Economy and Society, October 4, 2022: Texas joins investigation over S&P’s use of ESG in credit ratings

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.

Senate Banking Committee’s ranking member goes after ESG ratings services

On September 20, Senator Pat Toomey (R), the Banking Committee’s Ranking Member, sent a letter to 12 ESG ratings firms, questioning what he described as their “lack of transparency, conflicts of interest, and use of biased sources.” The letter to Sustainalytics, for example, read as follows:

“I am writing to request information about Sustainalytics’s practices related to assigning environmental, social, and governance (ESG) ratings to companies. My understanding is that these ratings are intended to help investors determine whether a company may be seen favorably from an ESG perspective.

The industry of ESG investing and related services has grown tremendously in recent years. According to Bloomberg, global ESG assets are projected to reach $50 trillion by 2025, accounting for one-third of total projected assets under management globally.1 ESG ratings firms, such as Sustainalytics, play a key role in this activity by evaluating the degree to which more than 10,000 companies meet certain qualitative standards. As a result, they have the ability to influence capital flows to many companies.

Notably, ESG ratings take into consideration information about companies that go beyond the extensive public disclosures firms are required to make under federal securities laws. For example, existing law requires that companies describe their business, properties, legal proceedings, and risk factors. Companies must also provide management’s discussion and analysis of the firm’s financial condition, results of operations, liquidity, and capital resources. Each of these disclosure areas are legally required to include any material climate change information so that the disclosures are not misleading under the circumstances. In determining a company’s ESG rating, however, many ESG ratings firms consider information that is not material or financially relevant under federal securities laws.”

Toomey proceeded to ask for documents from each company on proprietary methodologies and for answers to questions regarding compliance burdens their ratings might create for rated companies, veracity of the data they use, and any potential conflicts of interest.

Toomey gave the firms until September 28 to respond to his request.

In the States

Texas joins investigation over S&P’s use of ESG in credit ratings

On September 28, Texas Attorney General Ken Paxon (R) announced that he and his state had joined in a multi-state investigation of S&P and its use of ESG factors in creating credit ratings, an issue that was first highlighted in April by Utah Treasurer Marlo Oaks (R). The press release from Paxon’s office read as follows:

“Attorney General Paxton joined a Missouri-led multistate investigation into S&P Global Inc. for potential violations of consumer protection laws. This is the second investigation by state attorneys general into a company providing Environmental, Social, and Governance (ESG) ratings, based upon alleged consumer fraud and deceptive trade practices.  

S&P’s published ESG credit indicators, ESG scores, and ESG evaluations appear to politicize what should be a purely financial decision and may deceptively confound the distinction between subjective opinions and objective financial facts.   

“Too many consumers and investors have been hurt by the woke ESG movement’s obsession with radical social change and willingness to ignore the law,” said Attorney General Paxton. “We’re investigating S&P Global to find out if they’ve engaged in the types of destructive, illegal business practices that are so pervasive in the ESG movement. If so, they will have to answer for their actions.””

On Wall Street and in the private sector

CNBC: “There’s an ESG backlash inside the executive ranks at top corporations”

On September 29, CNBC released the results of its recent survey of corporate Chief Financial Officers (CFOs) regarding their beliefs and preferences about ESG. The results appeared to show frustration with and hostility to ESG practices and requirements:

“In public, U.S. corporations say the right things about environment, social and governance factors as part of their mindset. But how do executives really feel about the push to make ESG a core component of management philosophy?

Inside the C-suite, there is concern about the value of ESG metrics, while there is also support for recent political pushback against ESG by Republican leaders at the state level including Florida Governor Ron DeSantis and Texas Governor Greg Abbott.

That’s according to results from a new CNBC survey of chief financial officers at top companies in the U.S. which shows executive frustration with both regulators and asset managers when it comes to current ESG momentum….

Only 25% of CFOs surveyed by CNBC support the SEC’s climate disclosure proposal, according to the survey. More than half (55%) of CFOs are opposed to the SEC climate rule, and 35% say they “strongly oppose” it….

A critical issue for CFOs with the new SEC climate disclosure is the lack of a clear correlation between the climate data and financial statements. The closest reporting analog CFOs have to this new approach is non-GAAP metrics that within industries have become accepted in the dialogue between Wall Street and management (if not always by the SEC). But non-GAAP metrics within an industry are different from a blanket assertion across industries like greenhouse gas emissions.  

“Proponents are saying we need to do something here because there are costs that are coming to companies in the economy if we don’t understand carbon transition better. Then the next question is ‘how do we understand it better?’ … The SEC is speculating that general GHG disclosure will facilitate that understanding. Requiring information with the expectation or hope that it will be meaningful to investors is an uncommon approach to disclosure mandates,” said Jay Clayton, former SEC chairman and a senior policy advisor at Sullivan & Cromwell….

CFOs…were more broadly in favor of the ESG pushback from states, according to the CNBC survey, with 45% of CFOs saying they supported the moves by states to ban investment managers that use ESG factors from state pension fund business. While 30% of CFOs said they were neutral on the issue, only 25% of CFOs said they opposed the state moves, and only 5% expressed “strong” opposition….

