Emerging markets and ESG data: Three themes to watch in 2024

Significant progress is being made on the topics of coal phase-outs, scenario analysis and improving ESG data.

Would it be a stretch to say 2023 has been one of the best years for ESG? Perhaps not. Despite the brickbats, tangible progress has been made on global sustainability disclosure rules, widespread regulatory reform on ESG ratings and taxonomies, and serious attempts to make complex topics like biodiversity and due diligence operational.

As we gear up for what could well be another bumper year, here is my pick of three sustainability topics that are poised to make the leap from niche to mainstream in 2024.

Revisiting Asian coal

There are very good reasons to divest coal. Coal combustion is the largest single contributor to climate change and will be the first of the fossil fuels to go if the world is to reach net zero. So, it seems unlikely that ESG investors will overcome their aversion to a commodity with poor long-term prospects and a controversial public image.

But that is exactly what needs to happen to end its use once and for all, according to an emerging coalition of Asian governments, development banks, philanthropic organisations and coal plant owners.

The arguments go like this: coal plants in Asia are young – 14 years old on average, compared with around 45 years in the US and Europe – and insulated from market forces due to different forms of state ownership, long-term energy contracts and subsidies. This means they could operate well beyond the global deadline for coal use (2040, according to the International Energy Agency).

Only the owners of coal assets can realistically take them offline, and they will need to be cajoled and compensated for the inconvenience and loss in earnings. This is something many financial institutions are prevented from doing due to well-intentioned but inflexible climate policies. More than 200 major banks and investors have coal exclusion policies in place and counting, according to a popular database compiled by IEEFA.

Advocates of a managed phase-out of coal, such as Singapore’s central bank, have acknowledged that it may be difficult for financial institutions to reinvest in coal so quickly after making very public pledges not to do so.

But there is optimism that banks and investors will come around. For one, the need for phase-out financing is so great that, given the lack of progress in public finance-led initiatives such as the JETPs, funding phase-outs privately could see rapid social acceptance.

Adding to the momentum is an emerging body of best practices, which have been developed by organisers of phase-out initiatives.

Net zero coalition GFANZ has published a set of investment policy templates, and guidance on safeguards and carbon accounting methods, which it believes will allow institutions to finance coal phase-outs while continuing to observe climate goals.

The Monetary Authority of Singapore has separately included coal phase-outs in its new taxonomy and is also part of multilateral efforts to develop a new type of carbon credit based on phase-outs.

Refining and acting on scenario analysis

More organisations than ever are using climate scenario analysis and realising just how little of the information gleaned is “decision-useful” for the here and now.

Part of the problem is that existing scenarios have been unable to model significant events such as climate tipping points, or the self-reinforcing effects of an economic downturn caused by climate change.

Going through with the exercise will often yield results which are “far too benign, even implausible in some cases”, according to a recent report from the University of Exeter and UK actuaries.

In addition, the 50-plus year time horizon which commonly underpins climate scenarios makes it difficult for users to formulate short-term climate actions.

This could change sooner rather than later. The past year has seen the launch of at least four research papers and studies exploring ways to overcoming these limitations.

Some of the boldest ideas have come from a partnership between the UK’s Universities Superannuation Scheme (USS) and academics.

The team have designed their own climate scenarios featuring detail-rich narratives which “switch the focus away from climate pathways and towards the changes in politics, economics, asset prices and extreme weather events”.

One of the four scenarios proposed, for example, considers the hypothetical election of “a populist Republican president” and the partition of Ukraine following a Russian victory, and explores the ensuing recriminations that destabilise US-Europe relations and undermine global decarbonisation efforts.

USS is exploring ways to apply the scenarios to its strategic asset allocation process in 2024, in what would be a landmark move for a pension fund.

Separate analyses by Carbon Tracker, the University of Exeter and the UK’s Institute and Faculty of Actuaries, the New York Fed, and the Economics of Energy Innovation and System Transition project have proposed that climate scenarios utilise shorter five- to 10-year horizons (as already being developed by the NGFS), rethink the Capital Asset Pricing Model used for asset allocation, and use more realistic carbon-pricing assumptions.

On the regulatory front, the European Banking Authority said in October that it plans to use scenario analysis as a means to enhance its prudential enforcement over the long-term.

Much improved ESG data and next-gen analytics

Next year could be the beginning of the end for inaccurate, incomplete ESG datasets.

The issue has long been a bugbear for ESG investors over concerns that not enough companies are reporting material information on environmental and social performance. Estimated data from commercial providers are often not up to the mark, with studies showing them to be far less accurate than company-reported data.

Regulators have now taken the decision out of company hands, starting with the EU, which has ordered mandatory disclosures to be made from 2024. Most major markets are due to follow suit by adopting the ISSB’s global ESG reporting rulebook in the coming years.

The clincher is that an ecosystem is also being constructed around the disclosure chain to organise and convey information to investors and other stakeholders. This includes a diverse range of public and private actors, including the Bloomberg-led Net-Zero Data Public Utility, the open-source OS Climate data platform and the EU’s official ESAP database.

The upshot should be that investors will have unprecedented access to troves of free, high-quality ESG datasets, which in many cases will be subject to assurance. This could spur the use of AI and advanced data analytics to process vast datasets and find insights on complex topics such as company transition plans.

Most importantly, better data will give investors a clearer picture of the financed emissions for which they are responsible. A recent study has suggested that the true size of company Scope 3 emissions could be as much as 44 percent higher than has been reported to date. Discrepancies of this size could be enough to scupper or, at the very least, significantly delay the achievement of portfolio climate targets.