Economy and Society: SEC continues internal debate about its role in ESG investing

ESG Developments This Week

In Washington, D.C.

SEC continues internal debate about its role in ESG investing

On July 20, SEC Commissioner Hester Peirce delivered an address at the Brookings Institution in which she again made the case that the SEC’s current leadership is overstepping both its regulatory mandate and the bounds of what is objectively knowable about corporations and their impact on aggregate measures of environmental, social, and corporate governance (ESG) well-being. Peirce’s address, which is the latest public airing of grievances on the part of SEC Commissioners, conceded that SEC Chairman Gary Gensler and his supporters on the Commission have their hearts in the right place, seeking predictability for investors, but warned that, in her view, outcomes and intentions are often at odds. As a framework for her critique of proposed new disclosure mandates, Peirce presented ten theses that she argues all interested parties must consider before the Commission votes to make new disclosures compulsory:

“I. ESG as a category of topics is ill-suited, and perhaps inherently antithetical, to the establishment of clear boundaries and internal cohesion.

II. Many ESG issues lack a clear tie to financial materiality and therefore do not warrant inclusion in SEC-mandated disclosure.

III. The biggest ESG advocates are not investors, but stakeholders.

IV. ESG rulemaking is high-stakes because so many people stand to gain from it. 

V. “Good” in ESG is subjective, so writing a rule to highlight the good, the bad, and the ugly will be hard.

VI. An ESG rulemaking cannot resolve the many debates around ESG models, methodologies, and metrics. 

VII. Emotions around ESG issues may push us to write rules outside our area of authority. 

VIII. ESG issues are inherently political, which means that an ESG rulemaking could drag the SEC and issuers into territory that is best left to political and civil society institutions.

IX. ESG disclosure requirements may direct capital flows to favored industries in a way that runs counter to our historically agnostic approach.

X. An ESG rulemaking could play a role in undermining financial and economic stability.”

Peirce concluded, arguing that the SEC’s probable contravention of its statutory bounds could be remedied, if the Commissioners decided to take a more cautious, less over-optimistic approach to its regulatory limitations:

“You have made it with me through ten theses, so I will quickly draw to a close. I do not want to do so without first offering a potential better path forward. Rather than embarking on a prescriptive ESG rule that departs from and undermines our agency’s limited, but important, role, we could work within our existing regulatory framework. We could put out updated guidance to help issuers think through how the existing disclosure regime already reaches many ESG topics and to address frequently asked questions that arise in connection with the application of the existing disclosure regime. We also might consider whether we can give any Commission-level comfort about forward-looking statements along the lines of what former Chairman Clayton, Corporation Finance Director Bill Hinman, and Office of Municipal Disclosure Director Rebecca Olsen did in connection with COVID-19. Finally, we can work with investment advisers using ESG strategies and products to ensure that investors understand what that adviser’s brand of ESG means in theory and practice. I am looking forward to hearing other suggestions in the discussion that follows.”

On Wall Street and in the private sector

European ESG assets take a tumble—by design

According to the Global Sustainable Investments Alliance, the amount of money held by Europeans in sustainable investments fell from $14 trillion to $12 trillion. Given the relative stability of the bull market and the flood of funds into ESG, that seems counterintuitive at best. But it’s not, according to a Bloomberg Green story. The drop was not caused by decreasing value or a change in priorities but by an intentional reclassification of assets. Bloomberg Green reports:

“The decline isn’t the result of dampened investor enthusiasm for ESG investments, it’s because policy makers have tightened the parameters for what can be considered a responsible investment, said Simon O’Connor, chair of the GSIA….

Europe has led the global charge into ESG investments and its banks and fund managers are most advanced in calculating the impacts of their operations on climate change and biodiversity. The bloc’s politicians also have embraced sustainability by developing the world’s most ambitious climate strategy and a suite of new rules to bring the world of finance in line with its carbon neutrality target.

The EU’s anti-greenwashing rules known as the Sustainable Finance Disclosure Regulation, or SFDR, were introduced in March and require fund managers to evaluate and disclose the environmental, social and corporate governance features of their financial products. They require fund managers to classify funds, with Article 8 funds defined as those that actively promote environmental or social characteristics, while Article 9 funds have sustainable investment as their objective, with both categories subject to higher standards of disclosure under the SFDR.”

Meanwhile, in the rest of the world, sustainable assets continued to grow unremittingly:

“[S]ustainable investment assets in the U.S. increased to $17 trillion last year from $12 trillion two years earlier. Canada recorded the largest proportional gain in ESG assets between 2018 and 2020, with a 42% jump to $2.4 trillion.

The sustainable investment industry grew 15% in the two-year period to $35.3 trillion, and now accounts for 36% of all professionally managed assets across the U.S., Canada, Japan, Australasia and Europe, GSIA said.”

The Financial Times reports two stories of dissent

First, on July 18, FT reported that the private equity business appears, on paper at least, to have become a hub of counter-cultural investing, in which ESG issues are treated with rather less deference than they are in the world of publicly traded companies:

“Done well, private equity has a crucial role to play in modernising economies, helping companies to restructure efficiently away from the short-termist glare of public markets. Buyout firms rightly pounce on listed companies that they deem undervalued or bloated. In so doing, they keep capitalism efficient and act as a positive reactionary force.

But is private equity also reactionary in the conservative backlash sense of the word — facilitating a rebellion against some of the progressive constraints of public company existence, particularly the growing demands of complying with standards on environmental, social and governance issues? The evidence is mounting.

More freedom on governance has long been seen as a plus for private companies. As listed company governance has become stricter, so the advantage of private company status has increased. Heads at private equity owned companies relish diminished bureaucracy and the ability to earn more money without critical scrutiny from public company shareholders. Fortress’s agreed £9.5bn buyout of Morrisons this month came with a strong hint that management “incentives structures” would be boosted, only weeks after the listed UK supermarket suffered a shareholder revolt over pay….

Social issues, S of ESG, are also antithetical to much traditional private equity. Many listed companies increasingly trumpet “stakeholder value”, expressing concern for staff, customers and a company’s local area. Private equity remains a safe space for the hard-nosed. Quite rightly in some instances: public-company management may have been loath to take tough decisions on closing shops, factories or offices, and making job cuts.

But it is in the environmental field that a good chunk of the private equity industry is playing its most obviously reactionary role. When oil majors are looking to sell off stranded production assets, private equity are among the readiest bidders.”

On July 22, FT returned to the issue of ESG vs. shareholder value, with a profile of Eiji Hirano, the former chairman of the board of the Japanese Government Pension Investment Fund, the largest pension fund in the world. According to the paper: 

“Though carefully framed, Hirano’s comments highlight increasingly urgent questions over the future direction of the GPIF since the departure in March 2020 of its charismatic chief investment officer Hiromichi Mizuno.”

“The GPIF [Government Pension Investment Fund] must always go back to its investment purpose,” says Eiji Hirano, who stood down from the job three months ago. His comments reflect concerns that too great a focus on environmental, social and governance (ESG) standards can add risk, including a possible collision between the law and the investment philosophy under the GPIF’s previous regime.

According to the law under which the GPIF operates, it must invest with the sole purpose of benefiting Japanese citizens through the returns generated….”

“[A]rguably Mizuno’s boldest achievement, which he proselytised about at Davos and other global financial forums, was yoking the GPIF name to the then fledgling theme of ESG investing. The campaign included what Mizuno himself described as the “epochal” decision to mandate index-compilers FTSE and MSCI to create ESG indices for the GPIF. It sent the message that the GPIF under his stewardship would regard ESG factors as financially relevant.”

“That, says Hirano, is one key area where debate is now focused. While there is increasing evidence that some aspects of ESG-themed strategies boost returns in the long term, he thinks many ESG proponents, including Mizuno, rely on the argument that it is “common sense” that this will be the case across the board.”

EU efforts to compel greater disclosure receive pushback—months ahead of implementation

On July 6, the European Commission finalized its new banking regulation known as the green assets ratio. The regulation will go into effect in 2022, and banks will be compelled to make their first report by 2024. The GAR is designed to measure the green loans and securities a bank possesses (against its total assets). And according to Bloomberg, banks are already crying foul:

“It’s meant to be the ultimate metric for gauging how clean European banks are. But some in the industry say it will be flawed from the get-go.

The European Union’s planned Green Asset Ratio, intended to reveal how much a bank lends to climate-friendly companies and projects, will offer a distorted picture of reality, according to a Bloomberg survey of some 20 major European banks. The firms, which rely on clients for the data they need to calculate the ratio, point out that many small or international companies simply won’t provide it….

Europe is taking a more aggressive approach than the U.S. and other jurisdictions on climate change and will ultimately penalize financial firms that turn a blind eye to global warming. Banks that have long touted their green credentials are now being told to back up those claims with hard data. Lenders perceived to be laggards risk losing investors and depositors.

The European Banking Authority, which mapped out the Green Asset Ratio, says the metric will help compare banks both in terms of their exposures as well as their sustainability strategy and how they plan to mitigate climate-change related risks. The EBA “strongly believes” that the availability, quality and exchange of data can be improved with the right regulatory framework and incentives, a spokeswoman for the Paris-based authority said by email. Banks will also be allowed to use estimates for the environmental impact of their clients, she said.”

In the Spotlight

Moody’s launches new ESG ratings service

Moody’s just launched an ESG ratings service for small and medium-sized companies. But because ESG data is unavailable or limited for smaller companies, Moody’s had to develop a new methodology for estimating or predicting a company’s ESG ratings, which it has done:

“Based on a model derived from Moody’s proprietary ESG scoring methodology for large-cap corporates, the ESG Score Predictor provides financial institutions with essential quantitative data for portfolio and risk management, and helps companies monitor ESG risk across their global supply chains….

Assessing companies’ exposure to ESG risks requires comparable and standardized metrics. Limitations in company disclosures continue to affect data quality and company coverage, especially in the SME space. The ESG Score Predictor leverages state-of-the-art advanced analytics to provide 56 ESG scores and sub-scores for any given company using location, sector, and size. Customers can access approximately 140 million company ESG scores on Moody’s Orbis database, Procurement Catalyst and Credit Catalyst platforms, via an application programming interface (API), or leverage the ESG Score Predictor model with their in-house data to score their portfolios.”

What this means, according to a Moody’s white paper on the subject, is that the number of companies on which it can provide estimated ESG scoring is now infinite. According to the paper, “As long as we have data on a firm’s size, location, and industry, we can use these three factors as inputs to generate predicted metrics using the SP models.”

Economy and Society: SEC Commissioner advocates board’s role in ESG oversight

ESG Developments This Week

In Washington, D.C.

SEC Commissioner Lee delivers speech about board’s role in ESG oversight

On June 28, SEC Commissioner (and former acting director) Allison Herren Lee delivered the keynote address at the 2021 Society for Corporate Governance National Conference. In her speech Lee encouraged corporations to make wise decisions when choosing, compensating, and utilizing their directors. Increasingly, Lee noted, “boards of directors are called upon to navigate the challenges presented by climate change, racial injustice, economic inequality, and numerous other issues that are fundamental to the success and sustainability of companies, financial markets, and our economy.”

Given that many corporationsAmerican corporations, specificallyare responsible for more global economic activity than many smaller countries, Lee argued that corporations also need to be more responsible and effective at addressing global problems than some smaller countries. And the key to being thusly effective is a useful and adept board:

“Historically, many ESG issues were seen as not within the purview of the board of directors. These matters, referred to as “corporate social responsibility” or CSR issues, were largely treated as if they were separate and apart from the business of generating revenue and earning profits. Debates about director duties around climate and ESG often centered on whether directors were even permitted to consider issues that previously fell under the rubric of corporate social responsibility. In that Milton Friedman era, risks like climate change and many other issues we would now call ESG were characterized as topics that could bear on the public good, but were not relevant to maximizing value for shareholders.

Those days are over….

There is, for example, broad consensus regarding the physical and transition risks associated with climate. SASB (now the Value Reporting Foundation), the Global Reporting Initiative, and many others have clearly set forth financially material ESG risks for companies. There is tremendous and growing investor demand for climate and ESG disclosure. The world’s largest asset managers and other institutional investors have been direct and vocal in conveying that they consider ESG material to their decision-making. No matter the view of regulatory involvement in climate and ESG disclosures, directors must reckon with this growing consensus and growing demand from the shareholders who elect them. 

