What does it take to transition to a lower-carbon economy? Beyond involving complex technologies, extensive infrastructure changes, and sophisticated modeling, one fundamental element will be paramount to our collective success: we must remember that humans will be behind – and impacted by – it all. Governments and country leaders worldwide have already publicly recognized this, introducing the term “just transition” into the 2015 Paris Agreement. The legally binding international treaty on climate change calls on its signatories to consider “the imperatives of a just transition of the workforce and the creation of decent work and quality jobs in accordance with nationally defined development priorities”, all while working towards limiting global warming to well below 2 degrees Celsius compared to pre-industrial levels.
In 2021, the Canadian government published a discussion paper, People-centered just transition, along with a statement explaining that the just transition involves:
- “Preparing the workforce to fully participate in the low-carbon economy while minimizing the impacts of labour market transitions;
- identifying and supporting inclusive economic opportunities for workers in their communities; and
- putting workers and their communities front and centre in discussions that affect their livelihoods.”
Suffice it to say, although the transition to a lower-carbon economy may be an environmental issue at its core, its social implications are significant. The human element, the “H” in ESG, is inextricably linked to the transition, and investors have taken note. Capital markets have been increasingly focused on better understanding the social responsibility of organizations within the context of the transition, with the investment community publicly acknowledging the financial materiality of human capital management.
The COVID-19 pandemic has also helped shed light on the importance of this issue. During the past two years, our public systems and economies were shaken, and income inequality rose. Companies have had to alter the way they conduct business; team mental and physical distress levels have increased – and so have employee resignations.
This growth in employee attrition, paired with an increased competition for talent, has become a key ESG topic for many organizations. In Millani’s latest ESG Sentiment Study of Canadian Institutional Investors, one asset manager shared: “Every industry is facing human capital shortages. Companies must now go the extra mile to attract, retain, and train their employees or have a different approach […]. A change of mindset is required.” For instance, the Royal Bank of Canada increased its workforce by about 2% last year, but total human resources costs rose by 8.4%, further demonstrating the topic’s financial implications. These S-related issues can also have macro-level implications. In March 2022, some of CP Rail’s employees went on strike following rising tensions relating to compensation, at a time when commodities like fertilizer were scheduled to ship out for the start of seeding season, and livestock feed had to be sent to regions affected by recent drought. Combined with existing inflationary pricing pressures and supply chain interruptions, this type of situation could potentially engender serious repercussions on the functioning of farms nation-wide. It could also contribute to growing social unrest and income inequality – going against the very ethos of a just transition and leading to short-to-medium term consequences for our economy, and therefore for investors.
Corporate culture is another related theme increasingly being perceived as key to growing and protecting enterprise value. Investors know that a strong corporate culture helps build trust and reduces risk; however, if poorly managed, it can also be detrimental. Rio Tinto took a notably deep dive on this topic in its February 2022 Report into Workplace Culture, an official acknowledgement of the culture challenges that permeated parts of the organization. The report discloses the results of a third-party assessment which uncovered signs of racist, sexist, and other inappropriate behavior, and provides the framework put in place to remediate these challenges. It serves as a reminder that maintaining healthy and safe work environments can affect the ability to attract and retain employees, which is not only a key topic for issuers and investors, but also part of supporting a just transition.
Disclosure on S Topics
Through Millani’s work with corporate issuers and investors, a growing need for disclosures on social topics, and their financial materiality, has been identified. As we undertake the transition, we expect to see an increase in the standardization of employee-related metrics in ESG reporting frameworks, with regulators and standard setters already integrating social topics into corporate and investor disclosures requirements.
Of note, the International Financial Reporting Standards (IFRS) Foundation will be embedding the Sustainability Accounting Standards Board (SASB)’s industry-based standards development approach into the International Sustainability Standards Board (ISSB) standards, which will include human capital. Currently, SASB addresses three issues connected to human capital management in its standards: employee health and safety; diversity, inclusion, and engagement; and labor practices. A consultation project is underway to assess the scope and prevalence of various human capital management themes, namely workforce composition, costs, and turnover.
This desire for social disclosures is also growing in the U.S. The Securities and Exchange Commission (SEC) has already published disclosure requirements related to human capital, and we expect enhanced scrutiny of these topics in the short-term. In March 2021 during a keynote address to the Center for American Progress, Allison Herren Lee, former acting chair of the SEC, discussed the rise in investor demand for disclosure on topics like human capital. She further reiterated this point during the Shareholder Association for Research and Education (SHARE)’s 2022 Investor Summit, where she discussed the quality of disclosures for topics related to human capital and the desire for more robust disclosures.
Ultimately, the transition to a lower-carbon economy will be significant and addressing the human element in this transition will be crucial. The expectation that teams manage, track and build quality data around this topic will likely keep growing. Companies should also be prepared to disclose and be engaged on their ESG risks and opportunities related to social topics. As the market strives for a just transition, we expect social issues to remain at the forefront of investor engagement themes going forward.
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.