Economy and Society: Responses to ESG-disclosure rules

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.

Responses to ESG-disclosure rules 

As discussion continues about the Labor Department’s ERISA retirement plan rule, which is in the comment period, and the Securities and Exchange Commission’s proposal on ESG-related disclosure rules, the Mercatus Center at George Mason University released a report on the subject by Amanda M. Rose, a professor of law at Vanderbilt University Law School. Rose concludes that general, all-purpose disclosure requirements are too vague and too broad and suggests that the SEC move more deliberately, more simply, and more incrementally:

“The breadth of topics embraced by ESG and the breadth of motivations spurring the ESG movement have created a big tent that has undoubtedly served a purpose by helping the various causes of those involved to gain momentum. But it has also created problems. For example, ESG performance ratings are inconsistent and difficult to decipher. Which of the myriad ESG issues are factored into a rating, how performance on those issues is measured, and the weight each issue is given are subjective, usually nontransparent determinations that vary across ratings providers.

The breadth of ESG topics also makes studies that purport to show a positive link between ESG performance and financial performance difficult to interpret. There is no a priori reason to believe that a company’s approach to climate change and a company’s approach to diversity or any other ESG issue will each have the same sort of impact on a company’s financial performance; yet these studies often bundle ESG issues together to measure ESG performance or rely on ESG performance ratings that themselves bundle the issues together. They therefore leave unanswered which, if any, discrete corporate policies related to ESG actually affect financial performance….

Many are urging the SEC to create a comprehensive, mandatory, ESG disclosure regime, and title I of H.R. 1187, a bill recently passed by the House of Representatives, would require the SEC to do so….

The trouble with these proposals, however, is that they speak in generalities about the importance of ESG to investors without specifying which, if any, specific ESG topics are financially material, and they invite the SEC to model a mandatory ESG-disclosure framework after frameworks developed by private standard setters without strict regard for notions of financial materiality….

Questions of institutional competence and democratic accountability are particularly significant because advocates for ESG disclosure clearly see ESG disclosure as a mechanism for promoting certain types of corporate behavior and discouraging others. Mandating that such disclosures appear in SEC filings would amplify this effect by involving the board and executives who certify SEC filings in the ESG disclosure process. Advocates view this as a benefit of SEC-mandated ESG disclosure. But the SEC lacks the expertise and authority to broadly regulate corporate behavior.”

Professor Rose concludes by suggesting that: “Whether the SEC ought to mandate ESG disclosure and, if so, how it should do so can be approached and debated on a discrete, topic-by-topic basis, like any other item of arguably material information.” 

Will an emphasis on ESG compromise future retirements?

On November 19, RealClearMarkets published a piece on ESG in ERISA governed retirement funds by Bryan Bashur, a Federal Affairs Manager at Americans for Tax Reform and executive director of the Shareholder Advocacy Forum. Bashur argues against the Labor Department’s new proposed rule as follows:

“[R]eturns on ESG-driven investment strategies risk being lower than is the case with their more traditionally run counterparts. According to Pacific Research Institute research, $10,000 invested in an ESG fund would be around 44 percent lower than an investment in a fund that tracks the S&P 500 for ten years. 

In fact, some industry experts such as Tariq Fancy, a former chief investment officer for sustainable investing at BlackRock, believe that “the ESG industry today consists of products that have higher fees but little or no impact and narratives that mislead the public.”…

Biden is effectively allowing pension plan managers to redefine their fiduciary duty to the plan beneficiaries, in the name of ESG and other forms of socially responsible investing, a move that may well mean that could hit the amount in a beneficiary’s pension pot when the time comes to retire. 

Bashur also argues that the political warfare is not restricted to the federal level and some states are pushing back:

[T]here are solutions to ensure that Americans are secured after retirement. The Texas legislature passed, and Gov. Greg Abbott signed, a bill that would aim to maximize returns for state employee pensions and retirement funds by punishing governmental entities from contracting with or investing in financial institutions boycotting fossil fuel companies. The bill went into effect in September. 

Under the new Texas law, retirement funds will not be subjected to using taxpayer dollars to pay high fees for ESG products more focused on political initiatives than creating real economic value for employees.”

In education

The rise of ESG in business schools

A recent New York Times “DealBook” column detailed the rise of ESG in business schools. As it turns out, two years before, The Financial Times did its own rundown of the burgeoning field of ESG studies in business and management education. Among other things, FT noted:

“The University of Chicago has long been considered the epitome of free-market thought. No wonder: this was the intellectual home of economists such as Eugene Fama and Milton Friedman, who championed the pursuit of profit and the doctrine of shareholder primacy which has driven corporate America for nearly half a century.

“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business, ” Friedman wrote in a highly influential 1970 essay. “His primary responsibility is to them.”

But today something striking is under way in Chicago, says Randall Kroszner, an esteemed economist who teaches at Chicago Booth business school (and formerly served on the Federal Reserve Board).

While the business school remains a bastion of free markets, it has also started to teach its students about environmental, social and governance issues (ESG) — including the importance of serving “stakeholders” such as customers, employees and communities rather than just shareholders. “We have been changing,” explains Mr Kroszner, who argues that it is entirely wrong to view Chicago today just through the narrow lens of Friedman-style economics.

It is a powerful symbol of a bigger paradigm shift….

[W]hile investors watch the C-suite to see if it can (or cannot) live up to these lofty new goals, what has hitherto grabbed less attention is the crucial role that business schools are playing in this pivot to a more socially responsible model of capitalism….

