CURRENT TOPICS IN ESG AND THE SUSTAINABLE ECONOMY
THE ETHICAL SUPPLY CHAIN
In recent years, supply chain risk management has received more attention in the context of investing with a focus on ESG and the sustainable economy. Specifically, efforts to address social issues, such as modern slavery and human rights abuses, in global supply chains have been prominent, both as a means of mitigating risk and as a proactive way to enhance brand reputation. Driving forces behind these efforts include consumers, shareholders, nongovernmental organizations, and other advocacy groups calling for action.
Jurisdictions around the world have enacted or proposed legislation requiring companies to disclose their risks, policies, and proactive steps relating to modern slavery, such as forced labor and child labor, in their supply chains. Two types of legislation are emerging. The first type is disclosure-based requirements, essentially requiring companies to publish statements identifying what actions, if any, they are taking to address modern slavery in their supply chains. Examples of this type of legislation include the California Transparency in Supply Chains Act and the United Kingdom's Modern Slavery Act. The second type of legislation goes further and imposes an obligation on companies to engage in human rights diligence in their supply chains. France's duty of vigilance law and the Netherlands' child labor diligence law are good examples.
However, legislation is only as good as the enforcement mechanisms that uphold it. While earlier laws lacked meaningful enforcement mechanisms, relying largely on naming-and-shaming lists and public image-related motivation as incentives for companies to take action, more recent legislation has included stronger penalty provisions, including the potential for civil fines, criminal sanctions, and disqualification of directors.
Litigation is also a business risk for companies that fail to meet established standards. Consumer class actions, human rights litigation by victims, and suits to enforce compliance with modern slavery and disclosure laws have become increasingly common. Higher insurance premiums, supply chain disruption, and related business continuity issues are additional tools to exert pressure that may be available in some jurisdictions. In the United States, goods produced with child labor or without payment of minimum wages can be enjoined from shipment under the Fair Labor Standards Act, and goods being imported to the country can be held at the border if they were produced with forced or child labor. These real business risks can have a meaningful financial impact on a noncompliant company when enforcement measures are taken.
It is challenging to determine how to assess these risks and the adequacy of measures companies are taking to prevent them. Without a uniform standard or set of criteria to consider, companies, investors, and fund managers are left to create their own policies and investment criteria relating to ESG matters and the sustainable economy. While the consequences of failing to meet any one stakeholder's criteria may result in reputational and some commercial damage to a company, one stakeholder's requirements are generally not enough to persuade a critical mass of supply chain participants to open up their activities for scrutiny, let alone change their operations. Thus, reliable, broadly applicable metrics for detecting and reporting supply chain risks are necessary to have a material impact. Corporate pressure in this area has been building, and we anticipate that it will increase in coming years, particularly as technology solutions, such as blockchain for tracking supply chain actions, become more broadly available.
ENVIRONMENTAL AND ENERGY JUSTICE
The concept of environmental justice is one of the ways in which environmental action and social justice come together. More specifically, environmental justice is typically concerned with the fair and equal treatment and meaningful involvement of all people, regardless of race, ethnicity, national origin, income, or other factors, with respect to the development, implementation, and enforcement of environmental laws, regulations, and policies.
These concerns typically arise from the lack of environmental protections for socioeconomically or culturally disadvantaged populations or a failure to enforce environmental laws that exist. For example, in the United States, environmental justice principles typically reflect injustices in Black and other communities of color, and the harms that people are typically concerned with include contamination of drinking water and soil, as well as proximity to operations and activities that emit carcinogens and toxic particulates into the air, such as mining and highways. Discussions around siting of electric generation and natural resource processing facilities also arise in this context, and these discussions may function to bridge environmental and energy justice concerns.
Energy justice is a similar concept that focuses on the equal treatment and involvement of all people— again, regardless of race, ethnicity, national origin, income, or other factors—in decisions regarding how energy is generated, distributed, and used. Energy justice concerns have become especially pronounced in recent years as more and more data shows that communities disproportionately impacted by climate change are typically communities of socioeconomically or culturally disadvantaged people. Some of the topics discussed in this context include a lack of access to electric vehicles due to the inability to afford a new car, off-street parking, or housing in neighborhoods where electric vehicle charging stations are most likely to be installed. Similarly, people in these disadvantaged communities often rent rather than own their homes, so they cannot simply install rooftop solar panels, energy-efficient appliances, and climate control units. Furthermore, they may not be able to participate in green power programs offered by local utilities if their landlords choose not to participate.
