When it comes to sustainable finance, 2021 was a year of records: in 11 months to the end of November, investors had already directed over US$649bn into ESG funds – against full year totals of US$542bn in 2020 and US$285bn in 2019.¹ Furthermore, global sustainable bond issuance more than doubled to US$1,052bn in 2021 compared to 2020, according to Deutsche Bank Investment Bank.

This momentum is expected to continue in 2022, “not just because investors are keen to hold environmental, social and governance (ESG) debt, but also because corporates see that ESG issues now affect their business and investment risk”, Deutsche Bank Research Analyst Luke Templeman wrote in a recent report.²

So, what are the key drivers for ESG transition and sustainable finance in 2022? Which regulations and new reporting requirements should corporates place on their agenda? And how do macro trends such as inflation affect sustainability strategies? Deutsche Bank Corporate Bank’s ESG Client Solutions team has identified eight key themes that companies should watch over the weeks ahead. flow shares their recommendations – and explains how each of these trends affect corporates.

In 2021, corporates’ net zero pledges rose sharply. According to the Science Based Targets initiative (SBTi), an organisation that promotes best practice in reducing greenhouse gas emissions (GHG), to date 1,045 companies globally have set targets which are aligned with the goal to limit any rise in global warming to a maximum of 1.5°C.³ More than half of these companies, according to SBTi, have committed to reach net zero emissions across their value chain no later than 2050.

Yet, these long-term commitments need to be put into action immediately: According to the UN environment programme, GHG levels need to be halved over the next eight years to stand any chance of the 1.5°C goal being met by mid-century.⁴ It requires corporates to outline a detailed transition path and start strategic refocusing as soon as possible.

“While many companies and market participants have focused on ‘dark green’ activities over the last couple of years, managing the transition will become essential […] in 2022”
Lavinia Bauerochse, Global Head of ESG Corporate Bank, Deutsche Bank

“While many companies and market participants have focused on ‘dark green’ activities over the last couple of years, managing the transition will become essential for corporates and financial institutions alike in 2022,” says Lavinia Bauerochse, Global Head of ESG Corporate Bank, Deutsche Bank. This task is particularly important (and difficult) for activities that are energy-intensive and therefore not “green” by definition, such as steel manufacturing⁵ or chemical production.

As companies in “brown” sectors step up their efforts to meet climate objectives, it raises a further question: what will happen to assets where no transition is possible? “While we saw divestment strategies in the past, we expect engagement to play a more important role in 2022,” says Deutsche Bank’s Bauerochse. “It is a controversial debate, but as grey/private markets have limited oversight, the world might be better off with a responsible run down overseen by transparent reporting and stakeholder pressure.”

As such, essential questions need to be addressed this year: Could divestment alone decrease emissions? Who might be the best owner of harmful assets? Do governments need to intervene?

The shape of the market is where regulation comes into play – and here the next couple of months are expected to bring new developments.

Firstly, the EU has announced plans to publish later this year the technical criteria for the four remaining environmental targets of its taxonomy:

• the sustainable use and protection of water and marine resources;
• the transition to a circular economy;
• pollution prevention and control;
• the protection and restoration of biodiversity and ecosystems⁶

Following this exercise, Deutsche Bank’s analysts expect the focus of regulators to shift to defining a list of socially sustainable activities (“Social Taxonomy”) and a classification system for transition paths of companies operating in traditionally brown sectors (“Transition Taxonomy”).⁷ Both will provide guidance to companies on how to manage ESG transition of existing business models.

Secondly, banks’ ESG performances are increasingly in the spotlight: in 2022, the ECB and the Bank of England will review their practices of ESG risk management and conduct climate stress tests⁸ which could have implications for bank capital requirements. “We also expect other regulators globally to catch up and standard setters like the Basel Committee to drive harmonisation,” says Gerald Podobnik, Chief Financial Officer at Deutsche Bank, Corporate Bank.

Thirdly, the EU Green Bond Standard is expected to be adopted in 2022⁹, which would further increase standardisation and serve as a “gold standard” for green bonds – even though its international application remains an unresolved issue. All these regulatory initiatives are expected to shape capital and loan markets this year – also affecting treasury’s role in sustainability.

“We expect other jurisdictions globally to enhance their ESG reporting”
Gerald Podobnik, Chief Financial Officer at Deutsche Bank, Corporate Bank

As regulation is picking up, so are ESG reporting requirements for corporates. “In Europe, companies should carefully watch new developments with respect to the planned Corporate Sustainability Reporting Directive (CSRD),” says Podobnik. The new directive will require companies with more than 250 employees to disclose data on their sustainability performance.¹⁰ Although this rule only enters into force in 2024 for the financial year 2023 and onwards, a first set of sustainability reporting standards is expected to be published by mid-2022. He adds, “In addition, we expect other jurisdictions globally to enhance their ESG reporting”.