Accordingly, boards increasingly have oversight obligations related to climate and ESG risks – identification, assessment, decision-making, and disclosure of such risks.  These obligations flow from both the federal securities laws and fiduciary duties rooted in state law.”

Commissioner Lee concluded with several suggestions about how corporate shareholders could ensure that their boards of directors are properly positioned to accomplish their ESG tasks:

“This year, BlackRock emphasized that it expects “boards to shape and monitor management’s approach to material sustainability factors in a company’s business model” and will hold directors accountable where they fall short. Similarly, State Street announced that it will start voting against the boards of companies that underperform their peers when it comes to ESG standards. Proxy advisory firms ISS and Glass Lewis have announced new voting policies that include director accountability for ESG governance failures.

As shareholders and others increasingly emphasize the need for climate and ESG to be incorporated into risk management and governance practices, they have mechanisms to hold companies accountable where they fall short of expectations. They can put pressure on boards to act through shareholder proposals. They can replace directors, as we saw with Exxon. And ultimately both investors and consumers can take their capital elsewhere.

Importantly, all of these risks also present great opportunities. Boards that proactively seek to integrate climate and ESG into their decision-making not only mitigate risks, but better position their companies and business models to compete for capital based on good ESG governance.

So what are some key steps for boards that seek to maximize ESG opportunities, message their commitment on these issues, and position themselves as ESG leaders?

Enhance Board Diversity….

Increase Board Expertise….

Inspire Management Success….”

Republicans question Federal Retirement Thrift Investment Board about BlackRock, State Street’s voting guidelines

On June 30, two Republican Senators, Pat Toomey (PA) and Ron Johnson (WI)the ranking members of the Senate Committee on Banking, Housing, and Urban Affairs and the Permanent Subcommittee on Investigations of the Senate Committee on Homeland Security and Governmental Affairs, respectivelysent a letter to David Jones, the Chairman of the Federal Retirement Thrift Investment Board (FRTIB), with questions about the federal Thrift Savings Plan and the use of its invested funds by its contracted asset managers to pursue what they deem to be their own personal and political agendas. Specifically, they wrote:

“We are writing to you regarding troubling statements by the companies that manage federal employees’ retirement investments suggesting those asset managers are not putting federal employees’ retirement security first. Specifically, recent statements by the CEOs of BlackRock and State Street Global Advisors (SSGA) indicate they are using their control of proxy votes for federal employees’ Thrift Savings Plan (“the Plan”) investments to pressure other companies to adhere to their own environmental and social policy views. We are concerned that BlackRock and SSGA may be prioritizing their CEOs’ personal policy views over retirees’ financial security. Federal law explicitly requires all fiduciaries of the Plan, including BlackRock and SSGA, to discharge their responsibilities “solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries.”

After noting that BlackRock and State Street manage a combined $42 billion in federal employee retirement fundsjust over 60% of all funds in the plan​​Toomey and Johnson continued:

“While federal law bars the Federal government from exercising voting rights associated with funds in the Plan, FRTIB has taken the position that this prohibition does not apply to third-party investment managers serving as stewards of a large portion of the Plan’s assets. In fact, it appears that the only restriction on BlackRock and SSGA’s voting authorities is whether a vote is taken in accordance with each entity’s respective proxy voting guidelines.

Further, while these proxy voting guidelines are ostensibly focused on the investor’s fiduciary advantage, both entities are increasingly incorporating left-leaning environmental, social, and corporate governance (“ESG”) priorities into these guidelines. For example, BlackRock announced that in 2021 “key changes” in its voting guidelines “address board quality; the transition to a low-carbon economy; key stakeholder interests; diversity, equity and inclusion; alignment of political activities with stated policy positions; and shareholder proposals.” Not to be outdone, SSGA’s CEO stated “our main stewardship priorities for 2021 will be the systemic risks associated with climate change and a lack of racial and ethnic diversity.”

In light of these concerns, we ask that you provide a briefing detailing BlackRock’s and SSGA’s policies for using proxy voting rights derived from Plan assets, Board oversight of proxy voting use by Plan investment managers, and Board recourse if an investment manager is found to have violated their fiduciary duty….”

In the States

Bucks County dips its toes in the ESG Waters

Last week, Bucks County, Pennsylvania Treasurer Kris Ballerini penned an op-ed for a local, county newspaper (BucksLocalNews, July 9) in which she announced that she and others in county government have decided to invest a portion of the Bucks County public pension fund in ESG investments. The opportunity to, in her view, try to do well by doing good was, according to Ms. Ballerini, simply too enticing not to grab. She wrote:

“ESG investing concentrates on companies that emphasize sustainability as well as protecting the environment in their manufacturing plants and products. It also looks to see if the company is socially responsible by prioritizing human rights among its dealings with the public, with its employees and even with other countries. In addition, it examines if a company’s management is diverse, if executive pay is reasonable, and if the company responds to their shareholders responsibly. Finally, ESG investing asks whether a company is ethical and transparent in their accounting and business practices.

Along with Bucks County Controller Neale Dougherty, I, as Treasurer, sit on the Retirement Board for the county pension fund, which now has over a billion dollars in investments; and we asked our fund managers about devoting a portion of the fund to investments in ESG companies.

Before committing any funds to such an investment, our board reviewed the returns that such investments have earned. We found that according to the US SIF Foundation’s 2020 trends report, U.S. assets under management using ESG strategies grew by 42% from 2018 to 2020. In addition, a white paper by Morgan Stanley Institute compared the total returns of sustainable mutual and exchange-traded funds and found they were like those of traditional funds. Other studies have found that ESG investments can outperform conventional ones….

As a result, we have voted to devote a small initial portion of the pension fund to ESG companies. If this investment shows a strong upward trend, we intend to increase it. Not only will this benefit the fund financially, but we can also take pride in helping the environment and society at the same time—a “win, win” proposition that everyone can support.

As far as I am aware, we in Bucks County are among the very few innovators to take this approach in Pennsylvania. Hopefully, other public entities with pension funds and other long-term investments will join this trend—that would further benefit our ground floor investments, but also it would encourage more companies to seek to maximize their ESG compliance. That would increase the benefits to our environment and society.”

According to a report published last October by Boston College’s Center for Retirement Research, as of 2018 roughly 60% of the funds invested by public pension entities in the country ($3 trillion, out of $5 trillion total) was already invested in ESG-related products. Public pension investments in ESG accounted for fully 25% of all ESG investments in the country and roughly 33% of all institutional ESG investments.


Are ESG returns about to fall?

In a report published two weeks ago, on July 1, two European researchersAbraham Lioui of the EDHEC Business School in France and Andrea Tarelli of Catholic University of Milanargued that the often cited above-average returns associated with ESG might not be entirely accurate or particularly sustainable. The paper, titled “Chasing the ESG Factor,” was summarized by The Financial Times as follows:

“Abraham Lioui, professor of finance at Edhec Business School and an expert in the strategy of investing according to good environmental, social and governance principles, believes he and his co-authors have found signs that the ESG market is reaching maturity and could become a victim of its own success.

“We are going to the zone where the positive impact of the ESG buzz on prices is coming to the end of its cycle,” Lioui said. “Soon we will be at the stage where the relationship between ESG and performance will be negative as it [logically] should be.”…

Lioui and his fellow academics also found that according to most data sets, the accumulated alpha, or outperformance, for the E and S pillars of ESG was above 1 percentage point per year, supporting the thesis that companies can do well by doing good. “However, we identify a downward sloping pattern in this outperformance,” the paper said….

“It should not be a surprise if, in the long term, ESG investing does come at some cost to investors,” said Greg Davies head of behavioural science at Oxford Risk.

He said that while early investors have been able to benefit from the rise in interest in ESG, companies were likely to incur costs by trying to improve environmental and social scores, leading to less profitability in the long term.

In addition, ESG’s popularity was likely to drive up the prices of companies with better scores, without bringing any changes in their profitability. “Paying a higher price for the same profits means lower investor returns. This is true of any assets that are ‘popular’,” Davies said.

Kenneth Lamont, senior fund analyst for passive fund research at Morningstar Europe, agreed.

“The results of the paper suggest that as assets have piled into stocks with the strongest ESG credentials, the expected outperformance of these stocks have dwindled away in recent years,” he said. “To many in the financial industry this news won’t come as a surprise, as an ESG label doesn’t exempt stocks from the fundamental laws of the market.””

These results coincide with arguments made in a May report written by Rupert Darwall for RealClearFoundation and titled “Capitalism, Socialism and ESG.” As noted in the May 18 edition of this newsletter, Darwall argued that:

“ESG proponents claim that investors following ESG precepts earn higher risk-adjusted returns because companies with high ESG scores are lower-risk. Thus, their stock price will outperform, whereas those firms with low ESG scores are higher-risk, leading them to underperform….

This supposition conflicts with finance theory. Once lower risk is incorporated into a higher stock price, the stock will be more highly valued, but investors will have to be satisfied with lower expected returns.”

Economy and Society: SEC Chairman signals deeper look into ESG investing

ESG Developments This Week

In Washington, D.C.

SEC Chairman signals deeper look into ESG investing 

In a speech last week to London City Week, SEC Chairman Gary Gensler explained to the audienceand to the financial services world more broadlythat he does not intend for sustainability and climate disclosures from publicly traded companies to constitute the entirety of the Commission’s agenda for ESG this year. His ambitions are, he noted, much larger and much broader and will touch on nearly every participant in American capital markets.

First, Chairman Gensler was clear that he intends to ensure that companies that have told investors (and others) that they are green or that they intend to make environmentally friendly changes to their behavior and products are, in fact, keeping their promises: “I’ve asked staff to consider potential requirements for companies that have made forward-looking climate commitments, or that have significant operations in jurisdictions with national requirements to achieve specific, climate-related targets.”

Second, Gensler noted that he does not intend for the SEC’s ESG regulations to begin and end with sustainability and climate change and that he wishes to pursue the “S” (Social) and “G” (Corporate Governance) in ESG, in addition to the “E” (Environmental):

“[I]nvestors have said that they want to better understand one of the most critical assets of a company: its people. To that end, I’ve asked staff to propose recommendations for the Commission’s consideration on human capital disclosure.

This builds on past agency work and could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.”

Finally, Gensler warned asset managers that they are not the investors whose interests the SEC seeks to protect; that the SEC intends to exercise its mandate to protect small and individual investors from those asset managers when necessary: “I’ve also asked staff to consider the ways that funds are marketing themselves to investors as sustainable, green, and ‘ESG,’ and what factors undergird those claims.”

Country’s largest pension plan now offers ESG funds

Last year, the Trump administration attempted to compel the federal government’s Thrift Savings Planwhich covers federal employees and members of the armed servicesto quit offering funds that could invest in Chinese companies whose goals are perceived to be inimical to those of the U.S. government and its military. This year, with a new administration, the Thrift Savings Plan will now offer ESG funds:

“The federal government’s Thrift Savings Plan will begin offering environmental, social, and governance funds in 2022, the latest sign of the growing acceptance of sustainable investing by retirement plans.

The ESG funds will be available in a new “mutual fund window,” similar to a brokerage option, for the plan, a Thrift Savings Plan spokesperson told Barron’s.

The move is “huge” for the plan, the spokesperson said, but it is also significant for sustainable investing—and for the asset management industry, which is betting on growth in ESG. After all, the TSP is the U.S. largest retirement plan: It has about $760 billion in assets and covers about 6.3 million federal employees and service members. The window, which will include 5,000-plus funds, and will be run by Alight, will go live in summer 2022….

Lisa Woll, CEO of US SIF, the trade group for the sustainable investment industry, said the group has been in talks with TSP about adding sustainable offerings for more than a decade. “We’re really really pleased. The [participants] can’t get ESG options until they have that platform.”…

“This is a sea change,” says Matt Patsky, CEO of Trillium Asset Management, a sustainable investing specialist. “We’ve opened the floodgates to people feeling safe to select ESG options for retirement plans broadly.””

On Wall Street and in the private sector

Activist hedge fund that won three Exxon Mobil seats launches ETF

Last month, Engine No. 1, a small, activist hedge fund, shook up the energy and investment worlds by mounting a challenge to several of Exxon Mobil’s board seatsand then winning three of them. Last week, Engine No. 1 decided to launch its own, activist-centered exchange-traded fund:

“Earlier this month, Engine No. 1 came out of nowhere and won three Exxon Mobil board seats after a six-month proxy fight. The company says Exxon needed to significantly reduce emissions and move toward a cleaner energy strategy.

