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Jan 20, 2021

All eyes on sustainability this earnings season

Federated Hermes lays out expectations for companies on ESG matters

Our dedicated commitment to sustainable wealth creation means we are busy forming not only financial expectations for the upcoming earnings season, but also for ESG expectations. As the world increasingly mobilizes to tackle climate change, we continue to encourage our invested companies to implement sustainable business practices. We expect efforts to relay climate ambitions, such as communication of carbon-neutrality targets, to be prominently addressed and we will be placing as much importance on corporate sustainability activity as on the financials.   

Companies increasingly highlight ESG efforts through earnings releases – a welcome initiative

As investor interest in corporate ESG behavior continues to grow, companies are becoming increasingly vocal about their sustainability efforts via improving disclosure, inaugural or enhanced sustainability reports and dedicated time allocated to highlight key ESG developments during earnings calls – a key forum for companies to share their stories with capital markets. Around two thirds of global companies already have some form of ESG reporting within their earnings release. We see this as best practice for corporates to provide updates on the progress of their sustainability journey.

Challenges to convey and interpret ESG initiatives remain

Despite corporates being more vocal about their sustainability initiatives, challenges remain. While leading bodies such as the Sustainability Accounting Standards Board, Global Reporting Initiative and Task Force on Climate-related Financial Disclosures (TCFD) have made great strides, further standardization is needed, such as definitions of high-carbon sectors.

Additionally, corporate disclosure still requires advancement, and investors are left with data gaps on important metrics such as Scope 3 greenhouse gas emissions (indirect emissions that occur in a company’s value chain). Harmonization efforts are growing, however: the UK government expects that all listed issuers and large asset owners will be reporting in accordance with the TFCD’s recommendations by 2022 – in our view, a much needed and welcome objective.         

ESG narratives that stick link to financial materiality

We favor companies that proactively incorporate their ESG efforts into their long-term strategy. Leaders in this area set out specific goals and detail how they are going to achieve them. It is also critical for companies to demonstrate how their ESG initiatives translate into improved financial outcomes, such as specifically quantifying how much cash savings the issuer generates by increased usage of recycled water, substituting fossil fuel energy with renewables, or improved employee retention by investing in improved human capital management.

Efforts to relay climate ambitions will be key

While ESG issues and their financial materiality vary by sector, with climate change being identified as one of the biggest risks facing humanity, in 2020 we saw an increasing number of corporates making commitments to carbon-neutrality. Across multiple sectors, from banks to energy producers, announcements were made on medium and long-term emission-reduction targets associated with those commitments. We expect this momentum to accelerate, with more companies likely communicating their carbon-neutrality ambitions in the first quarter and throughout the year.

In addition, we would expect and urge those companies that have already outlined their goals to now provide a detailed strategy of how they will be achieved. We have been impressed by the likes of Barclays detailing its BlueTrack methodology to measure financed emissions and Occidental Petroleum providing progress updates on its large-scale, direct air capture plant – the world’s first –  with the potential for the company to generate more profits from carbon management than from oil and gas. We expect other corporates to come forward and follow this lead. 

ESG no longer a silo, active engagement vital to continued improvement

We firmly believe good ESG policies and behavior not only serve as risk mitigants, but also enhance cash flow and enterprise value as well as helping issuers to reduce their cost of capital. Consequently, we fully integrate ESG policies and behavior analysis into our investment. This process pulls on multiple sources, including our own analysis of company disclosures, updates on earnings calls, proprietary ESG scores and data from third-party providers. 

But active engagement with companies plays the most critical part in developing our views. Our engagement strategy allows us to gain a better understanding of how companies approach ESG risks and how genuine their efforts are. Furthermore, collaborative engagement enables us to share best practices and constructively influence issuers to pursue even more ambitious ESG policies and behavior, as well as improved disclosure. Therefore, this reporting season will provide us with the right tools to form our investment decisions and we hope to see companies meet our lofty yet necessary expectations.

Audra Delport is deputy head of credit research and Fraser Lundie is head of credit at the international business of Federated Hermes. This article originally appeared on the Federated Hermes website here