While these reporting requirements are likely to create more work for investor relations and finance divisions, there is good news for corporates as well: The International Sustainability Standards Board (ISSB), which was founded in November 2021 to define global sustainability disclosure standards¹¹, is expected to publish first drafts of a proposed standard later this year. Streamlining and formalising corporate sustainability disclosures will not only reduce the burden on companies to meet differing requirements in different locations, but the ISSB hopes it will also provide comprehensive information to investors and other providers of capital.¹²

Supply chains are of particular importance when it comes to transitioning towards a net zero economy, given that up to 90% of an organisation’s environmental impact lies in its value chain – either upstream (in the supply chain) or downstream (e.g. the product use phase). ¹³

Deutsche Bank Corporate Bank’s ESG Client Solutions team expects as a result that “the rising pressure for companies to track Scope 3 emissions and decarbonise their supply chains will continue. Especially value chains of global retailers and original equipment manufacturers (OEMs) are under scrutiny, pushing companies to seek for green products, such as green steel or aluminium.”

At the same time, social and governance factors within value chains will move into the spotlight. While the EU is still working on a due diligence law, aiming to improve ESG performance across value chains¹⁴, the German Supply Chain Law (“Lieferkettengesetz”) will go live in 2023 for companies with more than 3,000 employees¹⁵.

While companies should watch all these regulatory initiatives carefully, it could be the macroeconomic environment that will prove most challenging when it comes to driving ESG transition forward in 2022. This is because, it seems highly likely that companies will have to deal with inflated prices for energy, carbon and commodities over a longer period of time than first envisaged, as flow reported in its recent article “Higher energy prices – here to stay”. Coupled with the growing need to invest in decarbonisation technology, this trend is driving “greenflation”, i.e. (long-term) structural inflationary pressures caused by the greening of the economy.

On the one hand, greenflation weighs on companies’ profit margins. On the other hand, it is also challenging politics and society – especially if corporates are passing on their higher input costs to end consumers. As energy prices are rising and employment shifts away from carbon intensive industries, the importance of balancing transition efforts and social interventions will grow in 2022.

On the back of rising energy prices, emission trading schemes will continue to be in the spotlight in 2022. Last year, soaring natural gas prices led to a demand shift from gas towards more carbon-intensive coal which, in turn, propelled carbon prices within the EU to an all-time high of more than €90 per ton (see Figure 1). Similar developments were evidenced for other mandatory carbon markets in the UK and China, creating additional cost pressures for companies that need to purchase those permits.

The final trend corporates should include on their ESG agenda is rising importance of biodiversity issues. “Solving the climate crisis and conserving nature capital are two sides of the same coin, as a sustainable economy depends on sufficient nature capital as much as on low carbon,” says Deutsche Bank’s Bauerochse. She expects measuring natural capital to “finally move to the frontline in 2022” which is reflected among others by two events.

First, the Taskforce on Nature-related Financial Disclosures (TNFD) has begun work on a reporting framework, with a beta version to be published early this year. The framework “will provide companies and investors with decision-useful information to help shift the flow of global capital to nature-positive outcomes”, states the TNFD website, which was launched in June 2021 and is endorsed by the finance ministers of the G7.¹⁸

Second, companies should watch out for the UN’s biodiversity conference (COP15), which is taking place in Kunming, China from 25 April to 8 May 2022. This event could bring about progress on defining goals to preserve nature.

Sources

¹ See https://reut.rs/34gSOLi at reuters.com
² See https://bit.ly/3rzHRNH at dbresearch.com
³ See https://bit.ly/3ov34Go at sciencebasedtargets.org
⁴ See https://bit.ly/34Euh2y at unep.org
⁵ See Funding a zero-carbon future for steel at flow.db.com
⁶ See https://bit.ly/3Gz2gGA at ec.europa.eu
⁷ See https://bit.ly/3gwwfo6 at ec.europa.eu
⁸ See https://bit.ly/3si7OQS at forbes.com
⁹ See https://bit.ly/3HzbuUV at europarl.europa.eu
¹⁰ See https://bit.ly/3Hyi5i5 at responsible-investor.com
¹¹ See https://bit.ly/3rxOJLn at ifrs.org
¹² ibid.
¹³ See https://bit.ly/3uBdyrE at carbontrust.com
¹⁴ See https://bit.ly/3ov8HVk at gtreview.com
¹⁵ See https://bit.ly/34lztsd at bundesregierung.de
¹⁶ See https://bit.ly/3sqK9h0 at ec.europa.eu
¹⁷ See https://bit.ly/3Lg45fn at ec.europa.eu
¹⁸ See https://bit.ly/3GzFQVZ at tnfd.global