As a concept, neither environmental justice nor energy justice is new. Many jurisdictions, including the United States, have had laws and government regulations enshrining environmental justice principles for many years. These laws often concern public access to decision-making processes and equal protection of disadvantaged groups with respect to enforcement of environmental laws. Laws and regulations related to energy justice are also on the rise.
What is new is the increased focus of customers and investors in environmental and energy justice beyond compliance with applicable law, particularly in those jurisdictions where environmental laws are spotty, nonexistent, or enforced inconsistently. For instance, it is becoming increasingly popular for investors to probe how and to what extent a developer has engaged with the community when planning a renewable energy facility. In addition, as investors scrutinize their investments more, the companies in which they invest are increasingly attentive to the environmental and energy justice implications of their own operations and the practices of participants in their supply chain.
More and more, companies are setting goals that treat their relationships with employees, suppliers, customers, communities, and the world with an ESG and sustainable economy focus. These goals, and the actions taken to implement them, can encompass a broad range of considerations, including product and services sourcing, greenhouse gas output, waste handling, pollution mitigation, employee transit, and operational impacts to natural resources. In addition, corporate impact investing is on the rise, including direct investment in renewable energy facilities with specific social indicia (e.g., Microsoft's investment in solar facilities developed by Sol Systems), workforce housing with rooftop solar, and publicprivate partnerships to help fund publicly accessible electric vehicle charging stations throughout a metropolitan area.
CARBON
Global emissions of greenhouse gases have long been a key interest for some investors, but they are quickly becoming a topic of interest for many more. While there are a number of greenhouse gases, carbon dioxide—referenced simply as carbon— tends to capture much of the public's attention, particularly in the context of ESG and the sustainable economy. Conversations about carbon typically revolve around five major concepts:
- Decarbonization is a broad term that generally refers to efforts to reduce carbon emissions resulting from various processes, for example, product manufacturing, natural resource utilization, agriculture, and residential activities such as heating and cooking.
- Low carbon is a somewhat subjective phrase that refers to products or processes that have a lower carbon footprint than others. It is often used in conversations about the lowcarbon economy, i.e., an economy powered by low-carbon energy sources.
- Carbon reduction describes activities and processes that are comparatively less carbon intensive than similar activities and processes.
- Carbon neutral can refer to an activity or product that is produced without emitting carbon, or it can refer to a person's actions to offset carbon emissions attributable to their current activities. A number of businesses and some investment firms have announced goals to become carbon neutral.
- Carbon negative can refer to an activity that consumes, rather than emits, carbon on a net basis. It also can refer to a person's actions to go beyond carbon neutral, including methods to offset more carbon emissions than those for which they are responsible over a defined time period. For example, a few large multinational corporations have announced goals to offset all carbon they have produced throughout the life of the corporation.
Decarbonization clearly fits within the environmental category of the ESG and sustainable economy frameworks, but it is also inherently tied to environmental justice because of the impact on socioeconomically and culturally disadvantaged groups of both climate change and many of the processes associated with sequestering carbon.
Investors utilizing an investment strategy informed by ESG and sustainable economy considerations can achieve investment goals centered on decarbonization concepts by investing in physical assets, such as carbon-capture or removal facilities. However, while carbon-capture equipment is becoming more common in certain industries, e.g., natural gas processing and electricity generation facilities, it is very expensive. Direct air capture technologies that remove carbon from the ambient air are also available and on the cusp of achieving the scale necessary to have a material impact on the climate. However, they remain difficult to finance. Carbon-capture and technology-driven carbon removal activities and sequestration also inherently present physical asset, environmental, and offtake risk. For example, the gold standard for carbon reduction is currently secure sequestration in a geologic formation. However, pumping carbon dioxide into the ground can affect groundwater, and there is always a chance of leakage. In addition, geologic formations suitable for carbon sequestration are not available in all regions. Some of these risks can be reduced by utilizing captured or removed carbon while, in some cases, still storing the carbon such that it will not easily be emitted, e.g., manufacturing of high-carbon steel and concrete. Many other utilization technologies are also available or in development, but they have not yet become commercially viable, e.g., fuels made from algae grown using captured carbon.
Investors with no appetite for physical asset risk or the business risk inherent in investing in technology with an uncertain offtake market can still participate in the low-carbon economy. These investors may prefer more established asset classes, such as sustainable forestry and agriculture, where carbon is removed and stored through intentionally deployed natural processes, such as photosynthesis and biochar application. Alternatively, investors may purchase carbon credits or offsets to meet their carbon reduction goals. These methods have been available for some time in certain jurisdictions, and they are becoming increasingly common worldwide. In addition, markets in these carbon instruments and their derivatives are evolving quickly, which should help to bring more carbon-capture and removal facilities online in the near future.
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