Now, they are starting an ETF to promote their methods. Engine No. 1 Transform 500 ETF (VOTE) begins trading Wednesday.

The company says it is seeking “to encourage transformational change at the public companies” and that it will try to “measure the investment made by companies in their employees, communities, customers and the environment with financial, operational, and environmental, social and governance (‘ESG’) metrics.”

It is attracting outsized attention because it is the intersection between three hot investing themes: ETFs, ESG and activist investing….

One thing’s for sure: With intense interest in ESG and a very low fee structure (0.05%), VOTE is likely to start off strong, with north of $100 million in assets. Others are eager to join. Digital investment firm Betterment has already said it will add VOTE to its large-cap portfolio.

There is little doubt that the moment for investor activism has arrived.”

To address ESG disclosure needs, Price Waterhouse Cooper adding 100,000 jobs worldwide 

On June 15, accounting firm PwC (Price Waterhouse Cooper) announced that it expects to add as many as 100,000 jobs worldwide and spend as much as $12 billion over the next five years to address the needs of clients in navigating the waters of ESG disclosures:

“The new hires will come from mergers and acquisitions PwC completes and direct hires from competitors, Global Chairman Bob Moritz said in an interview. Of the 100,000 people PwC will hire, about 25,000 to 30,000 will be in the United States, and 10,000 of those will be from Black and LatinX communities, Moritz said.

At present, the firm employs about 284,000 people globally.

Moritz said PwC had approached ESG more “narrowly” before, focusing on reporting frameworks.

“Now every employee of PwC has to be familiar with the issues,” he said, adding that ESG will be embedded in the firm’s work….

PwC is increasing training for partners and staff in ESG in areas such as climate risk and supply chains and creating an ESG academy.

PwC will also set up new leadership institutes that help executives, boards of directors and C-Suites create diverse workforces and manage in uncertain times.”

Elsewhere, last week, the American Institute of Certified Public Accountants (AICPA) released the results of a study (conducted in conjunction with the International Federation of Accountants and the Chartered Institute of Management Accountants) that suggests that PwC is making a smart choice in choosing to pursue ESG matters:

“Interest in environmental, social, and governance (ESG) disclosures has risen dramatically during the past year, presenting great potential for CPAs to provide assurance on these disclosures as they become more common and as stakeholders are focusing on the quality of such disclosures.”

It’s an area of opportunity for CPAs to meet the public interest and provide value….

“The report found that, in the United States, of the companies included in the study that obtained assurance over their disclosures, nearly 90% of sustainability assurance is done by other service providers. But those outside the CPA profession aren’t necessarily governed by the same ethics and quality requirements, said Scott Hanson, director, Public Policy & Regulation at IFAC.

That means there are practice opportunities for CPAs in this area. Practitioners can help educate clients about ESG reporting and disclosures, including the consideration of risks related to climate that can be material to the financial statements, said Jennifer Burns, CPA, the AICPA’s chief auditor.

“CPAs are uniquely qualified, based on their understanding of their clients, to enhance the reliability of ESG-related disclosures. The auditor’s knowledge should be leveraged to deliver assurance over ESG,” she said.”


MIT study: “ESG funds often fail to vote their values, research shows” 

An article published June 21, by MIT’s Sloan School of Management, citing research published late last year, suggests that the SEC is right to be worried that ESG mutual funds and ETFs are overpromising and underdelivering. According to the Sloan article, many ESG funds talk the talk but fail to walk the walk in any consistent way:

“People who put money in vehicles like ESG index funds expect that their money will be invested in alignment with values such as a commitment to renewable energy or equal pay for women. But new research finds that even though these funds have an explicit ESG mandate, their proxy voting records often contradict their stated objectives. 

“As individual investors, we are not aware of how funds are voting,” said Gita Rao, an MIT Sloan senior lecturer in finance who conducted the research. “We are putting our money into these ESG funds, but they’re voting against what we believe in.”…

Reasonably, people investing in ESG index funds assume that the funds would vote in favor of ESG issues. “If a fund’s prospectus states that it is paying attention to environmental, social, and governance issues, then the fund’s voting should reflect that objective,” Rao said.

Yet little attention has been paid in the past to how these passive funds actually vote their proxies on ESG matters….

To better understand how ESG funds vote on proxy resolutions, Rao focused her research on the Vanguard Social Index Fund, the oldest and largest ESG fund, with more than $13 billion in assets under management, and the BlackRock DSI exchange-traded fund, which has assets of about $3 billion. She worked with the New York-based hedge fund Quantbot Technologies to create datasets and manually classify ESG shareholder resolutions appearing on proxies between 2006 and 2019.

Surprisingly, Rao found that the Vanguard Social Index Fund voted against almost all environmental and social resolutions over the time examined. The fund also voted against shareholder resolutions requesting disclosure of board diversity in every single instance since 2006. 

In addition, both Vanguard and BlackRock in 2019 voted against proposals requesting disclosure of board diversity and qualifications at Apple, Discovery, Twitter, Facebook, and Salesforce.“What we found was really not good,” Rao said. “I would give Vanguard a D. Their social index fund is one of the largest ESG funds in the market, particularly in the retirement space. It’s the oldest fund, and it votes most of the time against disclosure on environmental and social issues.””

In the spotlight

Alignment theory, again

Over the weekend, the Wall Street Journal published an essay by Alex Edmans, a professor of finance at London Business School, arguing that the efforts underway (and documented repeatedly in this newsletter) to align executives’ pay with ESG performance benchmarks is mistaken and could, potentially, undermine the entire ESG project:

“Executive pay has been the poster child for everything that’s wrong with capitalism. Chief executive officers are paid millions, while some of their employees make minimum wage. Bonus targets often tempt executives to take short-term actions that mortgage their company’s future.

But change is afoot. A rapidly growing trend is for executive pay to be tied not only to financial numbers, but to environmental, social and governance (ESG) targets as well. Two recent studies found that 51% of large U.S. companies and 45% of leading U.K. firms use ESG metrics in their incentive plans.

The rationale seems obvious. First, many advocates have claimed that good ESG practices will boost a company’s bottom line, so incentivizing ESG performance also will improve financial performance. This may be why even private-equity investors have started to mandate ESG targets.

Second, it is commonly believed that rewarding performance is the best way to ensure performance. Conversely, if a company won’t pay for an outcome, that is a telltale sign that it doesn’t actually care about it. Companies are making grand promises about diversity, decarbonization and resource usage—but these promises are hollow if they don’t affect CEO pay….

The evidence shows that paying for targets encourages executives to hit those targets. But it doesn’t necessarily encourage them to improve performance. The crux of the problem is that you can’t measure many of the performance dimensions that you care about—“not everything that counts can be counted,” as stressed by sociologist William Cameron (and commonly misattributed to Albert Einstein)….

Importantly, the problem of “hitting the target, but missing the point” occurs for any target—whether financial or nonfinancial. Binary thinking often equates “financial” with “short-term” and “nonfinancial” with “long-term.” But nonfinancial targets can be short-termist. Paying teachers according to test scores encourages them to teach to the test even at the expense of teaching students to develop critical thinking skills. Rewarding CEOs according to average employee pay may encourage them to outsource or automate low-paid jobs, or focus on salary rather than meaningful work, skills development and working conditions.

These unintended consequences might be even worse for ESG than financial targets….

A second problem is measurement. For a financial target such as earnings-per-share, there’s consensus on how to measure it. But that isn’t the case for an ESG metric. Should ethnic diversity be captured by the number of minorities on the board, in senior management, or in the workforce—or other factors such as the ethnic pay gap, or the proportion of minorities who get promoted from each level? Even ESG-rating agencies disagree significantly on how to measure ESG performance, so any measure might be perceived as unfair or ignore important dimensions.

Finally, let’s turn to the first rationale, which holds that boosting ESG performance will always boost financial performance. The evidence is far less conclusive than often claimed. In fact, only performance related to material ESG dimensions (those that are relevant to the company’s specific business model) ultimately pays off; boosting immaterial factors doesn’t. Thus, if ESG targets are to be used, they should be selected carefully based on materiality. Instead, they’re often a knee-jerk reaction to the demands of pressure groups or whatever issue happens to be the order of the day.”

Economy and Society: House passes ESG disclosure act

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.

House passes ESG disclosure act

On June 16, the U. S. House of Representatives passed “The ESG Disclosure and Simplification Act,” which, as its name suggests, aims to compel publicly traded companies in the United States to disclose and report ESG-related data annually, in addition to the pecuniary and other relevant disclosures they already make. The bill passed by a narrow margin and faces what commentators argue is an uncertain fate in the Senate, perhaps unlikely to be enacted. Its passage in the House, however, is considered by ESG advocates a symbolic victory:

“The measure’s passage, on a 215-214 vote, marked the first time the chamber has passed sweeping legislation for transparency on sustainability issues. The package of bills would require disclosure of ESG metrics broadly and dictate specific reporting expectations on climate risks, political spending, CEO pay and taxation rates.

The package “will create clear, consistent disclosure standards for issuers and finally provide investors and our markets with the information they need to make the best investment decisions possible and to hold the companies they’re invested in accountable,” House Financial Services Chairwoman Maxine Waters, D-Calif., said Monday during a Rules Committee meeting on the measure….

The legislation would require publicly traded companies to disclose and define ESG metrics and their view on the link between ESG and long-term business performance. It would allow the SEC to consider independent, internationally recognized disclosure standards for reporting when creating rules to facilitate the ESG disclosure and establish a Sustainable Finance Advisory Committee at the agency.

The package would also require public companies to disclose industry-tailored climate information, including direct and indirect greenhouse gas emissions and fossil fuel-related assets.

Other provisions would mandate quarterly and annual reporting on political activities by companies and their trade associations, including the amount, date, candidate and party for contributions. Companies would have to report a ratio of the percentage pay increase for executives compared to the raise for a median worker each year, and taxes paid by jurisdiction.

Before passage, the House adopted amendments that would require disclosure of the race, ethnicity, gender, sexual orientation and veteran status of board members and executives; workforce-related information, including diversity, safety and pay; settlements or judgments connected to workplace harassment; board members’ cybersecurity expertise; and sourcing of materials from Xinjiang, China.”

Worth noting in this bill is language providing explicit legislative authority for the SEC “to consider independent, internationally recognized disclosure standards for reporting….” As noted in this newsletter last week, SEC Commissioner Elad Roisman has expressed doubts about the Commission’s need to pass new reporting standards and about the legality of designating a non-governmental third-party to develop and apply those standards. This provision would, it appears, provide the authority that Roisman suggested the SEC currently lacks.

Tech companies push back against new disclosure standards

Tech companies—some of which are among the most widely held stocks in ESG portfoliosare resisting the rush to new disclosure standards. Among others, Alphabet (the parent company of Google) and Microsoft have asked the SEC to reconsider its position. Asset managers, in turn, have expressed their frustration with the tech giants, arguing that their resistance to mandatory reporting is, in their view, a betrayal of the ESG principles they helped to foster and from which they have benefitted:

“Microsoft and Alphabet have pushed back against calls to include disclosures on environmental, social and governance issues in key US regulatory filings, setting them on course for a tussle with major asset managers.

The tech companies told the top US securities watchdog that ESG information should not be included in a type of filing known as a 10k, which most public groups must submit each year. Microsoft and Alphabet said including ESG information in these filings would open them up to potential legal risks since such data are subject to more uncertainty than the detailed financials and risk disclosures that are currently required in 10ks….

The battle between asset managers and companies over ESG disclosure is expected to intensify in coming months. With global warming and human rights posing new risks for companies, the SEC has embarked on unprecedented disclosure rulemaking for the booming ESG sector.

In 2021, almost a third of global equity inflows have gone into ESG funds, Bank of America said in a June 1 report. Assets under management in ESG funds hit a record $1.4tn in April, more than double the level from a year ago and growing at nearly 3 times the rate of non-ESG assets, the bank said.

Microsoft and Alphabet have benefited from this surge. Microsoft is the most widely held company in US ESG funds, Bank of America said. Alphabet is among the top 10 most popular ESG companies and is held in almost half of all US ESG funds.

Alphabet joined other technology companies on an SEC letter last week that recommended ESG disclosures “be furnished via separate climate reporting to the SEC”.

“Given that climate disclosures rely on estimates and assumptions that involve inherent uncertainty, it is important not to subject companies to undue liability, including from private parties,” the companies said.”

