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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.

SEC Commissioner argues against integrating ESG concerns into its mission

ESG developments this week

In Washington, D.C.

New SEC Chair sworn in

On April 14, Gary Gensler was confirmed by the U.S. Senate (in a mostly party-line 53-45 vote) as the new chair of the Securities and Exchange Commission (SEC). He was sworn in April 17 by Maryland Senator Ben Cardin (D) in a small ceremony in Baltimore.

According to a press release issued by the SEC, Gensler said:

“I feel incredibly privileged to join the SEC’s team of remarkable public servants. As Chair, every day I will be animated by our mission: protecting investors, facilitating capital formation, and promoting fair, orderly, and efficient markets. It is that mission that has helped make American capital markets the most robust in the world…

I’m honored that President Biden nominated me, and I’m grateful to Vice President Harris and the Senate for their support. I’d like to thank Acting Chair Allison Herren Lee for her leadership the last few months and all of my fellow Commissioners for being so generous with their time and advice.”

Among the key issues that Gensler will deal with as the new chair are reporting standards for ESG metrics and definition of materiality as it relates to ESG matters.

Commissioner argues against integrating ESG concerns into SEC mission 

On April 14, the same day as now-Chairman Gensler was confirmed by the Senate, Commissioner Hester Peirce, one of two Republicans on the SEC, released a statement (also published in the April 2021 edition of Views – the Eurofi Magazine) in which she argued against the Commission’s plans to integrate ESG concerns into its mission. “The challenge we face in addressing the ever-increasing number of issues underlying E, S, and G is daunting,” Commissioner Peirce conceded, but “The task before us is to find a way to bring about lasting, positive change to our countries on a range of issues without sacrificing in the process the very means by which so many lives have been enriched and bettered.” She continued:

“At first glance, everything sounds good—common metrics demonstrating a joint commitment to a better, cleaner, well governed society. Common disclosure metrics, however, will drive and homogenize capital allocation decisions. A single set of metrics will constrain decision making and impede creative thinking. Unlike financial accounting, which lends itself to a common set of comparable metrics, ESG factors, which continue to evolve, are complex and not readily comparable across issuers and industries. The result of global reliance on a centrally determined set of metrics could undermine the very people-centered objectives of the ESG movement by displacing the insights of the people making and consuming products and services.

Hampering the ability of the markets to collect, process, disseminate, and respond to price signals by boxing them in with preset, government-articulated metrics will stifle the people’s innovation that otherwise would address the many challenges of our age. Moreover, converging standards would be antithetical to our existing disclosure framework, which is rooted in investor-oriented financial materiality and principles-based requirements to accommodate the wide variety of issuers.

The European concept of “double materiality” has no analogue in our regulatory scheme and the addition of specific ESG metrics, responsive to the wide-ranging interests of a broad set of “stakeholders,” would mark a departure from these fundamental aspects of our disclosure framework. The strength of our capital markets can be traced in part to our investor-focused disclosure rules and I worry about the implications a stakeholder-focused disclosure regime would have. Such a regime would likely expand the jurisdictional reach of the Commission, impose new costs on public companies, decrease the attractiveness of our capital markets, distort the allocation of capital, and undermine the role of shareholders in corporate governance.

Let us rethink the path we are taking before it is too late.”

On Wall Street and in the private sector

Top holdings in BlackRock’s new ESG Fund are tech-focused

In the previous edition of this newsletter, we noted BlackRock’s launch, two weeks ago, of its U.S. Carbon Transition Readiness ETF (ticker LCTU), which attracted $1.25 billion in its first day of trading, a record in the history of exchange-traded funds. While investors flocked to the new offering from the largest asset management firm in the world, Bloomberg Green’s Claire Ballentine noted on April 14 that the ETF suffers, in her view, from the same perceived problem that plagues many other funds in the ESG arena, namely, it is less E, S, or G-focused than it is tech-focused. She wrote:

“As the biggest launch in the history of ETFs, it’s a ringing endorsement of all things ESG. But beyond its billion-dollar debut, BlackRock Inc.’s new fund might feel awfully familiar to most investors.

The top holdings in the U.S. Carbon Transition Readiness ETF (ticker LCTU) — which lured about $1.25 billion in its first day on Thursday — turn out to be Apple Inc., Microsoft Corp., Amazon.com Inc., Alphabet Inc. and Facebook Inc.