Take Harvard Business School — an institution that was once viewed as the seminary of the religion of red-blooded, profit-focused American capitalism. Two years ago, Vikram Gandhi, a Wall Street veteran, developed the first HBS impact investing course which he teaches as part of the elective MBA curriculum. “We have written more than two dozen new case studies [for the course],” he says, including entities ranging from BlackRock to private equity group TPG’s Rise Fund and Japan’s government pension investment fund. “We, like others, recognise that ESG isn’t a fad — it’s part of a long-term trend.”

George Serafeim, another Harvard Business School professor, is overseeing a course that explores how companies and consumers can adopt ESG in their own lives….

New York University’s Stern School of Business has established a special ESG hub run by Tensie Whelan, formerly of the Rainforest Alliance, which offers intensive study on how ESG impacts specific business sectors, such as the auto industry.

Other business schools, such as Thunderbird in Arizona, or Berkeley in California, are also developing significant ESG footprints.”

In his book on ESG investing The Dictatorship of Woke Capital, independent market analyst Stephen Soukup writes that “When the histories of this era are written, 2019 will go down as the year of ESG….” It appears, at least according to The Financial Times, that many business schools would likely agree.

On Wall Street and in the private sector

Will the Labor ERISA rule further empower proxy advisory services?

In a piece published November 12, the editors of PlanAdvisor magazine suggested that the Biden Department of Labor’s proposed rule on ESG in ERISA-compliant plans will require some plans to change their fiduciary disclosures and guidelines, perhaps increasing their reliance on the two proxy advisory services that dominate that market, Glass-Lewis and Institutional Shareholder Services (ISS). As the editors point out in the text, PlanAdvisor is owned by ISS:

“Under the DOL’s proposal, funds or asset owners increasing their focus on ESG factors may require changes in their proxy voting disclosures and guidelines, according to Adam Shoffner, fund chief compliance officer at compliance and technology firm Foreside. For example, an asset owner that subscribes to a standard set of proxy advisory opinions may need to update the type of proxy advice it receives.

Gabriel Alsina, head of Americas, Continental Europe (ex-France) and global custom research at ISS, says ISS’s benchmark policy reviews environmental and social considerations when providing voting recommendations in some situations. ISS also offers specialty policies that focus on sustainability, socially responsible investing (SRI) and climate.

The DOL’s prior guidance hadn’t diminished the importance of ESG issues to institutional investors, says Alsina, who adds that demand for environmental and social research has increased. “E, S and G have become inseparable to most institutional investors, providing distinct avenues to assess risk and preserve long-term shareholder value,” he says. “Proxy voting guidelines have evolved to add more environmental and social criteria into consideration, not less.”…

Separate from the DOL action, the Securities and Exchange Commission (SEC) has proposed amendments to Form N-PX, “Annual Report of Proxy Voting Record of Registered Management Investment Company.” According to a legal update from Stradley Ronon, the proposed amendments are designed to enhance disclosure by requiring funds to identify the subject matter of the reported proxy votes.

From an adviser’s perspective, the information on the revised Form N-PX would provide greater insight into how closely a fund’s voting patterns align with the plan sponsor’s values. For example, if BlackRock’s change causes more fund managers to allow split proxy voting, it could create new opportunities for plans to vote their values versus defaulting to the fund manager.

It could also result in the development of proxy advisory services that focus on specific themes. Hoeppner says the industry isn’t there yet, but he speculates that proxy advisory services that have pro-environment or pro-manufacturing perspectives, for instance, could emerge. Plan advisers could use these services to help their plan clients determine their votes.”

In the spotlight

Incentivizing corporate leaders to meet ESG metrics on the rise while critics skeptical of impact

The incentivization of corporate leaders to meet ESG metrics was the topic of a November 14 piece in the The Financial Times, which summarized that “[s]enior management pay is increasingly linked to sustainability targets, but critics are sceptical this will amount to meaningful change”:

“As climate change has advanced up the boardroom agenda, so, inexorably, it has started to find its way into the incentives of senior executives. That has raised questions, not only about the clarity and solidity of the underlying goals and the ease with which chief executives might hit them, but about the purpose and effectiveness of monetary rewards as a way of changing corporate behaviour.

For now absolute numbers of companies using climate targets to calculate chief executives’ bonuses and long-term incentives remain low: just 24 companies in the FTSE 100, and only 20 in the S&P 500, according to ISS ESG, the responsible investment arm of proxy adviser Institutional Shareholder Services. But from a low base, the number of companies using climate pay targets more than doubled between 2019 and 2020. A survey by Deloitte in September suggested a further 24 per cent of companies polled expected to link their long-term incentive plans for executives to net zero or climate measures over the next two years.

“We have not seen that sort of increase since TSR became the measure in vogue” in the early 2000s, says Phillippa O’Connor, a partner at PwC, who advises companies on executive rewards, referring to total shareholder return, the metric of choice for tying executives’ incentives to financial performance.

The push to integrate climate goals, and wider ESG targets, into pay plans has been led by consumer companies such as Unilever. Investors have also intensified the pressure on oil and gas groups such as Royal Dutch Shell to follow suit. According to ISS ESG, 39 per cent of energy companies in the world’s biggest indices had incorporated climate targets into their chief executives’ pay by last year, the highest proportion of any sector.

Harlan Zimmerman, senior partner at Cevian Capital, an activist investment group, sees the introduction of targeted pay as a “forcing mechanism” to change mindsets about climate change.”