SEC Commissioner Roisman, who has warned against increased legal liability to corporations stemming from enhanced disclosure requirements, has asked for, at a bare minimum, a safe harbor for corporations to prevent or soften what he expects to be a post-mandatory-disclosure boom in ESG-related liability actions. Commissioner Allison Herren Leeone of the primary advocates for new disclosureshas agreed that a safe harbor may be necessary to alleviate legal action and calm corporations’ fears.

Activists prepare for greater ESG disclosure

Investor Update, a London-based market-intelligence firm, recently released a 100-plus page white paper on ESG and the market opportunities it offers now and in the near future. Among other insights offered in the report, IU argues that the current push for greater ESG disclosure will all but certainly provide greater opportunities for activists to make headway and to affect business operations and personnel. Greater disclosure means more information available to activists which means more opportunity to find mistakes and underperformance, and more opportunity to correct those mistakes through shareholder activism:

“ESG disclosure, already at record levels, is set to increase further thanks to a range of new regulations being planned or considered in markets such as the US, EU and UK.

‘Over time that will lead to a more efficient reflection of company behavior and industry performance,’ notes the paper from Investor Update, a market intelligence firm.

‘However, during the transition phase, increased regulation and enhanced disclosure… is providing more opportunity for activists as opposed to less. This is because it makes it easier to effectively measure performance and thereby more readily identify the outliers.’

When people think about activism, they instinctively think there is inefficiency of information, Andrew Archer, the author of the paper and head of ESG advisory at Investor Update, tells Corporate Secretary sister publication IR Magazine. ‘Whereas the reality is the opposite,’ he says. ‘Greater disclosure [offers] more opportunity for analysis and comparison, and therefore challenge.’…

‘There has been a great deal of movement and change over the last 18 months, which reflects the degree to which the key players in activism are repositioning around the ESG opportunity and looking to secure and leverage opportunities where they identify them,’ the white paper notes.”

On Wall Street and in the private sector

Inflation and ESG are reported primary investor concerns

According to various reports, including investing.com, as the markets prepare to enter the 2nd-Quarter earnings season, investors’ primary concerns are inflation and ESG:

“Also happening next week are two conferences on the hot topic of ESG. Environmental, Social and Governance are top of mind (along with inflation) in the C-Suite. On Tuesday this week, Cisco (NASDAQ:CSCO) and Goldman Sachs (NYSE:GS) will host an ESG Conference Call, and on Wednesday morning Johnson & Johnson will host an ESG Investor Update Webcast.

With a record number of S&P 500 discussing ESG during the Q1 earnings season, expect more such conferences as the year progresses, particularly as events move to traditional in-person settings….

At the Cisco & Goldman webcast, Cisco’s SVP of corporate affairs will provide an overview of the firm’s Corporate Social Responsibility (CSR) strategy and how it will help overall shareholder value creation….

J&J’s ESG Investor Update on Wednesday is slated to outline the company’s ESG management approach around its corporate priorities.”

Fidelity nearly doubles its ESG offerings

On June 16, Boston-based Fidelity announced that it is adding five new ESG funds to its product lineup, nearly doubling its ESG offerings. One of the new funds will focus specifically on gender diversity. A Fidelity press release couched the announcement as follow:

“Fidelity Investments today expands its sustainable investing lineup with five new actively managed Environmental, Social and Governance (ESG) funds – two equity mutual funds, one bond mutual fund and two equity exchange-traded funds (ETFs) – available June 17, 2021….

Fidelity’s new equity funds will seek to invest in high-quality companies that are addressing climate change via corporate strategy or through products and services, prioritizing and advancing women’s leadership and development, or that have proven or improving sustainability practices. Additionally, Fidelity will offer a bond fund seeking to invest in companies that provide environmental solutions or support efforts to reduce their own environmental footprints. The mutual funds and ETFs will be available for individual investors and financial advisors to purchase commission-free through Fidelity’s online brokerage platforms….

The three new actively managed mutual funds are Fidelity Climate Action Fund (FCAEX), Fidelity Environmental Bond Fund (FFEBX), and Fidelity Sustainability U.S. Equity Fund (FSEBX). The mutual funds will have no investment minimums, like most Fidelity funds, and will be available with both retail and advisor share classes.

The two new actively managed ETFs are Fidelity Sustainability U.S. Equity ETF (FSST)1 and Fidelity Women’s Leadership ETF (FDWM)1. The ETFs will have the same investment strategies as their like-named mutual funds.”

Companies plan for uncertain ESG future

On June 14, The Wall Street Journal ran a long piece on corporate moves to placate ESG investors, often taking costly action now to produce unknown future results that may or may not achieve any goal other than fending off ESG activists:

“Businesses increasingly are coming under pressure from investors, lawmakers and regulators who demand more details on their spending plans and the progress they are making to achieve their environmental, social and governance goals….

But, those investments present challenges for chief financial officers overseeing companies’ capital spending plans. Many of them are entering unknown territory by allocating funds to projects that carry big price tags, cover long time horizons and yield returns that are sometimes hard to quantify, executives said. Companies often make these investments before new regulations are proposed or consumer choices change, adding to the difficulty of finding the right balance….

Those investments come as policy makers are paying more attention to environmental, social and governance issues. President Biden as part of his infrastructure proposal wants to build more electric charging stations and generate more renewable energy. U.S. securities regulators are considering introducing mandatory disclosure requirements on climate-related risks, while lawmakers in California and Massachusetts recently banned gas-powered car sales starting in 2035.

Still, it could take more than a decade for these and other investments to generate returns, said Gregg Lemos-Stein, chief analytical officer at ratings firm S&P Global Ratings.”

In the spotlight

ESG and Bitcoin, again

As we have noted in this newsletter ESG and Bitcoinor almost any crypto-currency, for that matterare in the view of some commentators on a collision course, with the environmental concerns of ESG advocates running headlong into the perceived energy-intensive mining of Bitcoin. According to Coindesk, some crypto investors are responding with near full-blown panic, doing anything they can to avert this perceived collision:

“One cryptocurrency asset manager is buying emission offsets. A digital-asset trading platform says it wants to be “carbon negative” within 18 months. A new token would wrap bitcoin with carbon credits so that they could trade together as a single asset.

Just a month after Tesla CEO Elon Musk tweeted his concerns about the potential environmental harm from bitcoin mining, sending the cryptocurrency’s price into a tailspin, some industry players are rushing to respond. They’re looking at ways to address the environmental, social and governance (ESG) issues that might deter big institutional investors from embracing bitcoin….

Though some experts had been warning for years that the bitcoin market’s narrative of “institutional adoption” was on a collision course with the ESG mandate that now dominates the activities of big money managers like BlackRock, it’s too early to tell how much of a difference the latest efforts might make. Will the bitcoin mining industry actually shrink its carbon footprint or just announce ambitious goals and make peripheral adjustments to give big investors cover?…

The issue doesn’t seem to be going away, with bitcoin now changing hands at around $37,500, well off the all-time high near $65,000 reached in April.

So some big players are moving beyond the rhetoric and denial toward business changes that might help to address or remedy any environmental ills.”

The article also presents a rundown of what some major crypto dealers and investors are currently doing or plan to do to try to head off the perceived collision. 

Economy and Society: SEC commissioner addresses costs of new ESG disclosure rules

ESG Developments This Week

In Washington, D.C.

SEC commissioner on costs of new ESG disclosure rules 

On June 3, Elad Roisman, one of two Republicans commissioners on the SEC, gave a speech in which he appeared consigned to what he calls the inevitability of new mandatory environmental and workforce disclosure rules:

“There have been several calls for the SEC to require public issuers to include granular disclosure on ESG topics in their SEC filings. As you have probably heard me say before, I have reservations about the SEC issuing prescriptive, line-item disclosure requirements in this space, particularly in the areas typically designated as environmental (“E”) or social (“S”) disclosure, although I know people’s categorization of ESG information can vary….

I feel like a broken record, but our disclosure framework already requires public issuers to provide information that is material to investors, including information one might categorize as “E,” “S,” or “G.” The Commission has explicitly interpreted our rules to require disclosure of the material effects of climate change on a business. We also amended Regulation S-K last year to require disclosures regarding human capital. To the extent that other material risks to a company can be categorized as “E,” “S,” or “G,” I do not see a legal justification for failing to disclose that information under our existing rules.

But, the SEC Chair has made clear that further ESG disclosure is an area that the agency will pursue….

Today, I want to talk about potential costs of any new ESG disclosure regime and ways to mitigate them because I realize that the agency has such rules in process, and I believe this discussion is relevant, regardless of how the Commission approaches the other questions I have asked.

So, let me now proceed to put the electric cart before the horse and talk about the various costs and difficulties that would inevitably come from new line-item disclosure requirements in the areas of ESG and how the SEC might address them to make the regime workable for companies and to benefit investors.”

Roisman proceeded to make the case that, in his view, costs to companies must be minimized on a variety of fronts, before concluding that:

“In summary, any new ESG disclosure rules will inevitably come with costs…. I hope the Commission can predict these costs clearly enough to mitigate them in our rulemaking process. From my perspective, this can only help meet the stated objectives of any potential ESG disclosure proposal—that is getting this new information to investors.”

In response, Commissioner Allison Herren Lee, an advocate for new disclosures, appeared to acknowledge Roisman’s concerns about costs to companies and agreed that the new rules should be as inexpensive to implement and as flexibly implemented as possible. At a June 7 event for the Wall Street Journal’s CFO Network, Commissioner Lee said that she would like any new disclosure requirements to be applied carefully and judiciously. According to Bloomberg Law, Lee said that she wanted to ensure that the new rules were not implemented as “some kind of gotcha where we come up with a rule, and two months later, we’re knocking on your door.” She also said she wanted companies to “be given time to learn from their peers and get their ESG reporting right,” and for the SEC to phase in compliance slowly and/or “deploy a safe harbor to help companies with compliance.”

ESG and litigation risks

ESG has set off a boom in litigation, according to a story in the National Law Review, and the fear is that, without a safe harbor to help companies with compliance, the boom will grow much louder and more powerful:

“More than 95% of the Fortune 50 now include some ESG disclosures in their SEC filings. The topics on the rise in 2020 included Human Capital Management, Environmental, Corporate Culture, Ethical Business Practices, Board Oversight of E&S Issues, Social Impact and Shareholder Engagement.

While the increased attention on ESG presents an opportunity for companies to showcase their good work, it also creates increased litigation risk. These new challenges primarily fall into three areas: misrepresentations, unfair and deceptive trade practices, and securities fraud.”

Of particular concern, according to the story, is the fact that, after years with no perceived consistency of standards and several different bodies providing several different reporting guidelines, that many companies may find themselves with gaps in past reporting or inconsistencies with new mandates.

SEC disclosure push prompting rise in corporate lobbying

According to Bloomberg Law, the SEC has been meeting with lobbyists and other corporate representatives at an increasing pace so far this year:

“More than 20 companies, business groups, and other organizations have met with the SEC this year as the agency considers mandatory disclosures on climate risks and other environmental, social, and governance matters.

Uber Technologies Inc., Walmart Inc., and the World Economic Forum support corporate ESG disclosures and are among those that have spoken directly with the Securities and Exchange Commission in recent months, according to a Bloomberg Law review of agency records. Walmart and Uber are already releasing information about their greenhouse gas emissions and sustainability goals.

Skeptics are lining up, too. The U.S. Chamber of Commerce, which has publicly warned against expansive ESG disclosure requirements, also met with SEC officials recently, records show.

The stakes are high…. A mandatory reporting system from the SEC could be a “seismic shift” in corporate disclosure, said Keir Gumbs, Uber’s deputy general counsel and deputy corporate secretary, who met with commission officials on climate disclosures….

“A lot of people see how important this topic of discussion is and want to be part of the process,” said Gumbs, a former SEC counsel….

Most, if not all, of the SEC’s meetings so far with private-sector interests have included Kristina Wyatt, the agency’s new senior counsel for climate and ESG in its Division of Corporation Finance, which will take a leading role in any disclosure rulemaking. She’s often joined by John Coates, the division’s acting director. Sometimes, Satyam Khanna, the SEC’s senior policy adviser for climate and ESG, is there, too.

Public records from the meetings don’t provide detailed descriptions about what was discussed. But they show SEC officials spoke with a variety of company executives, lawyers, and other advocates, sometimes communicating with several representatives at multiple organizations in a single day.”