The same five companies, in the same order, are the top stakes in the largest environmental, social and governance ETF on the market, the $16.5 billion iShares ESG Aware MSCI USA ETF (ESGU). That’s also from BlackRock with a fee of 0.15%, half the price of LCTU.

In fact, those tech megacaps form the bedrock of many exchange-traded funds, both in the ESG space and beyond. For example, four of them also are among the five largest holdings of the $167 billion Invesco QQQ Trust Series 1 ETF (QQQ), which is simply tracking the Nasdaq 100….

The record launch comes while many questions linger in the still-maturing ESG sector. A report released Friday by the U.S. Securities and Exchange Commission cautioned that some firms are mis-characterizing their products as ESG, possibly even violating securities laws in the process. The agency didn’t name any companies.”

JPMorgan Chase to invest in ESG

JPMorgan Chase & Co., the biggest bank in the United States and the second biggest in the world, announced last Thursday that the bank will invest significant amounts in ESG efforts over the next decadea potential blow to fossil fuel energy companies. Reuters reported the story as follows:

“JPMorgan Chase & Co (JPM.N) aims to lend, invest and provide other financial services for up to $2.5 trillion of banking business to be done for companies and projects tackling climate change and social inequality over the next decade.

In a statement on Thursday, JPMorgan said green initiatives will account for $1 trillion of that total – the largest environmental, sustainable and governance (ESG) financing target announced by a U.S. bank to date.

That could mean lending or investing in companies that develop clean-energy technology for the trucking, aviation or industrial manufacturing sectors, the bank’s head of sustainability, Marisa Buchanan, told Reuters in an interview….

JPMorgan is among the leading U.S. lenders to fossil fuel companies, having provided $317 billion of lending and underwriting since 2016, according to a recent study by environmental activist group Rainforest Action network….

JPMorgan pledged to share more details about its ESG initiatives, including its work establishing emission targets for companies in its financing portfolio, in its next climate report, due out this spring.”

In the spotlight

Report: Are ESG ETF’s sustainable?

Impact Cubed, a sustainability analytics and research company based in London and partnered with some of the oldest activist asset management firms, released a report late last month, examining the impact of some of the biggest passively managed ESG funds in the world. According to Impact Cubed many such funds are, in its view, falling short of the impact achieved by actively managed funds. And some, it claims, are making sustainability matters worse:

“Passive ESG funds are designed to avoid ESG risk, but do they have positive impact? 

Impact Cubed turned its model onto some popular passive ESG funds to peel back the marketing and look under the hood. Top findings include:

·         Some passive ESG funds actually have an overall negative impact. 

·         ESG performance varies four-fold between the ‘best’ and ‘worst’.  

·         Smart investors who know what to look for can find a passive ESG fund with positive impact and lower tracking error. 

Many passive funds still have ESG growing pains and will need to measure impact if they are to improve and attract investor interest. 

Larry Abele, CIO of Impact Cubed and report co-author, advises “As ESG investing becomes more mainstream, passive ESG fund managers who want to secure a proper perch in the pecking order for capital allocation will need to be more transparent about the impact provided by their approach.””

Notable quotes

“Proponents have filed at least 435 shareholder resolutions on environmental, social and sustainability issues for the 2021 proxy season, with 313 pending as of February 19. Securities and Exchange Commission (SEC) staff have allowed the omission of 24 proposals so far in the face of company challenges; companies have lodged objections to at least 74 more that have yet to be decided—12 more than at this time last year. Proponents have already withdrawn about 90 proposals, however, up from 78 at this time last year and 71 in mid-February 2019.

Annual totals are down from a bit from the all-time high of just under 500 in 2017. About 40 percent of filed resolutions have gone to votes each year since 2018, around 45 percent have been withdrawn and between 13 and 16 percent omitted.

The tumultuous events of 2020 prompted a slew of new shareholder proposals investors will consider in 2021. New angles are most apparent in the big increase in resolutions about racial justice and equal opportunity, but proponents also are raising fresh ideas about worker safety, climate transition planning and lobbying.”

Economy and Society: SEC review finds potentially misleading ESG fund practices

ESG developments this week

In Washington, D.C.

