Insights

Math(s) isn't universal

23 Jan 2022 | Davos hypocrisy. Proxy power. Green protectionism. Plus, what does carbon offset controversy say about disclosures?

🛩️ The World Economic Forum at Davos exemplifies crony rather than free-market capitalism, writes The Spectator. This year, claims of hypocrisy are louder than usual. Criticism amplified by a cost-of-living crisis, conference attendees are accused of paying lip service to economic equality while shying away from action. But not everyone need worry about bad optics. In its 2023 Trust Barometer — published to coincide with Davos — PR firm Edelman finds Business is “the sole institution seen as competent and ethical.” (“Government and Media,” by contrast, “Fuel Cycle of Distrust, Seen as Sources of Misleading Information.”) The only group identified as more trustworthy is Scientists, 450 of whom just published an open letter imploring PR companies to ditch their fossil-fuel clients. Signatories cite a 2021 study on the unsung “major players in the climate political arena.” Through their campaigns on behalf of fossil-fuel companies, PR firms have “promulgated misinformation” (in Media) and “obstructed climate action” (in Government), effectively “shifting public discourse and the prospects for [policy].”

🗳️ Once the ‘Big Three’ asset managers extended proxy voting powers to clients, it was only a matter of time until advisers felt the political heat. Together, ISS and Glass Lewis control 97% of the proxy voting market. Their recommendations carry considerable weight. In a letter sent to both firms on Tuesday, Republican state-attorneys general challenged those relating to “climate and diversity, equity, and inclusion.” “Climate change advocacy and goals suggests potential violations of your contractual obligation [to] consider only one goal: the economic value of the investments,” wrote the attorneys of 21 states haemorrhaging hundreds of millions in higher-interest payments. The letter “reveals a fundamental misunderstanding of market forces at work,” responded ISS. Neither its voting strategy nor state activism has done BlackRock much harm. Speaking last week, CEO Larry Fink noted the $4B withdrawn by Republican states was more than offset by $230B in US inflows last year. “If you don’t have a lens to decarbonisation,” he added, “you’re not going to win one euro of business.”

🌐 Fault lines are deepening between the US and EU. In rhetoric if not action, central banks are diverging: The Fed “will not be a climate policymaker,” whereas the ECB has committed to aligning all policy with the Paris Agreement. But the real battle is playing out in green trade. (Ostensibly ‘green’, anyway. Those asking whether John Kerry were a protectionist in 2002 finally have an answer.) Seeking to alleviate European fears about the “discriminatory” Inflation Reduction Act, Commission president Ursula von der Leyen unveiled a Green Deal Industrial Plan at Davos. The counter package will channel capital towards, loosen restrictions on, and accelerate permits for green projects. “The story of the cleantech economy will be written in Europe,” she concluded. This is what the US wants, says the FT: coaxing the EU to its preferred territory of cash over rules. Carrot over stick, public spending over carbon pricing. EU dismay is understandable if naive. The ideological frontrunner has been overtaken and undercut by an ally that didn’t need to waste two years arguing about definitions. In one stroke, the US redefined 'sustainable'. And the WTO.

Story of the week: Math(s) isn’t universal

Here’s a fun number. New analysis reveals that over 90% of rainforest carbon offsets by the world’s biggest provider are worthless.

The Guardian, Die Zeit and SourceMaterial undertook a nine-month investigation into carbon credits approved by the world-leading Verra carbon standard, which accounts for two-thirds of the (rapidly growing) $2B voluntary offset market. Their conclusion: The vast majority are ‘phantom credits’ and may exacerbate global warming, on top of human rights abuses such as forced evictions.

The net-zero pathways of most multinationals depend on carbon offsets. Shell — which, just last week, published a report on the “record growth” in voluntary and regulated markets — has set aside more than $450M for offsetting projects, according to The Guardian. The oil major plans to buy the equivalent of half the current market every year, having been ordered to cut emissions by 45% by 2030 in a landmark 2021 case. The Dutch ruling marked the first time a company had been legally obliged to align its policies with the Paris Agreement targets. It won’t be the last.

Conceding the industry can ill afford a crisis of confidence, supporters argue that achieving net zero is impossible without offsets. Even the IPCC deems them “unavoidable.” Critics, however, say they just don’t work.

How you read this story depends on whether you see it as:

  1. an aberration in the system; or
  2. a function of the system itself.

… and that, in turn, has very real ramifications for how you interpret company reports.

Nobody wants to do harm (again)

It’s often said that sustainability is entering the mainstream. More accurately, sustainability is coming to define the mainstream, fuelled by supranational and national action of the type best exemplified by the Paris Agreement.

Broadly, reactions can be split into two buckets: Primarily supportive, on ideological grounds; and primarily opposing, on financial grounds. The former is best represented by the EU. To the latter, we can safely assign higher-emitting companies and economies that rely on carbon-intensive industrial activity. They might like the tenets of sustainability in theory. (This isn’t in a Marvel movie. It'’s unlikely anyone has a deep-seated planetary vendetta.) But compliance can be a nuisance.

Nobody in Group #2 wants to admit they’re in Group #2. The membership fee is high and rising, as governments and regulators reconfigure global financial frameworks to meet ambitious sustainability targets. Forget subsidies or taxes. Even if only reputational, there are enormous costs associated with being labelled a “brown” company (or a “do-harm” fund provider), particularly if your inclusion in an ESG-rating-weighted index depends on it. And so, they lie.

For a time, the “alphabet soup” of fragmented standards facilitated compliance arbitrage. But that form of greenwash was never going to last, which was clear to everyone involved. Investors wanted consistent and comparable disclosures, adding to the pressure on regulators to condense everything into one framework.

You don’t need to create standards to control them

It was this landscape into which the WEF stepped in 2019, armed with the ambition of harmonising the standard-setters (whether by mediation or co-option is a matter of opinion).

In conjunction with the Big Four, it published a report designed to serve as the basis for any ubiquitous framework: Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation. The ‘Common Metrics’ cherry-picked elements developed by the five standard-setters of the day, which were combined into a “nested ecosystem” under WEF’s second initiative: the Impact Management Project (IMP). The IMP was ultimately folded into accounting body the IFRS Foundation, whose global framework for sustainability disclosures is expected this year.

The trouble is, “sustainable value creation” is not the same as sustainable development. Littering your work with SDG icons, pretty though they are, does not translate into shared international prosperity. And social and environmental risk to enterprise value (known in the accounting world as ‘single materiality’) is not the same as social and environmental impact (‘double materiality’).

Based on the draft proposals issued by the IFRS last year — behind which the WEF has thrown its support — we can expect very little of the latter in its final framework.

Accounting regulators are among the most powerful and independent in the world. Companies manage what they measure, and they measure what accounting boards tell them matters. Between them, the WEF and IFRS have determined that means risks to enterprise value, and, of those, primarily the ones relating to climate.

It creates a fertile ground for another explicit WEF project. The highly complex carbon offsetting, sequestration, and trading market has been commoditised as a ‘win-win’ solution to meet the net-zero obligations of the Global North under the Paris Agreement. The Global South has land and livelihoods, the Global North capital and technology. It also owns and runs the markets.

The ultimate irony is that the defendants of carbon colonialism can do so while cloaked in the unimpeachable respectability of saving the planet.

Kenneth Pucker said it best in the Harvard Business Review. Backed by what Greta Thunberg describes as the machinery of “clever accounting and creative PR,” Sustainability Inc.’s focus on corporate reporting is not a proxy for progress.