On Wall Street and in the private sector

Citi calls ESG unstoppable

On June 9, various members of Citi’s investment businesses held a virtual media briefing in which they argued that the forces driving ESG investment are, in their words, unstoppable and will, thus, propel global investments for some time to come. CNBC reported on the briefing and the Citi commentary as follows:

“Alternative and green energy are “very productive right now” where global trends are concerned, said Ken Peng, head of investment strategy for Asia-Pacific at Citi Private Bank, during a virtual media briefing on Wednesday.

“Governments from around the world from China to Europe to US are focusing on sustainable development and they are putting money where their mouths are,” he said….

David Bailin, chief investment officer at Citi Global Wealth, also said that over the next five to 10 years, investors — especially younger ones — will place an “enormous emphasis” on sustainable and responsible investing, and not just focus on profits.

They will look at how companies treat the environment, employees, and even politics will form part of their investment decision….

He said the most important will be the “unstoppable trends” like climate change and social justice, including providing equal access to education and technology.

“All of those are areas that I think are going to have unusual growth in the next five to 10 years,” said Bailin, who is also the firm’s global head of investments. “So these two things will converge and I think, create an opportunity for investors to make money by doing good.””


ESG ratings confusion

On June 11, The Wall Street Journal published an analysis of positive-ESG stocks, their performance relative to negative-ESG stocks and to the market more broadly, and the perceived discrepancies in ESG ratings between the three largest ESG data and ratings firms. According to the Journal, general ESG stock performance appears highly dependent on the firm doing the ratings, which produces confusion and can affect perceptions of ESG and its overall viability:

“Money is pouring into stocks that get good grades on issues like building a diverse workforce and reducing carbon emissions. But figuring out how high- and low-rated companies perform is nearly impossible because of inconsistencies in the way they are rated.

A close look at the ratings and performance of stocks ranked by the three major providers of data on environmental, social and governance criteria shows that companies can have widely different ratings.

Depending on the time period and the provider, top-ranked ESG stocks either beat the market or lag behind it. Low-ranked stocks, which are generally deemed to pollute more and treat their workers less well, can outperform top-ranked ESG stocks, and the market overall.

Since company rankings vary widely depending on the provider, which groups win and which lose is inconsistent….

The Wall Street Journal analyzed nearly 500 U.S. companies rated by all three providers and examined their 2020 and 2021 stock performance.

The Journal sorted companies into three groups—ESG leaders, average performers and laggards—based on ratings assigned by Refinitiv, a data provider owned by the London Stock Exchange Group, index provider MSCI Inc., and Sustainalytics, a unit of Morningstar Inc. The Journal analyzed their performance by calculating an equal-weighted index for each category….

Shares of companies considered by Refinitiv to be poor performers on ESG metrics have jumped 26% since the beginning of this year. Companies with top marks rose by 14% during the same period.

At Sustainalytics, the top-ranked companies for ESG rose 26% during the same period, beating those with lower ratings. At MSCI, the average companies based on ESG scores were the winners, beating both the laggards and the leaders….

The reason for the disparity is that each rater creates scores using different data sources and procedures, often emphasizing different aspects of the companies’ behavior. Some methodologies assign scores relative to competitors in the same industry and others assess absolute risk based on a firm’s material exposure to ESG issues….

Monica Billio, a professor at Ca’ Foscari University of Venice, Italy, who co-wrote a paper on ESG rankings last year, said “the strong disagreement in the market does not allow the ESG relevance to be understood by the market.”

“Scores can create confusion because a company is rated highly by one agency and given a very low grade by another,” she said.”

In the spotlight

World Economic Forum disclosure standards adopted in Australia

With the SEC poised to approve new ESG disclosure requirements and with various external groups vying for the opportunity to be the provider of those standards, the World Economic Forum’s Stakeholder Capitalism Metrics appear to have taken a foothold as the new benchmark for disclosure. The metrics, developed by the WEF’s International Business Council, were officially released in September 2020 and, since the beginning of this year, have been adopted by at least 19 companies traded on the ASX (the Australian Securities Exchange):

“At the start of 2021, the first six ASX-listed companies began improving their Environmental, Social, and Governance (ESG) credentials and reporting their progress against the World Economic Forum’s 21 universal ESG metrics, using “ESG on-ramp” technology platform Socialsuite….

An additional thirteen ASX-listed companies recently signed on to ESG on-ramp and are leading the way globally by committing to ESG reporting.

The initial six companies to sign up to Socialsuite’s ESG-on-ramp have now completed their baseline ESG report, first quarterly ESG action plan, and continue to report their progress to stakeholders….”

Economy and Society: Proposed legislation would further integrate ESG into retirement plans

ESG Developments This Week

In Washington, D.C.ESG developments this week

Proposed legislation would further integrate ESG into retirement plans 

On May 27, four House Democrats introduced legislation they argue is aimed at promoting ESG transparency. The bills, Sustainable Investment Policies Act and the Retirees Sustainable Investment Opportunities Act, would continue the House’s efforts to overturn regulations enacted in the waning days of the Trump administration. A press release from Congressman Andy Levin’s office summarizes their perspective on ESG, ERISA, and investing for retirement:

“Congressman Andy Levin (MI-09), member of the House Education & Labor Committee and member of the Subcommittee on Health, Employment, Labor, and Pensions, along with Congressman Brendan Boyle (PA-02), member of the House Ways and Means Committee, Congresswoman Cindy Axne (IA-03), member of the House Financial Services Committee, and Congressman Jesús “Chuy” García (IL-04), member of the House Financial Services Committee, today introduced two pieces of legislation to protect and increase sustainable investments. The Sustainable Investment Policies Act and the Retirees Sustainable Investment Opportunities Act together would give workers a bigger say in where they invest their retirement savings by requiring large asset managers and plan investors and fiduciaries to take into account and explain to beneficiaries how they consider environmental, social and corporate governance (ESG) factors when making investment decisions….

The Sustainable Investment Policies Act amends the Investment Advisers Act to promote transparency and disclosure by having large asset investment advisors file a Sustainable Investment Policy (SIP) with the U.S. Securities and Exchange Commission (SEC). The SIP must describe the factors advisors consider when making investment decisions. These factors must align with an ESG framework. The ESG framework that investment advisers must consider includes, but is not limited to, the following investment considerations:

–          Corporate political spending and decision-making;

–          Worker and collective bargaining rights;

–          Climate and other environmental risks;

–          Global human rights and diversity and inclusion practices; and

–          The plan’s engagement with entities into which it invests, including proxy voting practices.

The Retirees Sustainable Investment Opportunities Act empowers ERISA-regulated plans to adopt a Sustainable Investment Policy (SIP) that explains how the plan’s investments will address considerations like job creation, worker pay and benefits, human rights, climate change, and more. The bill also affirms that ERISA plans may invest plan assets in sustainable investments so long as it is in the plan beneficiary’s best financial interest. The investment must also not compromise anticipated risk-adjusted returns.”

On Wall Street and in the private sector

Exxon shaken by ESG activist proxy fight 

On May 26, Exxon held its annual general meeting, at which it announced the results of voting on its proxy statement voting and acknowledged that an activist hedge fund had won at least two board seats. The Wall Street Journal explained the results as follows:

“An activist investor won at least two seats on the board of Exxon Mobil Corp. XOM +1.24% , a historic defeat for the oil giant that will likely force it to alter its fossil-fuel focused strategy and more directly confront growing shareholder concerns about climate change.

Exxon said Wednesday a preliminary vote count showed shareholders backed two nominees of Engine No. 1, an upstart hedge fund owning a tiny fraction of the oil giant’s stock. The final vote was not tallied as of early Wednesday afternoon, and the final composition of the board was unclear. Exxon Chief Executive Darren Woods was also reelected to the board, the company said.

The vote culminated a pitched, monthslong battle to persuade Exxon shareholders that turned into one of the most expensive proxy fights ever….

The hedge fund called for Exxon to gradually diversify its investments to be ready for a world that will need fewer fossil fuels in coming decades. Exxon defended its strategy to expand drilling, saying demand for fuels and plastics will remain strong for years to come, and pointed to a new carbon capture and storage business unit as evidence it is taking climate change seriously….”

Notably, the victory for the activists was enabled by the passive investment giants, Vanguard, BlackRock, and State Street, who constitute Exxon’s three largest shareholders, collectively owning more than 20% of the stock. The Wall Street Journal provides further details:

“Many of the world’s biggest investment firms helped elect directors proposed by an upstart environmental-activist fund to Exxon Mobil Corp.’s XOM -0.32% board. While votes are still being counted, BlackRock Inc., BLK 0.07% State Street Corp. STT -0.01% and Vanguard Group have said publicly they wielded votes for investors in favor of at least two dissident directors….

The investors backing Engine No. 1 turned into a who’s who list of Wall Street.

BlackRock voted for three directors proposed by Engine No. 1 and expressed concerns with Exxon’s strategic direction and the impact on its financial performance in the long term.

Vanguard voted for two directors proposed by the activist.

At least some Fidelity funds voted for Engine No. 1 directors, according to people familiar with the matter. T. Rowe Price Group Inc. TROW 0.60% voted for three of the four dissident directors, the company said Thursday.”

In response, the independent financial research operation Seeking Alpha warned that market participants who favor de-carbonization may feel triumphant but may also wish to hold off on their celebrations. According to Seeking Alpha’s Michael Boyd, the historical patterns show that when investors push ESG on fossil fuel companies from the outside, the companies tend to struggle and to underperform the market. This, he argued in a May 28 piece, is a function of the fact that outside activists tend to be concerned, in his view, with punishing the companies rather than improving their behavior and performance:

“[W]hat I set out to do is track performance of oil and gas firms that have enacted climate change policies, with weighting towards how “extreme” those measures were….

What was the outcome? On a backtested basis to early 2019, there has been no outperformance garnered from oil companies that have implemented varying ESG initiatives compared to those who have. In fact, there is a mild correlation with negative performance since implementation for the vast majority of the dataset….

ESG investors that are pushing for these changes do not seem to be increasing inflows towards oil and gas companies that are implementing the very policies they push for. BP is, without a doubt, one of the leaders on shifting its business model to adapt to the mainstream climate change narrative; the same is true for Royal Dutch Shell even with all the handwringing going on in the Dutch court system. Yet both are dramatically under-owned by pension funds, endowments, and ESG-motivated hedge funds, especially in comparison to North American counterparts that score particularly poorly on the above. Even after ESG policy initiations, those ownership stakes have not improved materially either.

This is an unfortunate habit of the ESG movement….[I]t’s about “dealing a blow” to the industry rather than actually taking carbon out of the environment.”

Mid-cap matters

In an article published May 28, Nasdaq highlighted the mid-cap ESG ETF market, suggesting that investors’ usual focus on large-cap and small-cap businesses made mid-caps a very attractive place for ESG-advocates to put their money:

“While it’s often said that mid cap equities are overlooked relative to their large- and small-cap counterparts, there are dozens of these funds for investors to consider.

The concept that may be going overlooked, at least for now, is mid cap potential in the ESG arena. The American Century Mid Cap Growth Impact ETF (MID) brings both concepts under one roof.

MID, which debuted last July, is part of American Century’s suite of active non-transparent exchange traded funds, or ETFs that do not disclose their holdings on a daily basis. The fund benchmarks to the Russell 1000 Mid-Cap Growth Index.

MID’s management teams looks for “companies that align with the United Nations Sustainable Development Goals (SDGs) that generate or could generate social and environmental impact alongside a financial return,” according to American Century.…”

The article concludes, noting that “mid caps are often more domestically focused than large caps, levering stocks in the middle to economic recovery.” This suggests that mid-caps might appeal not just to investors seeking continued returns but also to those looking to have an impact on Environmental, Social, and Corporate Governance matters in the U.S. primarily.

In the spotlight

Moody’s study: Biodiversity of growing interest among ESG advocates

Last week, Moody’s ESG released the results of a study that attempted to quantify the perceived risks posed to biodiversity by large, publicly traded businesses and to assess companies’ efforts to mitigate the perceived loss of biodiversity. According to the report, biodiversity is a growing concern among ESG practitioners and policy-makers alike. Nevertheless, according to the study, many large businesses struggle to incorporate these concerns into their ESG practices. A summary published by CFODive.com noted the following:

“Thirty-eight percent of 5,300 large, publicly traded companies operate at least one facility causing loss of habitat and a risk to biodiversity, according to a study by Moody’s ESG Solutions of more than 2.1 million facilities worldwide using “high resolution remote sensing data.”

