Economy and Society: SEC broadening definition of materiality

ESG developments this week

In Washington, D.C.

SEC broadening definition of materiality

In a March 15 speech given to the Center for American Progress, Acting SEC Chair Allison Herren Lee said that she was grateful for the opportunity “to reflect on the enhanced focus the SEC has brought to climate and ESG” and “on the significant work that remains.” Lee indicated that the Commission will utilize a much broader definition of materiality (which measures the relative financial importance of a factor among a company’s ESG considerations) over the course of its next term. Lee did not indicate whether this change in definition will be formalized or will be accomplished through informal attention to ESG-inspired disclosure rules. Lee stated the following:

“The most fundamental role that the SEC must play with respect to climate and ESG is the provision of information – helping to ensure material information gets into the markets in a timely manner. Investors are demanding more and better information on climate and ESG, and that demand is not being met by the current voluntary framework. Not all companies do or will disclose without a mandatory framework, raising the cost, or resulting in the misallocation, of capital. Investors also aren’t getting the benefits of comparability that would come with standardization. And there are real questions about reliability and level of assurance for the disclosures that do exist. Meanwhile issuers are assailed from all sides by competing and potentially conflicting demands for information. That’s why we have begun to take critical steps toward a comprehensive ESG disclosure framework aimed at producing the consistent, comparable, and reliable data that investors need….

…two weeks ago, we announced the formation of the first-ever Climate and ESG Task Force within the Division of Enforcement. The Task force will work to proactively detect climate and ESG-related misconduct, including identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules and analyzing disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”

Senator Pat Toomey (R, PA), the Ranking Member on the Senate Banking Committee, responded to the pre-release of Lee’s comments, tweeting, “This would be a total abuse of power and a politicization of SEC’s disclosure standard. What matters is whether an issue is financially material to a reasonable investor, not if it conforms to the woke Left’s opinion about what’s best for humanity’s general welfare.”

On Wall Street and in the private sector   

Former BlackRock official voices ESG criticism

On March 16, Tariq Fancy, former CIO of sustainable investing for BlackRock, the largest asset management firm in the world and a driver of the ESG investment trend, wrote an op-ed for USA Today that was critical of ESG and the sustainable investment movement more generally. He wrote:

“The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not….

As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community….”

That same day, Fancy also appeared on CNBC, stating, in his opinion, “There is no evidence that any ESG ETF has any positive social impact.”   

ESG’s higher management fees

On March 16 the Wall Street Journal featured a piece on ESG investing’s higher management fees: 

“Sustainability has been good for Wall Street’s bottom line.

Exchange-traded funds that explicitly focus on socially responsible investments have 43% higher fees than widely popular standard ETFs.

The environmental, social, and governance funds’ average fee was 0.2% at the end of last year, while standard ETFs that invest in U.S. large-cap stocks had a 0.14% fee on average, according to data from FactSet.

“ESG creates a fantastic revenue possibility for large firms,” said Dr. Wayne Winegarden, a senior fellow at the Pacific Research Institute.

Even a seemingly small increase in fees can have a big impact at scale. A firm managing $1 billion in a typical ESG fund, for example, would garner $2 million in annual fees versus managing the standard ETF’s $1.4 million.

“It’s fresh, feels good and new,” said Andrew Jamieson, global head of ETF product at Citigroup Inc., of ESG. “But it’s not any different than anything else. These things aren’t any more expensive to run.””

The Journal noted that other categories of ETFs charge even higher fees than the ESG funds but none as prevalent or as massively capitalized.

Research estimates one-in-four dollars invested in ESG

Last week, the investment banking and research firm Cowen claimed that its estimates show that roughly one-in-four dollars invested in American markets is now invested directly in an ESG vehicle. The firm also expects that the growth in the ESG sector over the last few tears will continue for the next few as well:

“Investors poured record amounts of money into environmental, social and governance-based funds in 2020 as the pandemic, climate disasters and racial injustice came into sharp focus.

