Ongoing crises, like the global pandemic and the war in Ukraine and new tests driven by data needs and the regulatory landscape are expected to offer investors myriad opportunities and challenges in the realm of environmental, social and governance this year, according to research released Thursday.
The report “Actionable Insights: Top ESG Themes in 2023,” the annual global outlook from by ISS ESG, which, like CIO, is owned by International Shareholder Services Inc.
The report points to climate change, the regulatory environment, cryptocurrencies, the future of corporate and ESG ratings, an employer’s role in the well-being of employees, the food production industry, and the energy transition among important issues and concludes, “In this investment landscape, access to adequate data is crucial.”
Not Just an Environmental Concern
Beginning with environmental concerns, the report highlighted biodiversity loss as an economic problem just as much as a biological one, because more than half of global GDP is “moderately or highly dependent on nature.”
London-based ISS ESG pinpoints the food industry as the main culprit of biodiversity devastation. Food companies are responsible for more than half of all negative impact on biodiversity, one-third of global greenhouse gas emissions, 90% of global deforestation and make up nine of the top 10 companies responsible for the largest negative impacts on biodiversity, according to the firm’s Biodiversity Impact Assessment Tool
The report highlighted soil degradation and biodiversity loss while ascertaining that prioritizing healthy soil would increase carbon sequestration, reduce existing greenhouse gas emissions and support crop yield.
Energy transition and the move toward net-zero carbon emissions may provide an opportunity for investors. Decarbonization solutions extend to wind, hydro, solar, nuclear and the storage of energy, all of which will likely be prioritized moving forward.
“Historically, growth from new energy sources has added to total energy consumption, rather than replaced legacy energy sources,” Nicolaj Sebrell, ISS ESG’s sector head, wrote in the report. “For example, the introduction of coal as a new energy source during the industrial revolution did not displace biomass energy (mainly wood).”
Sebrell continued that nuclear and wind energy are the power sources that produce the least carbon during their lifecycles, noting that solar power generation produces several times more carbon than the outputs of wind or nuclear, though solar still represents a drastic improvement upon the emission profiles of fossil fuels.
The ISS ESG report cites the scarcity of data about companies’ operations and efforts on the journey to net-zero carbon emissions as reaching a peak in 2023.
“While this process comes with costs, there will also be opportunities: for example, in the production of transition-exposed commodities such as cobalt, lithium, and copper,” the report states.
Regulatory Challenges
As another focal point for the year, the report identified the necessity for investors to evaluate potential risks to enterprise value stemming from regulatory action and targeted legislation of business activity deemed to be anti-competitive, specifically potential antitrust cases that could face Big Tech.
Focusing on antitrust concerns in Big Tech, the report depicted a social cost created by business models of dominant digital advertising players: “Users trade personal data and attention for content, while advertisers pay the platform to target users based upon their demographic profile and online behavior,” the company wrote. “If the digital advertising market is less competitive because of a few dominant platforms, users will likely get reduced- or lower-quality content and services or have to give up more privacy, while advertisers will pay higher prices, [creating a] social cost that becomes more extreme as competitive dynamics veer toward monopoly.”
To limit powers flowing to Big Tech, the EU recently finalized the Digital Markets Act, which becomes applicable on May 2. The law designates a commission that will eventually designate digital gatekeepers to whom the law will apply. Gatekeepers will be required to comply with a set of rules to operate specific services within the EU. In addition to requiring the review of potential acquisition, the rules prohibit behaviors that enhance market power, including combining personal data across services without explicit user consent; conditioning access to core platform services upon registration or use of another service; processing third-party data for targeted advertising; self-preferencing; or not allowing third-party app stores or software to run on an operating system.
In the week when the U.S. Department of Justice and eight U.S. states sued Google seeking to increase competition in the online ad business, the report concluded that, “Investors in the digital sector will encounter growing regulatory risks in 2023, and ESG analysis can help investors navigate these risks.”
Crypto’s ESG Profile?
The report also examines the controversies in the cryptocurrency industry. They are unlikely to lead to an ultimate downfall for the sector, according to the report’s authors, but rising interest rates and the opportunity for investors to earn a real rate of return in conventional fixed-income, plus the FTX collapse have brought serious doubt to the non-security “currencies.”
Crypto falls into the ESG category obliquely, with questions about the regulation of the sector and the energy consumed to create new coins. Crypto currently has no regulatory framework.
“[Cryptocurrencies] generally do not pay an interest rate, nor can they call on an established institutional framework in the event of a bank run on a particular crypto asset or entity,” the report stated. “Crypto’s attractiveness to some investors has come from its secrecy and its use of blockchain, which could be interpreted as bypassing traditional financial watchdogs.”
The ISS ESG authors suggest that one way to provide confidence in crypto and the wider decentralized finance sector would be for crypto companies to actively seek out industry-wide regulation to protect consumers.
“Such regulation might include the following: a clear definition of purpose/genuine business case; reasonable capital adequacy constraints where depositor assets are held; regular reporting and transparency on key metrics; independent third-party audits; location in markets where financial regulations apply; and disclosure of conflicts of interest,” the authors wrote.
The heightened awareness of the environmental impact of specific industries will influence investment decisions in 2023, as many investors continue to move toward net-zero carbon emissions. Obtaining transparent, reliable and standardized data on portfolio companies’ emissions, targets and reduction strategies, in addition to global sustainability standards and disclosures, will be of keen focus this year.
One size does not fit all, from a regulatory perspective, as some industries’ relationships with regulation presents a contrasting situation to investors; the future performance of web-based businesses may be affected by increased regulatory measures meant to counter anticompetitive practices. Meanwhile, achieving a regulatory framework to protect consumers may become a required catalyst to restore confidence in the crypto sector.
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Tags: antitrust, Big Tech, COP15, Crypto, ESG, ISS, ISS ESG, Net Zero, Nicolaj Sebrell