Moody’s ESG Solutions found in its study that efforts by companies to reduce harm to biodiversity often fall short of commitments they make in public disclosures. For example, 61% of heavy construction companies disclose commitments related to biodiversity but less than 10% received a “robust” or “advanced” score from Moody’s for implementation.

Moody’s flagged “urban sprawl” as a major threat to biodiversity in the U.S., singling out big-box retailers such as Dollar General that pursue a “pattern of growth that inspires more sprawl by developing low-density, single-story buildings on the outskirts of town, in vegetated, undeveloped land.”

Moody’s ESG concluded that biodiversity will become one more argument in favor of a dual-materiality standard for businesses.

Notable quotes

“It was precipitated by the ESG [environmental, social and governance] movement and this notion, which was exacerbated by Elon Musk, that there are some real environmental problems with the mining of bitcoin. A lot of institutional buying went on pause….

Elon probably got a few calls from institutions. I noticed that BlackRock is [Tesla]’s number three shareholder and Larry Fink is the CEO. He is focused on ESG and especially on climate change. I’m sure BlackRock registered some complaints and perhaps there are some very large holders in Europe who are extremely sensitive to this.”

Cathie Wood, ARK Investment Management, on the fall of Bitcoin over the last few weeks, in an interview with Nathaniel Whittemore on the CoinDesk Podcast Network, May 28, 2021.

Economy and Society: Labor Department ordered to revise rules limiting ESG

ESG developments this week

In Washington, D.C.

Biden Executive Order prompts Labor Department to revise rules limiting ESG

This past week, President Biden issued an Executive Order asking the Labor Department to begin the process of undoing a Trump administration rule warning asset managers about their fiduciary responsibilities under ERISA:

“President Joe Biden has issued an executive order that among other things directs the secretary of labor “to consider publishing by Sept. 2021” proposed rules to suspend, revise or rescind agency rules that limited investments focused on environmental, social or governance (ESG) factors in retirement plan accounts and limited plan fiduciaries from voting in favor of climate-related shareholder proposals.

Those rules were approved under the Trump administration last October after an unusually short comment period that attracted opposition from many financial firms, including BlackRock, Fidelity Investments, State Street Global Advisors and Vanguard, as well as sustainability advocates like the Grantham Foundation for the Protection of the Environment and the US SIF: Forum for Responsible and Sustainable Investment….

The executive order requests that the labor secretary submit within 180 days a report to the director of the National Economic Council and the White House national climate advisor that identifies actions taken by the agency to protect life savings and pensions of U.S. workers and families from climate-related financial risk. It asks the same of the Federal Retirement Thrift Investment Board, which administers a 401(k)-like savings plan for federal employees.”

Also this past week, Senator Tina Smith (D), introduced a bill that would make a new Labor Department rule unnecessary, permitting “environmental, social and governance (ESG) criteria to be considered in ERISA-governed retirement plans”:

“The bill, the Financial Factors in Selecting Retirement Plan Investments Act, is co-sponsored by Sen. Patty Murray, D-Wash., chairwoman of the Senate Health Education Labor & Pensions Committee.

The bill would allow a plan fiduciary to consider ESG or similar factors, in connection with carrying out an investment decision, strategy or objective, or other fiduciary act; and consider collateral ESG or similar factors as tie-breakers when competing investments can reasonably be expected to serve the plan’s economic interests equally well with respect to expected return and risk over the appropriate time horizon.

Lisa Woll, CEO of the Forum for Sustainable and Responsible Investment, said Thursday in a statement that “investors consider ESG criteria because they are material to financial performance.”…

The bill also “clarifies that ESG criteria may be considered in qualified default investment alternatives,” Woll said.”

In the States

Stanford joins the ESG-debt trend

Stanford University in Palo Alto, California, has become the first American university to issue construction and renovation bonds that are designated as sustainable. According to the Stanford News:

“On April 7, 2021, Stanford went to market selling $375 million in public market debt securities to help finance or refinance various projects included in the university’s capital plan.

The securities are in the emerging ESG (Environmental, Social and Governance) investment category. Two ESG designations have been externally verified: the International Capital Markets Association’s Sustainability Bond designation and the even more rigorous Climate Bond Certification, reflecting alignment with the Paris climate accord. Both are based on the United Nations’ Sustainable Development goals….

The Stanford bonds also received sustainability and climate certifications – a step that State Treasurer Fiona Ma said marks a new era in higher education bond funding.

“ESG financing provides the multi-pronged benefits of greenhouse emission reductions, health equity research, affordable housing, and systemic and academic equity,” Treasurer Ma said. “I hope more California colleges will follow Stanford’s lead.”…

University Treasurer Karen Kearney, whose office initiated and led the financing, said obtaining the designations added complexity to the process, since Stanford elected to, for example, obtain external ESG certification of its offering by an approved verifier. Bank of America led the team of underwriters handling the sale. It included Wells Fargo, Morgan Stanley and Siebert, Williams, Shank & Co, an Oakland-based woman- and minority-owned firm.

“This market evolution, together with a review of the annual Sustainability at Stanford report was a lightbulb moment for me,” Kearney said. “We had been contemplating green bonds for some time, and now we could identify a discernable pricing advantage by associating a bond issue with Stanford’s longstanding emphasis on the environment, access to education and social responsibility. Seeking ESG designations promised both financial advantages and the opportunity to extend Stanford’s environmental and social stewardship into the financing domain.””

On Wall Street and in the private sector

Tech-related stocks most widely held among largest ESG funds

According to the index-provider MSCI, the single stock most widely held by the 20 largest ESG funds last year was Alphabet, the parent company of Google. In its analysis of the fundswhich included both actively managed and passive (i.e. index or exchange-traded) fundsMSCI determined that:

“The information technology sector of the S&P 500 accounted for the largest allocation in most funds, according to MSCI’s analysis. Funds’ holdings in these stocks ranged from 3.5% of their assets to more than 37%.

Most of the ESG funds in the study had well over 20% of their assets in IT.

Meanwhile, energy stocks accounted for a minimal portion of the funds’ holdings. This helped the ESG funds outperform last year, as tech rallied while energy declined.

Indeed, Google’s parent company was held in 12 of the funds — making it the most widely held stock among the participants — with an average weight of 1.9% at year end, according to the study….

Google’s parent was present in more of the ESG funds, but Apple was the stock that accounted for the highest concentration within these portfolios.

The funds held Apple at an average weight of 5.6%, followed by Microsoft at 5%. 

Other top stocks held by ESG funds include Applied Materials, Cadence Design, Adobe and Texas Instruments, according to MSCI’s analysis.””

MSCI’s analysis also found that ESG-sustainability investing does not necessarily mean divesting from fossil fuel companies:

“An MSCI study of the 20 largest ESG funds by assets under management found that 25% held shares of energy companies. The study further found that some funds without oil companies in them actually have a larger carbon intensity due to other industrial names in them. So far this year, oil and energy plays have been performing well as the U.S. economic reopening continues.”

Fidelity International adds to its ESG team

Fidelity Internationala private company spun-off from Fidelity Investments that handles investments for clients in Asia Pacific, Europe, the Middle East, South America and Canadarecently announced the addition of a new director for sustainable investing, to be based in Hong Kong. According to the firm, Gabriel Wilson-Otto, formerly at BNP Paribas, will now be in charge of “integrating sustainability-related considerations into the investment process, working on Fidelity’s proprietary sustainability ratings and support[ing] the execution of its related regulatory program.”

SASB moves forward

The Sustainability Accounting Standards Boardan organization that aims to serve as a quasi-official standards board for ESG reportingcontinues its process of updating and issuing global ESG reporting standards and prepares to take on a much larger global role as it moves toward a merger with the London-based International Integrated Reporting Council:

“SASB held a board meeting Wednesday [May 5] to discuss some of its upcoming standards on tailings management, human capital, supply chain management in the tobacco industry, and alternative meat and dairy products. The board members also heard updates on SASB’s progress on its merger later this year with the International Integrated Reporting Council to create a Value Reporting Foundation, and the International Financial Reporting Standards Foundation’s proposal to establish an international sustainability standards board that it would oversee alongside the International Accounting Standards Board.

The meeting came at a time when the Securities and Exchange Commission and international financial regulators are pushing for more consistent disclosures of ESG reporting. The growth in popularity in ESG funds among investors has attracted greater scrutiny from regulators, who are pushing standard-setters like SASB and the IIRC, along with the Global Reporting Initiative, the Climate Disclosure Standards Board, and the Carbon Disclosure Project to harmonize their standards to keep companies from taking a lowest common denominator approach to touting their environmental bona fides….

SASB has been working with the Global Reporting Initiative and the other standard-setters on harmonizing their standards and frameworks. “SASB and GRI have been part of this group of five and have also been working directly together to show how our frameworks can be mutually compatible and try to help companies meet their reporting needs to varying stakeholders,” said Hales. “SASB is very focused on investor needs and GRI is broadly focused on stakeholder needs, including investors as well as some others. Just last month, we put out a guide on sustainability reporting using both sets of standards and how companies can use that.””

Notable quotes

“There are thousands of papers on ESG, several meta-studies and even studies of the meta-studies trying to determine whether there may be some added financial benefit to ESG investing, At the same time, we’ve seen several studies into the non-ESG stocks, the so-called sin stocks, that show they tend to outperform. So the idea that there’s a true alpha thesis for ESG is still in doubt, though there is some encouraging research emerging….

Because the client is being driven by these concerns, we’re moving past the point where client interest is the only reason that the advisor has to engage, but the danger is that there are a lot of stories out there that say aligning portfolios with values won’t cost you money or can lead to better returns, and that’s not exactly the case. ESG conversations with clients have to be nuanced enough to capture that, and we have to be realistic depending on the products….

The future of investment reports is going to look much closer to what is currently called an ESG impact performance. Advisors will be expected to tell clients not just about their return and standard deviation, but also what impacts were made on their ESG interests versus a benchmark – how many fewer barrels of oil did they use, for example.”

Dana D’Auria, co-CIO Envestment, from “ESG Investing’s Return Premium Still Unproven, Envestnet Exec Says,” Financial Advisor Magazine, April 7, 2021.

Economy and Society: SEC to begin investigating ESG disclosures

SEC to begin investigating ESG disclosures

ESG developments this week

In Washington, D.C.

Is the SEC making its move? 

On May 14, FoxBusiness’s Charles Gasparino reported that the new SEC chairman, Gary Gensler, has asked his staff to begin investigating whether corporations are making proper ESG disclosures and, if they are not, to charge them with fraud. Gasparino wrote:

“Wall Street’s top cop Gary Gensler wants to charge companies who aren’t woke enough with securities fraud.

FOX Business has learned that the Securities and Exchange Commission is launching a series of inquiries into whether corporations make proper disclosures involving so-called Environment, Social, Governance issues, known by the short-hand ESG. 

The purpose of the crackdown, initiated at the behest of Gensler, who became SEC chairman last month, is to prod corporate America to adopt policies that improve diversity, and other non-financial issues such as environmental concerns, securities lawyers who represent potential targets tell FOX Business.

These lawyers, who spoke on the condition of anonymity, said the SEC will also look at such issues as “conflict minerals,” or whether companies import raw materials from countries that use the money to finance war and adequately disclose the matter in corporate reports. 

Another area of concern includes whether companies disclose if so-called forced labor is used anywhere in their global supply chains, these lawyers add. The SEC will also be monitoring the racial diversity of corporate boards, and whether companies alert investors about fully meeting environmental standards, these lawyers say.”

Gasparino concluded his report, noting that “It’s unclear if any of the inquiries by the SEC will result in enforcement actions involving civil securities fraud, which are usually settled by targets without admitting or denying wrongdoing.”

In the States

State treasurers for ESG

A group of state treasurersincluding those from Massachusetts, Rhode Island, Illinois, and Californiawill soon be sending a statement to a variety of investment-related constituencies, demanding that they treat climate change as a vital consideration in investment decisions. According to a report by Responsible Investor, these state treasurers argue that, in their view, assessment of and accounting for climate risk will be vital to maintaining healthy investment profiles:

“A group 16 of US State Treasurers managing more than $1.2trn of assets combined will be sending a statement on the urgency of dealing with climate risk to major investment firms, companies, investment consultants and fellow US State Treasurers. 

