ESG Honestly

Posted 24 January 2024

2024 ESG outlook –The five key trends that could shape ESG investing this year

The next 12 months are likely to be another eventful period for ESG investing and its development. We run through the top five trends investors will have to contend with.

Enhanced ESG reporting

In recent years, companies have been under growing pressure to be more transparent about their ESG attributes. Investors are increasingly interested in the non-financial fundamentals of companies, such as how much CO₂ emissions they produce and the diversity of their senior management team. To improve data uniformity between companies, and corporate transparency generally, 2024 will see new regulatory standards introduced that are designed to enhance companies’ ESG disclosures.

In the EU, the Corporate Sustainability Reporting Directive (CSRD) came into effect from 1 January 2024 and substantially increases reporting requirements that companies must meet. This will lead many EU companies to report heavily on all areas of ESG governance, provide thorough targets and assessments and align these with their business models and strategies. Over the next few years, the scope of companies that will be required to compile CSRD reports will increase – from only listed companies, banks and insurers, to non-listed companies over a certain size. This will bring the scope of companies from 11,600 to 49,000 across the EU.

Though not as advanced, the SEC is also targeting climate disclosures among US companies. The US regulator is drafting new regulations requiring listed companies to disclose climate-related risks, with the regulator wanting to improve standardisation of climate disclosures across US companies.

Supply chain scrutiny

Disclosure of companies’ ESG data is about to become more challenging in another way. In 2024, scrutiny will continue to intensify on companies’ supply chains. Investors have become increasingly motivated to learn more about the indirect ESG risks their portfolios are exposed to. For example, a high street fashion brand may have strong ESG credentials for its immediate organisation but use third-party suppliers that rely on child labour. Or an electric car manufacturer may produce zero-emission cars but rely on ecologically damaging mines to produce minerals critical to its batteries.

The focus on supply chains is now entering the regulatory field through the reporting of Scope 3 carbon dioxide emissions. These are the emissions produced throughout a company’s supply chain and can be very difficult to calculate. Originally a voluntary requirement, mandatory reporting of Scope 3 emissions is now coming into force in several regions. In the EU, this is part of the recently implemented CSRD, and the upcoming International Sustainability Standards Board (ISSB) rules will also require this. The latter is a global standard and several countries, such as the UK, are currently consulting on whether they will adhere to imposing mandatory requirements for Scope 3 emissions.

Carbon pricing prominence

This year we also expect carbon pricing to continue developing in its coverage and sophistication around the world. This has already been developing at pace and in 2023 revenues from carbon taxes and Emissions Trading Systems (ETS) reached a record high of $95bn, according to the World Bank. More countries have been adopting the approach of monetising carbon and over the past decade the global carbon tax and ETS coverage of emissions has increased from 7% to 23%.

The majority of ETS are in developed markets, but some are in operation in emerging markets such as China, Indonesia, Mexico, South Korea and Kazakhstan. Internationally-coordinated efforts are now being made to build on this progress. Organisations including the World Bank are supporting the establishment of an ETS in 17 emerging markets, with many others – such as Brazil, India and Vietnam – also exploring the creation of schemes.

The impact of the EU’s Carbon Border Adjustment Mechanism (CBAM) will also become more visible in 2024. Introduced last year, this is designed to combat carbon leakage – where businesses transfer emissions-heavy processes to countries where carbon is not priced. The CBAM is complex but essentially will tighten up compliance and see more companies price their carbon emissions.

Higher standards for funds

Some of the ESG regulations being implemented in 2024 will directly impact investment firms. In the UK, the FCA will soon introduce new Sustainability Disclosure Requirements (SDR) to ensure ESG investment products are transparent and report accurately investors. This will include new rules on how investment firms market their funds, the kinds of information they disclose and approved ‘sustainability’ labels for funds. The labelling of funds has come under greater focus in a bid to combat greenwashing, as some firms have been known to exaggerate the ESG credentials of the funds they are marketing.

In addition, more UK asset managers will come under the remit of the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD first came into effect in 2023 but only for firms with over £5bn in assets under management. This is set to change from the summer of 2024, so firms with under this amount will also be mandated to meet these reporting requirements. These include producing a litany of climate-related disclosures with public product-level reports being regularly published. This will mean a greater compliance burden for smaller investment managers, but investors will be able to benefit from a wider dataset.

Numerous elections

Several major elections will occur during 2024, in countries from the US and the UK to Russia, India and Taiwan. Although there is no accurate way to predict the outcome of an election, these will be important events for investors to watch. This is because any changes in governments could have significant impacts on economic policies and global trade.

Particular to ESG investment, however, is the impact new governments can have on sustainability requirements. The prime example of the potential for drastic policy shifts is the US. Under President Donald Trump, several ESG policies were repealed with the administration heavily supporting the fossil fuel industry. When Trump was replaced with President Joe Biden in 2021, the latter reversed many of his predecessor’s policies. Biden also introduced the Inflation Reduction Act, which includes an unprecedented $369bn in support for energy security and climate change policies. During Biden’s presidency, anti-ESG sentiment has grown within Republican states as the issue has become increasingly politicised. Should Biden lose the election in 2024, this could put ESG investments currently benefit from his policies at risk.

Therefore, it will be important for investors to remain vigilant throughout 2024 as to how ESG could be impacted by political change.