain.
According to Josh Gregory, founder and chief executive of green investing app Sugi, investors should look at Scope 3 pledges to understand how committed a company is, because that’s what requires the most effort.
Sugi recently launched a service to allow retail investors to check the temperature alignment of their investment portfolios.
“What we’ve discovered is through connecting portfolios, test portfolios with particularly sustainable funds or ESG funds, which are on offer from major asset managers is actually the temperature alignment is not particularly good. So it’s like 3.5°C, 4°C, 4.5°C,” Gregory told Proactive.
“If temperature becomes more widely used… I think that it can possibly cause some problems for people who are trying to sell sustainable funds, when actually they end up not appearing particularly sustainable.”
Many companies resort to carbon offsetting programmes to limit their environmental harm, so they pay for others to reduce emissions or absorb CO2 to compensate for their own.
Big oilers, such as BP PLC (LON:BP) and Royal Dutch Shell PLC (LON:RDSB), have embarked in several offsetting initiatives but environmental groups say it’s not solving the problem.
Others, such as ExxonMobil, promote the use of carbon capture technology even though it has not been entirely developed or deployed at scale.
Gabriela Herculano, chief executive and co-founder at iClima Earth, part of the HANetf funds, said the best way to avoid carbon in the atmosphere is by not emitting the first place.
“In the end we’re going to need to have some offsetting as we’re never truly going to be a zero-emission economy even by 2050, but let’s not lead with that,” she told Proactive.
“Offsetting is the idea that we’re going to plant trees or somebody who’s going to come up with a way to sequester, so we will continue with the business as usual and which is miraculously going to take away that carbon that will then be in the atmosphere.”
“It’s waiting for the magic moment right and that math may not work,” she added.
Herculano, whose company has launched the world’s first ESG ETF focused entirely on stocks that avoid emitting CO2 in the atmosphere, says we need to focus on companies that offer solutions to the climate crisis.
“It’s not diminishing or minimising what we all doing as individuals and as companies, if we’re trying to reduce our carbon footprint… But let’s not put the spin that this is where capital markets are solving decarbonisation because Google, Microsoft and Amazon are not going to decarbonise the planet. We need to look at the solutions, and shed the spotlight on what is really relevant,” Herculano told Proactive.
Another issue with corporate targets is setting up goals far away in the future without outlining a detailed roadmap.
In fact, although 2050 as a date makes sense because it matches the Paris Agreement, it can give a bit too much wiggle room to continue with business as usual.
“If a company says it in 30 years in advance, how is there going to be any kind of tracking towards that in terms of the leadership of the company? How do you measure the KPIs towards that and that kind of distance?,” Gregory commented.
“There’s also the point that it’s actually cheaper to do climate solutions to reduce emissions earlier rather than later. So if you’re saying 2050, and then you kind of backload the actual reductions it’s much more expensive for the planet, as well as the company. And also, it’s just too late, everyone wants action now.”
ESG funds have grown at more than double the rate of non-ESG funds during the past five years, with equity and bond ESG fund assets rocketing 197% and 181% respectively.
Although governments will continue tightening rules in the hope to avoid greenwashing, eco-conscious investors can now start figuring a thing or two by themselves.