Speaking to RI, Deborah Goldberg, Massachusetts State Treasurer and a signatory to the statement, said: “It is the role of state treasurers to be forward thinking in terms of the long term impact of the health of their pension funds. However it’s not enough. You’re not going to impact climate risk by individual states setting standards. This needs to be universal.”

The statement, signed by the likes of California State Treasurer Fiona Ma and Rhode Island General Treasurer Seth Magaziner, says climate change will impose systemic, undiversifiable, portfolio-wide risks to long-term and institutional investors and calls for financial institutions to measure, disclose and eliminate their Scope 1,2 and 3 by 2050. 

It also calls on federal regulators to identify climate change as a systemic risk and stress test organisations. It urges the US Securities and Exchange Commission to mandate climate and ESG risk disclosure and asks the US Department of Labor (DOL) to reverse proxy voting rules under the Employee Retirement Income Security Act (ERISA) that undermine ESG integration. The DOL will not enforce the latter rules until the publication of further guidance, but they have not been formally dropped.”

On Wall Street and in the private sector

BlackRock makes personnel moves

BlackRockthe world’s largest asset management firmrecently made several significant ESG-related personnel moves. On May 7, Business Insider reported on the moves:

“BlackRock is continuing to double down on sustainability as it expands its environmental, social, and corporate governance-centric (ESG) leadership.

The world’s largest money manager has hired a climate scientist from the World Wildlife Fund into a top sustainability research position and appointed a new COO for its sustainability-focused division, according to a memo sent to all employees Thursday seen by Insider.

BlackRock Vice Chairman Philipp Hildebrand, who also chairs BlackRock’s sustainability initiatives, and Paul Bodnar, the firm’s recently appointed global head of sustainable investing, said in the memo that Chris Weber has been named as head of climate and sustainability research.

Weber was most recently the global climate and energy lead scientist at conservation organization World Wildlife Fund, the firm said in the memo Insider viewed. He will report to Bodnar in his newly created role and will start later this month….

Beatriz Da Cunha, a longtime BlackRock leader, was named BlackRock Sustainable Investing’s (BSI) first chief operating officer. Her mandate will be to scale the sustainable investing platform. She has been with the firm for 15 years, and has worked on BSI’s ESG integration team, according to the memo. 

The firm also created two new roles to boost the BSI unit in Asia.”

Fossil fuel analyst sees ESG bubble burst

On May 7, Oilprice.com published a piece by Alex Kimani, identified as a veteran finance writer, celebrating what he believes is the end of alternative energy stocks’ domination of the market. In a piece, titled “The ESG Bubble has Finally Burst,” Kimani wrote:

“Back in January, we warned that the green energy sector was in danger of overheating after massive runups by clean energy stocks in 2020. The momentum remained strong early in the year after Joe Biden ascended into the Oval Office in hopes that his ambitious clean energy plan would be a tailwind for investors in the so-called sustainable or ESG funds.

It was not long, however, before cracks began to appear in the clean energy bull camp.

After emerging as the hottest corner in the clean energy universe in 2020, solar stocks began to let off steam in January, with leading solar names such as First Solar Inc. (NASDAQ:FSLR), SolarEdge Technologies (NASDAQ:SEDG), Enphase Energy Inc. (NASDAQ:ENPH), SunPower Corp. (NASDAQ:SPWR), and Canadian Solar Inc. (NASDAQ:CSIQ) selling off in double-digits.

And now everything has finally come unstuck.

Clean energy has so far been the worst-performing sector, with investors yanking cash from the sector at the fastest pace in a year….

But the biggest reason why clean energy stocks are selling off is simple: They are too expensive.

“As money rotates away from those emerging growth themes and into the more economically sensitive areas of the market, clean tech has become a source of funds,” Dan Russo, portfolio manager at Potomac Fund Management, has told Bloomberg.

With their heavy-tech exposures, clean-energy funds could come under even more pressure.

Last week, JPMorgan Chase & Co. strategist Marko Kolanovic warned that big allocations into growth and ESG strategies may leave money managers vulnerable to inflation, and many might be forced to shift from low-volatility plays to value stocks….”

In the spotlight

RealClear Foundation releases report critical of ESG

On May 13, RealClear Foundation released a report by Rupert Darwall, a senior fellow at the Foundation, in which he argued that ESG, in his view, is deceptive in its promises, dangerous in its implementation, and distracting in the way in which it removes large, societal problems from governments’ agendas and attempts to solve them with a mechanism poorly suited to the task. In his report, “Capitalism, Socialism and ESG,” Darwall argues the following:

 “– In contrast to the older ethical investment movement, which accepted that morally constrained investment strategies incur costs, ESG proponents claim that investors following ESG precepts earn higher risk-adjusted returns because companies with high ESG scores are lower-risk. Thus, their stock price will outperform, whereas those firms with low ESG scores are higher-risk, leading them to underperform.

— This supposition conflicts with finance theory. Once lower risk is incorporated into a higher stock price, the stock will be more highly valued, but investors will have to be satisfied with lower expected returns. Unsurprisingly, claims of ESG outperformance are contradicted by studies.

— Claims that ESG-favored stocks outperformed during the Covid-19 market meltdown disappear once other determinants of stock performance are controlled for. ESG factors were negatively associated with stock performance during the market recovery phase in the second quarter of 2020.

— The corollary of the ESG thesis—that low-ESG-rated “sin stocks” are condemned to underperform the stock market—is decisively refuted by the data. When institutional investors “went underweight” by selling down their holdings in tobacco stocks, it made them cheaper for other investors to buy and make money, especially when they subsequently outperformed the market.

— The weaponization of finance by billionaire climate activists, foundations, and NGOs threatens to end capitalism as we know it by degrading its ability to function as an economic system that generates higher living standards. This usurpation of the political prerogatives of democratic government invites a populist backlash.”

Notable quotes

“When fund managers like BlackRock say that they “anticipate more engagement and voting” on whether companies are addressing issues such as climate change, keep in mind that the economic burden of that agenda can fall on ordinary folks who want to enjoy a comfortable retirement. If ESG investing truly maximized returns, fund managers wouldn’t fake a commitment to it while quietly doing their job—investing in companies that focus on shareholder returns and profits.”

Andy Puzder and Diane Black, “Who Really Pays for ESG Investing?The Wall Street Journal, May 12, 2021

Economy and Society: Buffett rallies opposition to ESG proposals on company proxy statement

ESG developments this week

On Wall Street and in the private sector

An Oracle’s opposition

The big story in the ESG world last week was the news that the so-called Oracle of Omaha, Berkshire Hathaway CEO Warren Buffett, opposed ESG proposals on his company’s proxy statement and was able to rally support among members of the board of directors and other shareholders to defeat proposals that would have forced the investment company to disclose various ESG data for all of the companies it owns. Buffett argued, and a majority of shareholders agreed, that the costs associated with such an effort would be damaging to shareholder value and, in his view, provide little by way of useful information. Reuters put it this way:

“Buffett and his board opposed two shareholder resolutions at Berkshire Hathaway’s annual shareholder meeting last week that called for annual reports on how its companies are responding to the challenge of climate change, as well as reports on diversity and inclusion in the workplace.

He prevailed, supported by directors who along with him control a combined 35% of Berkshire Hathaway’s voting power. But some of his top investors, including BlackRock Inc (BLK.N), the world’s biggest asset manager, were part of the roughly 25% of Berkshire Hathaway shareholders who defied him and voted for each resolution. The California Public Employees’ Retirement System, the largest U.S. public pension fund, and Federated Hermes Inc (FHI.N), the $625 billion asset manager based in Pittsburgh, were among sponsors of the climate-change resolution.”

While, according to the report, many shareholders appear to be drawing the line on ESG, even without Buffett and the board’s 35%, the resolution did not muster the support of a majority of outstanding shares, losing 40%-25%. 

ESG pioneer reexamining fiduciary duty

In her BloombergOpinion column last week, Shuli Ren disclosed that the world’s largest pension fundJapan’s $1.6 trillion Government Pension Investment Fundhas begun questioning its involvement in ESG, with some employees reexamining their fiduciary responsibilities as they relate to socially responsible investing. This reexamination, in turn, has led the fund to cool its support for ESG:

“In July 2017, Japan’s $1.6 trillion Government Pension Investment Fund — the world’s largest — blazed a trail by putting 1 trillion yen ($9.1 billion) into three indices that track Japanese stocks that put emphasis on environmental, social and corporate governance issues. GPIF then plowed 1.2 trillion yen into two carbon-efficient indices in 2018, and another 1.3 trillion yen into two ESG foreign equity indices last December.

But top officials of the pension fund have been talking up fiduciary duty lately. GPIF “can’t sacrifice returns for the sake of buying environmental names or ESG names,” a senior director at the fund’s investment strategy department told Bloomberg News in April. 

At issue is poor performance. For instance, one of GPIF’s earliest ESG picks was a thematic social index, which invests in domestic companies that hire and promote women. The MSCI Japan Empowering Women Index, the so-called Win index, has fared poorly against the benchmark Topix Index. Performance is all-important to GPIF: the fund is required to pursue a real investment return of 1.7% to support an aging Japan.

Over the last year, the Japan ESG indices that GPIF tracked could not outperform the benchmark Topix Index. 

Ren concludes, starkly:

No doubt, with the European Union and Biden administration pushing fiscal stimulus money into clean energy and climate technology, ESG investing will remain a hot topic. But if the world’s largest pension fund seems to have become more circumspect, shouldn’t you? From the perspective of pure returns, passive ESG investing can still be fruitful, but one has to be nimble and practical, able to switch quickly from one thematic fund to another — or out of ESG funds altogether. Dogma won’t work.”

BlackRock identifies ESG as the future of global investing

This past weekend, CNBC recapped an interview with Armando Sebra, the head of BlackRock’s iShares Americas, who insisted that ESG is the wave of the future for global investing. “We are just at the beginning” of the ESG era, Sebra said in a brief interview with the network’s Bob Pisani. CNBC continued:

“Environmental, social and governance (ESG) investments could become a $1 trillion category by 2030, BlackRock’s head of iShares Americas, Armando Senra, told CNBC’s “ETF Edge” this week.

With U.S. investment in iShares’ suite of ESG funds starting to pick up in earnest this year, “we’re just at the very beginning” of what could be a decade-long growth story, Senra said.

ESG funds are on track for a record year of inflows, raking in over $21 billion in the first quarter of 2021. That’s an acceleration from 2020, when they earned over $51 billion for the year; 2019, when they accrued $21.4 billion; and 2018, when they saw about $5.4 billion in inflows.

Senra attributed the interest to larger asset managers and model portfolio managers incorporating sustainable investments into their strategies in more impactful ways.”

Study on ESG alpha goes public

In the last issue of this newsletter, we noted a study, conducted by the company Scientific Beta, that purported to show that the alphai.e. the excess return over the market averagegenerated by ESG funds is a myth created by mistaken categorization of risk. The article we cited, published by Institutional Investor magazine, claimed to have seen the study, even though it had not yet been published. This week, the study and its results became public and have circulated among the niche and mainstream financial press. Among others, The Financial Times noted the following:

““There is no ESG alpha,” said Felix Goltz, research director at Scientific Beta and co-author of the as yet unpublished paper, “Honey, I Shrunk the ESG Alpha”.

“The claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed,” with analytical errors “enabling the documenting of outperformance where in reality there is none”, he added.

Scientific Beta analysed 24 ESG strategies that have been shown to outperform in other academic papers. It did find evidence that ESG funds have tended to outperform, with ESG leaders typically beating ESG laggards by almost 3 percentage points a year.

However, in both the US and other developed markets, it found that three-quarters of the outperformance is due to “quality” metrics, such as high profitability and conservative investment.

Quality has long been recognised as one of the investment “factors” that have traditionally tended to drive above-market returns.

“Despite relying on analysis of non-financial information by hundreds of ESG analysts, ESG strategies perform like simple quality strategies mechanically constructed from accounting ratios,” the paper said.

“Of the 24 strategies, not one has significantly outperformed when you adjust for this factor and that to me is quite striking,” said Goltz. “It’s just the case that over the last decade quality has outperformed and if you use ESG scores that inherently tilts [a portfolio] to quality.

“You can ask the question; what is the value of the ESG analysis?” Goltz added, if ESG portfolios can be constructed simply by analysing high-level balance sheet data.”   