That momentum will grow in 2021 and beyond, according to Cowen.

The firm noted that roughly one in four dollars in the U.S. is now invested through an ESG lens. If two equities offer similar expected risks and returns, investors are increasingly likely to choose the name that screens better on sustainable investing scores.

Indeed, sustainable funds attracted a record $51.1 billion in inflows in 2020, according to data from Morningstar. That figure more than doubled 2019′s prior record.”

Putting the “S” in ESG

Last week a group of ESG advocates and investorsAs You Sow, Sustainable Investments Institute, and Proxy Impactreleased the joint annual proxy preview. Confirming earlier reported expectations that 2021 would be the year that “s” in ESG began to play a much more prominent role in the investment movement, the groups reported that “of 435 shareholder resolutions already filed, about 300 are headed for votes at spring corporate annual meetings.” While the number of such proposals focusing exclusively on climate change fell from 87 to 78, the “number of proposals on workplace diversity more than doubled from 2020.”

Vanguard increasing its ESG capacity      

Vanguard, the second-biggest asset management firm in the world (by assets under management) and the manager with the largest passive investment portfoliowhich according to some analysts has been slow in following the ESG trendrecently begun putting together the workforce and other resources it will need to remain competitive in the ESG investment world:

“Vanguard isn’t known for its broad suite of environmental, social and governance investment funds. It has just five available in the U.S., versus dozens at rival Blackrock and other firms.

But as billions of dollars have flowed into rival firms’ ESG products in the past year and a half, the fund giant may be shifting its stance as it adds expertise in the area.

Kaitlyn Caughlin, who oversees the firm’s portfolio review, wouldn’t say whether or when to expect new products, but noted the firm is doing “a lot of additional research right now.”

The firm recently created an ESG product category team in the U.S. with two dedicated ESG product managers and three support staff. In Europe there is a head of ESG strategy who leads a group of product specialists who are largely, though not solely, dedicated to ESG. Those teams will collaborate with others in Vanguard, both related to ESG products and ESG integration in conventional products.

The hiring shows Vanguard is expanding into the space….”

In the spotlight

Agency theory and Canadian corporate governance

Our March 9 edition of Economy and Society highlighted the aspect of agency theory that advocates alignment of corporate managers’ self-interest with the interests of the corporation, specifically by tying executive compensation to company performance. To date, this practice is only rarely used regarding ESG matters, although that is starting to change.

As it turns out, according to a report from Bloomberg, the concept is already an integral part of Canadian corporate governanceor at least it is at Canadian banks:

“Canada’s six largest banks have all added ESG components to their chief executive officers’ compensation frameworks, putting them in a small minority of companies that tie executive pay to such measures.

How environmental, social and governance matters affect pay varies by firm, as does the percentage of compensation involved. Still, the Canadian lenders stand out because only 9% of the 2,684 companies in the FTSE All-World Index tracked by researcher Sustainalytics in a 2020 study had tied executive pay to ESG.

The moves, disclosed in the banks’ proxy circulars earlier this month, put them at the front of a push by activists and investors to establish incentives for actions like reducing emissions and diversifying workforces. At Canadian Imperial Bank of Commerce, the impetus to make changes also came from within, said Sandy Sharman, head of the bank’s people, culture and brand team.

“We didn’t want this to be something that we just report on and it’s a check-box,” Sharman said. “We actually wanted to drive accountability, and we also wanted to put areas in there that we wanted to improve. You need that healthy tension to move up your game.””

Notable quotes

“Imagine the planet is a cancer patient, and climate change is the cancer. Wall Street is prescribing wheatgrass: A well-marketed, profitable idea that has no chance of curing or even slowing down the cancer. In this scenario, wheatgrass is the deadly distraction, misleading the public and delaying lifesaving measures like chemotherapy. But like giving false hope to unproven cures in the midst of a pandemic, the consequences of such irresponsibility are all too obvious. And motivation for why the industry continues to greenwash is all too obvious.”