ESG Developments This Week

In Washington, D.C.

Responses to the SEC’s sustainability disclosure rule announcement

In the week since the Securities and Exchange Commission (SEC) announced its plans to require sustainability disclosures from publicly traded companies, the reactions have been both manifold and diverse. Some support the idea, while others don’t. In any case, the new disclosure rules have many in Washington newly interested in ESG, including Rep. Byron Donalds (R-Fla.) who wrote the following for The Hill last week:

“President Biden has his sights set on the next tool to push his destructive climate agenda: Environmental Social Governance. ESG scores are based on a host of woke factors such as a company’s carbon emissions, energy consumption, and board diversity, among others. The more woke the company is, the higher the ESG score. The higher the ESG score, the more “investable” the company is said to be. While this Chinese Communist Party-style social credit score was once limited to a few virtue-signaling companies, there is growing effort from the Biden administration to make ESG a mandatory part of doing business in America. 

The president is attempting another “ultimate workaround” by again legislating through federal agency regulation. Knowing these Green New Deal policies could never pass the democratically elected Congress, the Biden administration is trying to shove their radical agenda down the throats of Americans everywhere through unelected and unaccountable bureaucrats. Worse yet, they are doing it with our hard-earned money.  

The Department of Labor has expressly disregarded any “anti-sustainable investing rules.” When presented the opportunity to demonstrate increased investment returns because of ESG, the DOL failed to do so and simply refused to enforce the Trump-era rule, which sought to prioritize pecuniary interests ahead of non-pecuniary for fiduciaries. The Securities and Exchange Commission is in the process of proposing ESG rules for securities issuers and exchanges as well as establishing an SEC ESG Task Force, designed to investigate and enforce ESG rules. The Office of the Comptroller of the Currency has supported ESG initiatives among private banks and is composing an ESG regulatory framework focused on climate impact.

As Black Rock CEO Larry Fink, laid out in a January 2020 letter, “the goal [of ESG] cannot be transparency for transparency’s sake. Disclosure should be a means to achieving a more sustainable and inclusive capitalism.” In a 2020 New York Times op-ed, former Federal Reserve nominee Sarah Bloom Raskin called for a number of energy companies to be excluded from COVID-19 relief because they generated too many carbon emissions. This is the terrifying business future ESG proponents are trying to create.”

Richard Morrison, a research fellow at the Competitive Enterprise Institute, a Washington, D.C. free-market think-tank, penned a piece for National Review Online’s “Capital Matters” in which he spelled out some of the likely consequences of the SEC’s new proposed rule. He wrote:

“The SEC’s proposal would be difficult, on any reasonable interpretation, to square with the exercise of its normal authority over financial markets, and is yet another troubling example of regulatory mission creep. It is also a disappointing and alarming development for those who care about property rights and a competitive, growing economy….

The SEC has always required firms to disclose financially material information about their structure, operations, and plans for the future. Something doesn’t — and shouldn’t have to — fall into a topic-specific bucket such as climate to be worthy of such attention. The SEC has traditionally used a “principles-based” approach to materiality, under which a company’s management draws attention to the risks and opportunities that it considers most important to that particular company. This allows for, as the SEC’s Walter Hinman described in a 2019 speech, a disclosure regime that “keeps pace with emerging issues . . . without the need for the Commission to continuously add to or update the underlying disclosure rules as new issues arise.” The new proposals foolishly go in the opposite direction.

Similarly, the concept of materiality itself gets a problematic twist. By introducing specific, prescriptive requirements rather than ones based on general financial principles, the agency is trying to put its thumb on the scale and suggest that anything climate-related should be considered presumptively material. This is not an honest attempt to protect investors; it is climate activism in finance-regulation drag. The goal is to force firms to disclose information about greenhouse gases and carbon intensity on the assumption that future investors will penalize them because of it. The one silver lining in this case is that investors — if they are left to make up their own minds — are unlikely to consider “climate exposure” nearly as much of a poison pill as the climate campaigners are hoping….

Much of the specialized reporting and audit assurance called for would need to be outsourced to consultants, accountants, and law firms with climate-focused practices. The world of ESG business services is already salivating over such increased demand stemming from this and similar initiatives. Big Four accounting powerhouse PwC announced last year that it was planning to hire 100,000 new staff to deal with climate and diversity issues over the next five years alone. Additionally, the proposed rule acknowledges that the change may result in heightened litigation risk and the revelation of trade secrets.”

On Wall Street and in the private sector

While ESG has tough year, investors grow impatient

On March 27, Barron’s posted a story citing an investment research report, noting that ESG has, so far, been having an exceptionally difficult year, particularly for those funds that have little or no exposure to energy. Moreover, for the first time, investors are seeming to notice, according to the story:

“Inflation and the war in Ukraine have jolted the U.S. economy—and weighed on the performance and investment flows of environmental, social, and governance, or ESG, funds. That’s especially true of funds underweight energy and defense stocks, according to a recent report from Bernstein.

“ESG funds and indices have underperformed this year across regions,” the authors noted. “While ESG funds have experienced positive inflows this year, the first week of March marked a rare outflow from ESG funds, the largest weekly outflow in the 30-year history of the EPFR database.”

Sarah McCarthy, head of European equity strategy research at Bernstein and co-author of the report, says the outflows and poor performance challenge the conventional wisdom about ESG investing and shed “some light on the fact that ESG funds have been forced almost to take on huge macro risk.” That’s because many ESG funds tend to exclude stocks in sectors such as defense and tobacco, which typically underperform as inflation expectations rise, and energy, which typically outperforms in an inflationary environment….

