Companies active in the energy sector would not be blamed for losing sight of their ESG strategy in 2022; the energy industry’s pre-COP 26 focus on climate-change action has been somewhat superseded by the race to balance the energy transition with security and affordability of supply.
Recent turbulence in financial markets and the threat of impending global recession have also served to pull focus away from boards’ hard fought ESG gains of previous years. That said, however gloomy the economic and global outlook may be for 2023 the fact remains that investors and regulators alike will continue to insist that boards create more than just shareholder value alone.
Over the past two years, the UK Government has rolled out compulsory TCFD-aligned reporting (TCFD being the Taskforce on Climate-related Disclosures) to help ensure large companies have considered the longer-term implications of their operations. While a degree of flexibility has been afforded to allow companies to come to terms with the full extent of their climate-risk profile, there is an expectation that, in the longer term, reporting and strategy will expand and refine, and investors may look unfavourably on those companies which are unable to demonstrate clear strategy for sustainable returns.
If shareholders cannot identify any truly ambitious ESG proposals, or if they perceive an actual or projected failure to achieve the same, they may engage with the board or even vote against their plans at AGM.
Further evidence of the paradigm shift in investor expectations can be seen in the recent annual survey by Institutional Shareholder Services (ISS), where 50% of shareholders polled agreed that ISS should consider recommending voting against directors of oil and gas companies that do not have realistic medium-term (through 2035) targets for reducing scope 1 and 2 emissions.
A failure to make adequate disclosure regarding climate-related strategy, risks and targets (under a framework such as TCFD) was reason enough for 79% of shareholders polled to agree that there should be an ISS recommendation against such directors.
This importance of driving down scope 1 and 2 emissions aligns with the requirements of flagship industry deal – the North Sea Transition Deal.
Boards are therefore well motivated to ensure that these factors remain of key importance notwithstanding the challenging market conditions. Oil and gas companies will also be considering how the recently announced 33rd offshore licensing round fits with their longer term aims and strategies from an ESG perspective; notwithstanding that the UK Government in announcing the new licensing round has confirmed it is satisfied that its “climate compatibility checkpoint” (which aims to ensure the compatibility of future licensing with the UK’s climate objectives) has been met, engagement by individual organisations will require careful navigation.
One anticipated method of expressing investor discontent on ESG in the 2023 AGM cycle will be executive pay. The current ‘Investment Association Principles of Remuneration’ include recommendations on incorporation of ESG metrics into pay structures, including by attaching performance conditions.
If ESG metrics are not incorporated into executive pay structures already, boards may need to demonstrate to investors how and when they will be incorporated in future, and be ready to defend their delay.
In terms of the other stakeholders, in addition to the growing suite of regulation surrounding the scope of due diligence on the sustainability of corporate supply chains, and the heavily publicised activities of climate activists, employees’ expectations of their places of work are also shifting. Potential employee activism as a result of perceived ESG failings, in the form of online criticism, leaving, “quiet quitting”, or just investing less in employee share schemes, is another new concern.
Implementation and constant renewal of a properly-scoped ESG strategy remains key to market participants, who should anticipate challenge on their ESG targets and achievements from a wide variety of stakeholders going forward.