Economy and Society: Bank of America warns regulatory scrutiny could halt ESG growth

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C.

FINRA Chair joins the regulatory chorus

On November 3, CNBC released an interview with former co-CEO of Ray Dalio’s Bridgewater Associates Eileen Murray, who is currently the chair of the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization that oversees and regulates the actions of its members. Murray joined a growing number of government officials and regulators who argue that the key to making ESG investing work is, in their view, more serious and stringent government regulation. On the specific matter of the environment she said the following:

“My skepticism is not about tackling ESG. I think we absolutely have to do that. I think the way we’re going about it, there’s a lack of consistency and standards, in terms of what’s being reported to the public. Who’s accountable? Who’s accountable for those disclosures? Right. And what is the transformation that we need to have to make ESG really real? You know, we’re polluting the planet. How are we going to stop that? And so when I stepped back, my skepticism is about – and I wouldn’t have said this 20 years ago – I really think we need regulators to step up. They have in certain parts of the world, and start to ensure that companies are applying standards and disclosure, that companies are being open about what they’re doing and transparent. 

It’s complicated. And you know, it’s evolving. So people say, “Oh, it’s too complicated. We can’t deal with it.” Well, 20 years ago, we had a lot of changes in credit exposure reporting and people thought that was very complicated. Same thing with trading analytics. So I don’t believe that this is so complicated, that smart people can’t come to solutions. But I think it’s going to take regulators, business, and educators to deal with this. And it’s an ecosystem problem. One company cannot do this alone and that’s why I think we need government and regulators. So my skepticism is not about the call to action, my skepticism is, are we doing enough? Or are we going to wait till this is a pandemic to deal with?”

Regarding the “S” in ESG (i.e. “social”) Murray said the following:

“Take DE&I – how many years has that been around?…

Diversity we’ve been talking about since I was in my 20s, which was quite a quite a long ways ago. But you know, when I first started working, diversity, it was like, 0.5% of the senior people were women and today it’s 17%. And you know Leslie, I don’t know if I should do the happy dance or cry. But we just haven’t made enough progress. And I believe had regulations been more involved, that we would be further along on diversity. I don’t think it’s just about diversity. I think it’s also about inclusion to really be successful and so I think we both know that. One of the things for example, what the NASDAQ just did, I’m not talking as the chair of FINRA, but as Eileen Murray, individual, I applaud them….

Yeah, and they’re basically saying, comply or disclose. So you either comply or you disclose. Well, what’s wrong with that? What’s the criticism about that? I just think without those kinds of movements, we’re not going to make progress. And I think history demonstrates that….I think without disclosure and transparency, it’s going to continue as it is with people focused on the urgent, people focused on short term profits, and not looking at the long term impact to their company, or socially.”

Murray argued that, in her view, government regulation and leadership are absolutely imperative:

“[I]f you asked me 20 years ago, should we have government or regulators involved in diversity, I’d say no, companies will get there, they’ll do it on their own, it’s the right thing to do, it’s great for business. Well, I was wrong. I was dead wrong….

And, and what I have seen work is when regulations come out and say, “Thou shalt report on the following things, and it will be disclosed.” And directors will have fiduciary responsibilities to see that it’s done well, and CEOs will be held accountable through compensation. I see that really work.”

But not everyone thinks more regulation will help

As FINRA’s chair was arguing for greater regulation of the ESG industry, Bank of America was arguing that any such increase would stall the growth in ESG and, thereby, stall the progress its advocates argue it’s making. ETF Stream notes the following:

“The boom in environmental, social and governance (ESG) asset gathering could hit a stumbling block as global regulators intensify scrutiny of financial products amid greenwashing fears, the Bank of America (BofA) has suggested.

In a research note published last Thursday, the BofA said investors should be more cautious in labelling their products ESG in the face of a regulatory clampdown, adding it expects asset managers to temper their ESG assets under management (AUM) figures as a result of stricter definitions.

Last year was a record year for ESG inflows with the rise of products claiming to adhere to climate or ESG considerations reaching $1.7trn AUM by the end of 2020.

Globally, ESG funds AUM is growing at three times the rate of non-ESG funds, BofA said.

However, the scale of greenwashing in the asset management industry was laid bare last month after it emerged 71% of equity funds falling into the broad ESG category were misaligned with on the Paris Aligned Benchmark, according to research from think-tank InfluenceMap.

As a result, BofA said ESG AUM inflows could stall as regulatory oversight intensifies.

Menka Bajaj, EMEA ESG strategist at BofA, said: “Given the surge in ESG financial products, global regulators are ramping up the review of sustainability statements for compliance with current law.

“We believe investors should reconsider their ESG criteria and be more cautious when making claims about green/social investments….””

On Wall Street and in the private sector

Effects of ESG investing driving inflation 

Bill Ackman, the activist investor who is the founder and CEO of Pershing Square Capital Management, has arguedand has, most notably, argued to the Federal Reserve Bank of New Yorkthat the Fed, its interest rate policies, and the effects of ESG investing are driving inflation too far, too fast. On November 4, Markets Insider (a publication of Business Insider) had the details:

“Bill Ackman believes initiatives related to ESG investing are contributing to a surge in inflation, and that the Federal Reserve is not paying attention….