According to Bernstein, global and U.S. ESG funds both underperformed non-ESG funds in January by 120 basis points. (A basis point is one hundredth of a percentage point.) In the same month, European Union ESG funds underperformed by 50 basis points.

Year to date, the Morningstar US Sustainability TR USD index has fallen 8.7%, while the Morninstar Global Markets Sustainability NR USD index is down 8%. The Morningstar Europe Sustainability NR USD index has lost nearly 13%, according to Morningstar Direct. All three indexes have underperformed non-ESG indexes.

Net outflows from ESG funds, meanwhile, totaled a record $1.3 billion in the first week of March. ESG funds have seen net inflows of $31.4 billion so far this year, according to EPFR.”

Meanwhile, in Canada, the country’s largest pension fund is unhappy with recent ESG results and insisting that directors resign. Interestingly, the results that most concern the company are not returns but the effective application of ESG values:

“Canada Pension Plan Investment Board, the country’s biggest pension fund, said on Thursday that directors of its portfolio companies presiding material environmental, social and corporate governance (ESG) failures should be asked to resign immediately.

The change is part of revised proxy voting rules for the fund, known as CPP Investments, which will allow it to vote against a director seeking re-election following failures of oversight, along with voting against the director deemed most responsible for failing to remove them from the board.

CPP Investments, with C$550.4 billion ($431 billion) in assets, will also consider voting against all directors at portfolio companies with classified boards where ESG oversight failures have occurred. Classified boards are companies in which only a subset of directors are up for election.

“While this structure can provide enhanced continuity and stability … classified boards actively inhibit the rights of shareholders to hold specific directors to account annually,” CPP Investments said in a statement.

The move is aimed at ensuring that CPP’s portfolio companies are compliant with climate change, board gender diversity and corporate governance issues, which are high on investors’ mind.”

ESG and China

In a long report for Bloomberg (and republished here by Yahoo! Finance), Natasha White and Saijel Kishan noted that many ESG funds are using the outbreak of war between Russia and Ukraine to rethink some of their other more potentially volatile investments, particularly those in China:

“Caught flat-footed by Russia’s war on Ukraine, fund managers who get paid to avoid environmental, social and governance risks have started to look at China with a fresh sense of unease.

Their exposure to China is huge. Pure ESG funds domiciled just in Europe have about $130 billion invested in China assets, according to data compiled by Bloomberg. A further $160 billion is held by European-based funds that have screened for ESG-related hazards.

And yet the investment industry finds itself starting to contemplate the once unthinkable, as China’s ambiguous response to Russia’s invasion of Ukraine leaves the world on edge. China, the world’s second-largest economy, has sought to straddle both sides of the geopolitical divide, condemning the loss of life in Ukraine while blaming NATO for provoking Russia. And when the International Court of Justice voted to order Russia to “immediately suspend” military operations in Ukraine, only two countries dissented: Russia and China….

The attack of Ukraine hasn’t only renewed scrutiny of the parallels between Russia and China, it has put the countries’ relationship in the spotlight. Just before the war began, Chinese President Xi Jinping hosted Putin at the Beijing Olympics, a public demonstration of warm relations.

Of the ESG funds holding Chinese assets, a number are categorized as Article 9, which is the highest sustainability classification within Europe’s Sustainable Finance Disclosure Regulation. Together, these funds hold $7 billion. A further $124 billion is in Article 8 funds, which is a laxer ESG category within SFDR.

About $162 billion is in Article 6 funds, for which managers screen their portfolios to decide whether it’s relevant to disclose ESG risks.”

In the spotlight

Financial Times identifies conservative pushback against ESG

On March 27, The Financial Times carried a piece on what appears a rising tide of conservative pushback against ESG in terms of shareholder activism:

“The right has never been this engaged” in shareholder activism, said Justin Danhof of the National Center for Public Policy Research’s Free Enterprise Project, a conservative group that succeeded in placing motions at this year’s Disney, Costco and Walgreens Boots Alliance meetings.

The Securities and Exchange Commission “opened the floodgates” to activists’ resolutions last November by rescinding Donald Trump-era guidance that had limited which proposals on social policy issues could go to a vote, Danhof said. “We had three [proposals allowed] last year; we’ve already presented three this year and we will have at least 10 more that we know of.”

Between them, Danhof’s group and the National Legal and Policy Centre have submitted 19 proposals in 2022, up from a total of 16 last year, according to research from the Conference Board….

Proxy filings are growing across the political spectrum, with the Interfaith Center on Corporate Responsibility reporting that its members have filed a record 436 proposals this year, up from 244 at the same stage in 2021.

A proxy season analysis from As You Sow, the Sustainable Investments Institute; and Proxy Impact found that a record 529 environmental, social, and governance proposals had been filed as of last month, up 20 per cent year on year. Conservative groups had filed 5 per cent of them, it said.

Several of those proposals call for greater disclosure on charitable giving and racial equity audits, topics historically favoured by their liberal opponents.

This stemmed from a deliberate strategy, said Danhof: “Because of procedural hurdles at the SEC we have to file proposals that are rather similar to previously successful liberal proposals,” he said, “[so] our only avenue to the proxy ballot is to use as much leftist language as possible.”…

The conservatives say they are trying to save US companies from being distracted by liberal social causes. “The American capitalist system is the greatest system man has ever created economically but Marxist wokeism is . . . a cancer. We have to kill the cancer without killing the host,” Danhof said.

The left had taken over other institutions from universities to media outlets, he argued, and conservatives feared that it was doing the same in business and finance: “Now we have the leading bankers and tech titans all speaking the language of Davos and not championing American capitalism whatsoever.”