Former Managing Director at AQR Capital argues ESG funds cost more

In his May 7 BloombergOpinion column, Aaron Brown argued that there is very little difference between most ESG ETFs and an S&P 500 fundwith one exception, the ESG fund costs more for investors:

“Want to align the core of your investment strategy with climate-change values? Or build a sustainable equity portfolio for the long-term by focusing on environmental, social and governance goals? A variety of ESG exchange-traded funds have made these and other promises. But as the table below shows, they mostly hold the same large capitalization technology stocks as the S&P 500 Index, represented in the top row by a popular ETF with a miniscule 0.03% expense ratio, in similar weights.

Not only are the portfolios similar, but performance is nearly identical. The Vanguard ESG fund has a 0.9974 correlation to the S&P 500 fund since inception in September 2018, which is higher than most index funds have to their benchmarks. A correlation of 1 would mean the two funds run perfectly in sync.

Instead of putting $10,000 in the Vanguard fund, you could put $9,948 in the S&P 500 fund, and $52 in a long/short fund that bought a bit more of some stocks and shorted small amounts of others so the combination of the two funds had precisely the same holdings as the Vanguard ESG fund. The ESG fund charges $12 per year in expenses, while the index fund charges $3. The extra $9 in fees is really paying for the $52 “active share” fund, an annual expense ratio of over 17%!

The other ESG funds charge similar outrageous fees for tiny adjustments to the S&P 500. FlexShares charges 0.32%, which works out to 16% on the active portion of its portfolio. Conscious Companies charges 0.43%, but has a lower S&P 500 correlation, so is a relative bargain at only 11% for its active portion. SPDR charges 0.20%, or 18% on the active portion. ESG Aware is the second cheapest on raw fees at 0.15%, but its sky-high correlation of performance with the S&P 500 means you’re paying more than 20% on the active share.”

In the spotlight

Business schools jump on the bandwagon

According to The Financial Times, large businesses and some business schools have begun working hand-in-hand to educate corporate employees about sustainability efforts and their importance and to turn ESG into a much more mainstream business practice and investment strategy. Focusing on Nespresso and NYU’s Stern School of Business, the paper reports the following:

“By taking a commodity and turning it into a luxury product, Nespresso has generated billions in sales from its coffee pods. Boosted by the endorsement in its adverts of actor George Clooney, the company, owned by Swiss multinational Nestlé, has an annual turnover of SFr5.9bn ($6.3bn).

However, Nespresso has come under heavy criticism over the environmental impact of the aluminium pods that end up in landfill, because the metal is not biodegradable. It can be recycled, though.

Nespresso turned to NYU Stern School of Business in New York to create a custom executive course, run most years since 2016, to help employees understand coffee sustainability. There have been 118 participants, from different levels of the company, and what they have learnt has already helped it improve recycling rates.

Attendees visit a coffee farm in Costa Rica to understand the company’s sustainable sourcing programme, set up in 2003 with the Rainforest Alliance, an environmental organisation. They also take business classes, learning about brand storytelling to court consumers, and are encouraged to develop proposals for projects on the course — for example, ways to reduce waste in Nespresso’s offices….

In the wake of the 2008 financial crisis, some critics labelled business schools “academies of the apocalypse”, arguing that they were partly culpable. Many institutions, however, are moving beyond the shareholder-primacy model and emphasising the longer-term interests of employees and broader society in their executive education programmes, encouraging organisations to become better corporate citizens.

This month, the University of California Berkeley’s Haas School of Business launches a new course on how to integrate sustainability into a business strategy. Robert Strand, executive director of Haas’s Center for Responsible Business, says the pandemic has put “stakeholder capitalism on steroids”. It has “exposed and worsened inequalities, but it’s also an opportunity to change the narrative of capitalism, and redefine the purpose of a corporation”, he adds.

Academics disagree over whether coronavirus will really reset capitalism, but the appetite is strong for executive courses that go beyond the bottom line. Nicholas Pearce, professor of management and organisations at Northwestern University’s Kellogg School of Management in Illinois, says many executives are interested in using business as a platform for social change. “The pandemic forced people to reflect on their responsibility to use positions of privilege and power to do good,” he says.

Pearce says Kellogg’s corporate clients are increasingly requesting bespoke programmes on social purpose, employee wellbeing, and diversity and inclusion. Likewise, Ioannis Ioannou, associate professor of strategy and entrepreneurship at London Business School, agrees that demand for such training outstrips supply. “Coronavirus has awakened the ‘S’ in ‘ESG’,” he says, reflecting a rethink by companies particularly on social issues alongside environmental and governance factors.”

Notable quotes

On the perceived potential for an ESG/Bitcoin collision

“To the extent that financial firms need to improve on the sustainability of cryptocurrency products, this can be achieved for example by purchasing carbon credits at the custodial level to offset the current carbon impact of mining per coin held in custody per unit time.

So far, we have seen limited specific demand for such offsets and to my knowledge no large custodians currently offer them but it may well become a common product component.” 

Chris Bendiksen, head of research at CoinShares, “Bitcoin Under ESG Scrutiny,” etf.com, May 5, 2021.

Economy and Society: ESG references in federal lobbying reports on the rise

ESG developments this week

In Washington, D.C.

ESG references in federal lobbying reports on the rise

On April 29, Roll Call reported that references to ESG in federal quarterly lobbying reports have grown over the last few monthscoinciding with the start of the Biden administration. According to the paper, lobbying mentions of ESG had risen slowly during the Trump presidency:

“More lobbyists reported raising environmental, social and governance issues with U.S. officials and lawmakers this year, with Democrats now controlling Washington, than ever before….

Lobbyists mentioned the acronym ESG in first-quarter 2021 lobbying reports for 37 unique clients. The reports, which were due April 20, cover activity from Jan. 1 through March 31, including the beginning of the Biden administration and Democrats’ control of both chambers of Congress.

The figure is up from 21 distinct reports that mentioned ESG for the final quarter of 2020, 24 from last year’s third quarter, 18 from the second quarter and 14 from the first quarter. The final quarter of 2019 saw 15 reports mentioning ESG, which was the first time the term appeared widely in lobbying reports. It was mentioned once before in a report from the U.S. Chamber of Commerce covering 2018’s second quarter….

Groups that disclosed such lobbying included large trade associations, asset managers, financial services firms, insurers, pension-focused groups and at least two left-leaning organizations advocating ESG disclosure rules, the United Nations-supported Principles for Responsible Investment and Public Citizen.

Among all filings mentioning ESG, about 29 percent specifically reported lobbying on the ESG Disclosure Simplification Act, a bill from Rep. Juan C. Vargas that would require public company disclosure of ESG information. The California Democrat initially proposed the measure in September 2019. More than a dozen listed a Labor Department rule related to ESG, which was finalized under the Trump administration and changed requirements for employer-sponsored retirement plans when selecting investments.

Of the 37 reports that mentioned lobbying on ESG during the first three months of 2021, most mentioned ESG issues, disclosure, investing or ratings generally. Five groups reported lobbying on Vargas’ legislation, and three on the Labor Department rule that Democrats may soon roll back. One group detailed involvement in an ESG workgroup meeting at the Securities and Exchange Commission.

The world’s largest asset management firm, BlackRock Inc., mentioned ESG specifically in a lobbying report for the first time in 2021, reporting that it addressed the “ESG Rule/DOL.” The manager of $9 trillion also disclosed lobbying on “climate risk” for the first time.”

On Wall Street and in the private sector

BlackRock signaling increased support of ESG

On April 30, The Wall Street Journal reported that BlackRock, a leader in Wall Street’s ESG and sustainability efforts, with $9 trillion in assets under management, has used the current annual meeting season to put its proverbial money where its mouth is. According to the paper, BlackRock has increased its support for shareholder proposals focusing on environmental, social, and corporate governance matters:

“BlackRock Inc. BLK -0.97% has so far increased its support for shareholder-led environmental, social and governance proposals, and published a slew of criticisms of public companies that haven’t bent to its overall requests.

The firm votes on behalf of the investors in its many funds. For the roughly 170 ESG shareholder proposals it voted on during the first half of the proxy year, BlackRock backed 91% of environmental proposals, 23% of social proposals and 26% of corporate-governance proposals.

That included voting for a proposal to make it easier for shareholders to push for changes at Tesla Inc. and another to make Spanish airport operator Aena SME SA publish carbon-emission reduction plans. Most of the votes for the proxy year come in the six months ending in June.

For the 1,000-plus proposals for the year ended in June 2020, BlackRock backed 6% of environmental proposals, 7% of social proposals and 17% of governance proposals….

The firm is one of the top three shareholders of more than 80% of the companies in the S&P 500, according to S&P Global Market Intelligence, through its many funds. The money manager casts a long shadow on shareholder meetings where it can vote on behalf of its investors on board directors, executives’ pay packages and other company matters.”

ESG assets under management approaching $2 trillion 

On April 30, CNBC (citing Morningstar) reported that ESG assets under management are now nearly $2 trillion, after massive ongoing inflows throughout the 1st quarter of 2021:

“Sustainability-focused funds attracted record inflows during the first quarter, pushing global assets under management in ESG funds to nearly $2 trillion, according to a report from Morningstar released Friday.

The rise underscores the momentum behind ESG investing, or when environmental, social and governance factors are considered. Assets in these types of funds first topped $1 trillion in the second quarter of 2020.

Global sustainable funds attracted a record $185.3 billion during the first quarter of 2021, up 17% quarter over quarter. Overall, assets in ESG funds jumped 17.8% compared to the fourth quarter of 2020.

“2021 began where 2020 left off with record demand for sustainable investment options across the globe,” noted Hortense Bioy, global director of sustainability research at Morningstar.”

Meanwhile, on April 29, ETFStream.com, citing data from Ultumus, reported that more than half of all inflows into European investment markets in the 1st quarter went to ESG-aligned funds.”

In the spotlight

Are ESG returns a mirage?

On April 26, Institutional Investor magazine reported on the results of a new but yet unpublished study on the returns generated by ESG investments. The results of the study suggested that ESG fund outperformance that supporters claim is generated by ESG factors is, in fact, generated by other, more generic factors:

“Scientific Beta, set up by EDHEC-Risk Institute in 2012 and now majority-owned by Singapore Exchange, has found that 75 percent of the outperformance of ESG strategies cited in popular academic studies on the subject was due to their exposure to the quality factor, which can be cheaply accessed through systematic funds. Quality is a well-known premium, or source of return, that academic research has shown outperforms the market over long-term economic cycles.

In a report not yet published but seen by Institutional Investor, Scientific Beta deconstructed the reported ESG performance gains to account for the potential contribution of sector tilts, factor exposures, and attention shifts, meaning the steadily growing popularity of strategies over the time period that was studied. The research group also evaluated whether incorporating ESG factors protected investors from losses, another popular claim of ESG asset managers.

“We find that over the past decade these strategies did deliver positive returns,” Felix Goltz, Scientific Beta’s research director and one of the authors of the study, said in an interview. “One example is the outperformance of a fund that holds long positions in ESG leaders and short positions in ESG laggards.”

Goltz said he wanted to quantify the specific performance that could be attributed to ESG, once everything was adjusted for generic factors, such as equity styles and industry sectors, a common practice in attribution analysis. “Well, it disappears,” he said….

“We conclude that claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed,” the authors wrote. “Omitting necessary risk adjustments and selecting a recent period with upward attention shifts enables the documenting of outperformance where in reality there is none.”…

Goltz said he thinks sustainable funds have plenty of value in terms of their potential impact on society, but outperformance isn’t one of them.”

Notable quotes

“Peter McKillop, founder, Climate and Capital Media: When did you first become skeptical about BlackRock’s ESG push?

Tariq Fancy, former chief investment officer for sustainable investing, BlackRock: I had to figure out an investment mechanism for how to create social change because Larry was writing that in letters and I kept getting asked by clients, “How does this actually lower emissions?” So I started writing a long paper to explain how ESG and sustainable investing will, over the long term, actually start to transform capitalism into better outcomes. By the time I had finished, I realized I had just written a somewhat tortured argument that the free market will slowly correct itself. And I said, “Oh my God, we’ve known for decades that climate change is the greatest market failure in history.”

I could clearly see that the markets would not “correct” themselves without government action. At some point we have to accept that burning fossil fuels is dangerous to us unless we do something.”

Peter McKillop, “BlackRock’s former head of sustainable investing says ESG and sustainability investing are distractions,” Greenbiz.com, April 28, 2021.