“Central bankers have not considered how inflationary ESG initiatives are. ESG is not transitory, but rather persistent and growing. Stakeholder capitalism will drive much needed increases in wages, but also higher energy costs, among other inflationary factors,” Ackman tweeted on Wednesday.

ESG’s focus on companies that implement various environmental, social, and governance practices has shifted investment away from lower-cost fossil fuel energy and towards higher-cost renewable energy. Some on Wall Street have warned that energy prices are spiking now because years of underinvestment in oil, gas and coal resulted in lagging supplies….

In a tweet last month, the billionaire investor said the Fed should taper its bond buying program and raise interest rates as soon as possible. Fed Chairman Jerome Powell, however, has indicated that the central bank likely won’t begin to raise interest rates until 2023….”

New tools for private company ESG disclosure

Last Tuesday, Institutional Investor magazine ran a piece making the case that, as its title put it, “It’s Time for Private Companies to Come Clean on ESG.” In it, writer Hannah Zhang made her case thusly:

“Private companies are under pressure to disclose more data relating to their performance on environmental, social, and governance issues….

Larry Lawrence, executive director and head of ESG products for the wealth management market at MSCI ESG Research, said that public companies have been publishing ESG data in their financial reports, making it easier for investors and rating agencies to track their performance on these measures. But when it comes to alternative assets, including private equity and private debt, “there’s really little to no information,” Lawrence said.

To address the transparency gap in the private markets, MSCI constructed an ESG analytic tool to be similar to the ones it designed for the public markets. And it chose to tackle the “E” element first through a partnership with Burgiss, a data and analytics provider focused specifically on private markets and based in Hoboken, New Jersey. 

Starting in October, the index provider has been tracking the carbon footprint of private assets by using market information collected by Burgiss and a model it has developed. The new analytical tool can now estimate carbon emissions for more than 15,000 private companies and nearly 4,000 active private equity and debt funds.”

But is a new tool necessary?

The demand for disclosureand the creation of this new tool for creating estimatesmight not be entirely necessary, some argue. As Institutional Investor itself reported only a week before:

“Investing with environmental, social, and governance goals is quickly climbing in private markets.

Asset managers committed to ESG investing now oversee an aggregate $3.1 trillion, or 36 percent of the value of total global private market assets, as of October, according to a Preqin report released Wednesday….

According to the report, larger asset managers disclose more information about ESG, and the average ESG transparency metric becomes more robust as the funds’ assets increase….

There’s no question that private capital is the future of ESG, said Yury Yakubchyk, CEO and co-founder of Elemy, a privately held business-to-business platform that connects users with in-home pediatric healthcare providers. As a business with a socially-driven mission, Elemy has attracted high-profile investors, including Pershing Square’s Bill Ackman.

“The mentality that I’m detecting from investors is that, over the past few years, Silicon Valley has gravitated more toward mission-oriented businesses,” Yakubchyk told Institutional Investor. “Now, the financial and investment community is playing catch up. I’ve had investors point-blank tell me that if a company doesn’t have a mission that makes sense to their LPs, they’re not going to invest.””

In the spotlight

Professor Luigi Zingales argues “Democracy before ESG”

In a recent piece published by Project Syndicate, University of Chicago Finance Professor Luigi Zingales made the case that supporting and promoting democracy must be the first step in any realistic and legitimate ESG investment scheme:

“Amid growing concerns about climate change and social unrest, institutional investors are increasingly applying environmental, social, and governance criteria in their portfolio decisions. Yet while ESG factors are important for investors to consider, the new focus risks obscuring an even bigger issue: the role that corporations play in the democratic process.

What do corporations have to do with democracy? In fact, many corporations play a leading role in distorting the democratic process, the proper function of which is to transform popular will into legislative action. Let me illustrate the point with examples from the United States, which used to be considered the world’s most advanced democracy.

In 2019, Ohio’s Republican-controlled state legislature passed House Bill 6, which provided $1 billion in subsidies to bail out FirstEnergy Solutions, a nuclear-plant subsidiary of an electric utility. The bill was hardly an expression of the will of the people of Ohio. On the contrary, a dark-money group, Generation Now, has since pleaded guilty to charges of carrying out a massive bribery scheme to secure approval for the bailout. Generation Now backed the campaigns of 21 different state-level candidates, including the Speaker of the House, Larry Householder, who also received more than $400,000 in personal benefits.

And if this was not bad enough, when Ohioans started collecting signatures for a referendum to abolish HB6, Generation Now launched an ad campaign claiming that the Chinese would take over the state’s power grid if the repeal was successful. A local news outlet also found that the group had “hired ‘blockers’ who followed, encircled, harassed, and (in a couple cases) physically hit petition gatherers.” It was later revealed that Generation Now was founded with $56.6 million from FirstEnergy Solutions, but this scandal would never even have been exposed if not for an FBI investigation.

Since this episode seems to belong more in 1950s Guatemala than in twenty-first-century America, can we dismiss it as an isolated case, limited to one bad company, one state, or just the Republican Party? Unfortunately, we cannot….

The first principle of responsible investing, then, is to ensure that corporations are not violating or rewriting the rules of the democratic game, either at home or abroad.”