Another reason why CFOs at publicly traded companies may support pushback against the asset management community and firms like BlackRock has less to do with fund performance than proxy battles. As the large index fund managers have come to dominate investment flows and represent as much as one-third of the shareholder base of companies, they have been increasingly using that power to influence the outcome of shareholder votes on ESG issues, and on climate most prominently.”

Fox News op-ed questions the ethics of ESG

In an op-ed piece for Fox News, Allen Mendenhall, an associate dean and Grady Rosier Professor in the Sorrell College of Business at Troy University, made the case that the large asset management firms’ focus on sustainability and other ESG criteria are both doing a disservice to their clients and behaving unethically. He wrote:

“[T]he biggest asset managers – companies like BlackRock, Vanguard and State Street – have gained voting rights in publicly traded companies and are pushing those companies into “wokeness.” Rather than divesting from the corporations that don’t satisfy vague ESG standards, the asset managers use their proxy power to change the corporations in leftward directions. 

This raises troubling questions: Aren’t the true owners of these companies the clients of the asset managers, the people whose money the asset managers are investing and supervising? When an asset manager aggregates hundreds of funds, which include companies in which it enjoys voting rights and companies that directly compete, how can the asset manager vote in the best interests of any one of these companies? Aren’t there conflicts of interest? 

The unethical character of companies like BlackRock is finally coming to light. 

Responding to warnings from Republican state attorneys general, BlackRock, earlier this month, denied that it “dictated” specific emissions targets to companies. Now New York Comptroller Brad Lander, the custodian and delegated investment adviser to the New York City Retirement Systems and a man of the left, decries the apparent contradiction: “BlackRock cannot simultaneously declare that climate risk is a systemic financial risk and argue that BlackRock has no role in mitigating the risks that climate change poses to its investments by supporting decarbonization in the real economy.””

New York Times guest essay: “One of the Hottest Trends in the World of Investing Is a Sham”

On September 29, the New York Times published a guest essay by Hans Taparia, a clinical associate professor at the New York University Stern School of Business, in which the professor insisted that ESG–“One of the Hottest Trends in the World of Investing”–is, in his words, a “sham.” Taparia argues that ESG could be of benefit to markets, investors, and stakeholders but that its practitioners are preventing that from happening. Taparia concludes that the system must be changed. “The current system,” he writes, “needs an overhaul. Reform may not be as kind to corporate America, but it would make it easier to invest in the future of our society and planet.”:

“Wall Street has been hard at work on a rebrand. Gone is the “Greed is good” swagger that embodied its culture in the 1980s. “Greed and good” may best summarize its messaging today as it seeks to combine high profits with lofty intentions.

“To prosper over time,” Laurence D. Fink, the founder and chief executive of the investment giant BlackRock, wrote in a remarkable public letter in 2018, “every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”

At the heart of this rebranding is a new industry of funds, created by BlackRock and peers such as Vanguard and Fidelity, that purport to invest in companies that are good corporate citizens — that is, companies that meet certain environmental, social and governance criteria. These E.S.G. criteria are wide ranging, pertaining to issues such as carbon emissions, pollution, data security, employment practices and the diversity of corporate board members.

On the face of it, E.S.G. investing could be transformative, which is why it’s one of the hottest trends in the world of investing. After all, allocating more capital to companies that do good helps them grow faster and lower their cost of capital, creating an incentive for all companies to be more socially and environmentally conscious.

But the reality is less inspiring. Wall Street’s current system for E.S.G. investing is designed almost entirely to maximize shareholder returns, falsely leading many investors to believe their portfolios are doing good for the world.

For E.S.G. investing to achieve its potential, Wall Street players will have to change their system. More likely, the Securities and Exchange Commission will have to change it for them….

[C]ontrary to the spirit of E.S.G. investing (and likely unknown to most investors), the leading rating agencies are not scoring companies on their degree of environmental or social responsibility. Instead, they are measuring how much potential harm E.S.G. factors like carbon emissions have on companies’ financial performance….

McDonald’s, for instance, was given an upgrade of its E.S.G. rating last year by MSCI, which cited reduced risks to the company’s bottom line as a result of changes that the company made concerning packaging material and waste. But greenhouse gas emissions from the operations and supply chain of McDonald’s, which is one of the world’s largest buyers of beef, grew by 16 percent from 2015 to 2020. Those emissions are a direct cause of climate change, but because MSCI didn’t see them as posing a financial risk for McDonald’s, they didn’t negatively affect the rating.

This is hardly an isolated case.

This system works well for Wall Street. It keeps the raters in business because it ensures that their customers, the investment firms, have lots of stocks with which to construct portfolios. It enables financial institutions to present themselves as contributing to the well-being of society and the planet. And it allows them to charge higher fees to investors, because E.S.G. funds are seen as different from conventional index funds, in part because they tap into investors’ consciences.

But this system isn’t good for the world.”