ESG developments this week

In Washington, D.C.

SEC reviewing ESG disclosure practices of publicly traded companies

Late last month, the Securities and Exchange Commission, led by acting Chair Allison Herren Lee, announced that it has started reviewing ESG disclosure practices and demands among the publicly traded corporations it regulates. According to Lee, “Now more than ever, investors are considering climate-related issues when making their investment decisions…It is our responsibility to ensure that they have access to material information when planning for their financial future.”

Lee’s statement suggests a potential change in SEC policy and a concomitant issue on the Commission over the definition of materiality, the financial elements deemed fundamental to the long-term success of a company’s ESG strategy. In a statement released just over a year ago, just after the SEC’s Divisions of Corporation Finance and Economic and Risk Analysis and Office of General Counsel released new recommendations on efforts to modernize and enhance financial disclosures, Commissioner Hester Peirce wrote:

Thanks in part to an elite crowd pledging loudly to spend virtuously other people’s money, the concept of materiality is at risk of degradation. We face repeated calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality. The proposed amendments and companion guidance do not bow to demands for a new disclosure framework, but instead support the principles-based approach that has served us well for decades.

SEC announces ESG enforcement task force

Last week, the SEC announced that it will create a new task force targeting those who engage in fraudulent ESG behaviors. To be housed in the Commission’s enforcement division, the new, 22-person task force will be charged with ensuring that corporations are complying with existing ESG-friendly disclosure rules and will play a much more significant role if new rules are added. According to Reuters, the task force will be run by Kelly L. Gibson, currently the acting deputy director of SEC’s enforcement division. Reuters also notes that Satyam Khanna, the Commission’s newly appointed senior policy adviser for climate and ESG, declared that the task force is evidence that the SEC intends to take an integrated approach to enforcement of climate-related issues, rather than simply assigning the matter to one small group within the Commission. The announcement, Khanna said, is evidence that the new administration and its appointees are “taking an ‘all of SEC approach’ to climate and ESG risks.”

ESG in Sweden

On March 5, the Swedish Society for Nature Conservation released a report accusing the nation’s state-backed pension funds of failing to meet their obligations and to keep their promises regarding climate change and other ESG matters. Specifically, the Society accused pension fund managers of remaining invested in fossil fuel companies, which, it claimed, is a violation of promises made, both to activists and pensioners. Fossil fuel investment accounts for less than 1% of the funds’ total assets under management. According to Bloomberg:

The AP funds, which oversee about $250 billion in assets and have all committed to environmental, social and governance goals, continue to invest in fossil-fuel companies that are contributing to a dangerous rise in temperatures, the Swedish Society for Nature Conservation said Friday in a report.

“Not a single one” of the fossil-fuel companies held by the AP funds has set climate goals that live up to the Paris Agreement, the group said….

The comments mark the latest clash between a financial industry keen to tout its ESG credentials, and climate protection groups who say their strategies do little more than pay lip service to the idea. That’s as the industry stretches the definition of sustainability to include companies that pollute now, but say they have plans to cut their emissions in the future.

Despite cuts in the AP funds’ holdings of fossil-fuel companies last year, they still have about $1.8 billion invested in 66 of the world’s 200 biggest polluters, the Swedish Society for Nature Conservation found.

On Wall Street and in the private sector   

Putting the ‘S’ in ESG

Last week the investment news site Seeking Alpha suggested that the rise of Black Lives Matter and other social movements may have triggered greater concern among investors about the ‘S’ in ESG:

While the reflection on environmental and governance factors remains at the forefront of asset owners’ interests, social issues such as health and safety, human rights, labor rights and equality have recently been pushed into the spotlight.

Our 2020 ESG Manager Survey showed an uptick in social factors, when compared to the previous years’ responses….

While environmental and governance factors have been in focus for a number of years, the coronavirus pandemic, along with the Black Lives Matter movement, #MeToo movement and campaigns for equal pay, have increased the focus on social factors.

ESG in Asia

While much of the analysis and discussion around ESG investing focuses on the United States, United Kingdom, and Europe, Asia’s financial sector is moving quickly and significantly into the ESG space. In the recently published results of its global institutional investor survey, MSCI, an American finance company, noted the following about the Asian ESG market:

Around 79% of investors in Asia-Pacific increased ESG investments “significantly” or “moderately” in response to Covid-19, according to a recent MSCI 2021 Global Institutional Investor survey.

That is a slightly larger share than the 77% of investors globally who upped sustainable investments during the period. Overall, the figure rose to 90% for the largest institutions, or those with over $200 billion of assets, the survey found.

Meanwhile, 57% of Asia-Pacific investors expect to have “completely” or “to a large extent” incorporated ESG issues into their investment analysis and decision-making processes by the end of 2021.

“Once an issue for ‘green funds’ and side-pockets, ESG and climate are now firmly established as high priority issues,” Baer Pettit, MSCI president and chief operating officer, said in the report. “2020 marked a profound shift in the way institutions invest as many investors have recognized that many companies with strong environmental, social and governance practices outperformed during the pandemic.”

In the spotlight

Agency theory in ESG

Agency theory, as it evolved during the 1970s, focused on improving the performance of a corporation by aligning the interests of the corporation and its managers. In their work “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Michael Jensen and William Meckling argued that alignment between corporate and managerial interests would greatly and swiftly advance managerial performance. Later, Jensen and Kevin Murphy suggested that paying managers with company shares would cement the alignment and ensure that managers would constantly and permanently try to maximize the company’s value to its shareholders. 

Currently, there are some attempting to apply agency theory and corporate alignment practices to ESG. For example, Environment and Energy Leader reported last Friday that Chipotle Mexican Restaurants has announced that it is attempting to lead this agency movement:

Chipotle Mexican Grill has gone public with its intention to tie executive compensation to its environmental, social and governance (ESG) goals. The company has introduced a new ESG metric that will hold its executive leadership team responsible for making business decisions that prioritize corporate responsibility. Ten percent of the annual incentive bonus for officers will be tied to the company’s progress toward achieving those ESG goals.

The announcement comes following a year in which a litany of disrupters boosted the profile of corporate responsibility issues. With the pandemic, social injustice, extreme weather and wildfire events setting a magnifying glass over how ESG influences the global economy in 2020, such topics will continue to play out on a larger stage in 2021, S&P Global Ratings said earlier this year.

Meanwhile, Bloomberg Business reported that Cevian Capital, described as “an activist investor with sizable stakes in some of Europe’s biggest companies,” is advocating the same alignment tactics in Europe. Bloomberg noted:

The new campaign is intended to address growing concerns that too many firms are touting environmental, social and governance goals without always living up to their promises.

“Several of our companies are not currently where they need to be, including larger ones such as ABB, CRH and Ericsson,” Cevian Managing Partner Christer Gardell told Bloomberg.

Cevian wants the matter to be put to shareholder votes in its portfolio companies at annual general meetings next year. Those companies that have yet to take ESG seriously need to “start,” while the rest need to “accelerate” strategies already in place, it said in a statement….

The investor plans to “hold companies and their directors to account” through a combination of voting on director elections and compensation plans.

Notable quotes

“[I]f capitalists are unable to reform capitalism, it will be reformed for them. The American public is already distrustful of big business, and only half of American adults under 40 view capitalism favorably — down from two-thirds in 2010. Companies that don’t adapt will find themselves at odds with their customers, employees, investors, and regulators.

Michael O’Leary and Warren Valdmanis, “An ESG Reckoning Is Coming,” Harvard Business Review, March 4, 2021