SEC investment fund review reveals potentially misleading ESG practices

On April 9, the Securities and Exchange Commission announced that its recently enhanced examinations of the investment community’s use of and adherence to ESG investment principles has yielded results. The Commission set out to find whether investment companies were keeping the promises they were making to investors. And it learned that, in some cases, according to an article in the Wall Street Journal, they aren’t:

“The Securities and Exchange Commission said Friday it has found some investment firms that tout socially responsible investing were potentially misleading investors, part of the agency’s enhanced review of funds that claim to support environmentally friendly policies but don’t adhere to them.

These funds broadly market themselves as trying to invest in companies that pursue strategies addressing environmental, social or governance issues from climate change to corporate diversity.

The SEC didn’t disclose the names of firms or how many were involved in the review.

The regulator found instances in which investment firms were making potentially misleading statements about their ESG investment processes as well as their adherence to global ESG frameworks. It has also seen cases where portfolio managers weren’t consistently disclosing their ESG strategies and where their proxy voting on shareholder proposals didn’t align with advisers’ stated stance on socially responsible issues.

Several firms didn’t have proper policies and procedures in place to address ESG or reasonably prevent violations on such matters, the SEC said, finding controls inadequate to ensure clients’ ESG-related investing preferences were reflected. Some firms also lacked compliance programs that could reasonably guard against inaccurate ESG-related disclosures and marketing materials, the agency said.”

On Wall Street and in the private sector

BlackRock ESG ETF launch biggest ever

On April 8, BlackRock launched a new ESG ETF (exchange-traded fund) that became the biggest fund launch in the 30-year history of the ETF business, securing more than $1 billion in its first day of trading: 

“Investors poured about $1.25 billion into the BlackRock U.S. Carbon Transition Readiness ETF (ticker LCTU) on Thursday, making it the biggest launch in the ETF industry’s three-decade history, according to data compiled by Bloomberg….

LCTU’s eye-catching debut comes amid a broad boom for ETFs focused on investments that meet environmental, social and governance standards. They attracted a record $31 billion in 2020, almost four times the prior year. About $6.3 billion was added in January, also the most ever, as investors bet the Democrats clean sweep of the U.S. government would usher in a swath of green policies.

That’s all taken ESG ETF assets to a record $74.8 billion, up from less than $10 billion two years ago. The largest ETF in the space is also from BlackRock. The iShares ESG Aware MSCI USA ETF, with $16.3 billion of assets, is trading at an all-time high after returning more than 50% in the past 12 months.”

BlackRock joins ESG credit-line trend

Last week, BlackRock also became the latest large, high-profile corporation to sign on to an ESG-directed credit facility. According to the Wall Street Journal, the new credit deal was disclosed in a regulatory filing made public last week and was signed on March 31:

“The firm struck a financing deal with a group of banks that links its lending costs for a $4.4 billion credit facility to its ability to achieve certain goals, like meeting targets for women in senior leadership and Black and Latino employees in its workforce.

The firm plans to boost the share of Black and Latino people in its U.S. workforce 30% by 2024, a spokesman said. It aims to increase the share of women in its senior leadership ranks by 3% each year.

BlackRock’s progress on growing assets in funds focused on companies with high environmental, social and governance ratings will also impact its lending costs. The firm aims to grow the roughly $200 billion it manages in so-called sustainable strategies to $1 trillion by 2030….

BlackRock is best known for its sprawling lineup of funds that trade rapidly and track indexes. The firm and its CEO, Larry Fink, have pushed companies its funds invest in to be more attentive to environmental and social risks—and to increase workforce diversity….

Going forward, the new lending facility will impose a cost on the asset manager for missing its workplace-improvement and other goals.”

Europe’s biggest oil producer goes green

In an interview conducted by Bloomberg on April 9, Norwegian Finance Minister Jan Tore Sanner described his country’sand, by extension, its massive sovereign wealth fund’s intention to invest heavily in sustainability-related investment vehicles. “We must have the highest possible return on our money,” Sanner told the financial news organization, “but we also want to know that it is invested in a responsible way.” Bloomberg continued:

“The goal is “to increase the competence related to climate risk, investment opportunities, the consequences associated with the transition to the low-emission society,” Sanner said. “This is because this will be perhaps the most important framework condition for large investors in the next 10-20 years.”

Western Europe’s biggest oil nation is now trying to use its giant wealth fund to steer the planet toward a greener future. Its chief executive, Nicolai Tangen, has said he will use his clout to try to force companies to act more responsibly.

Under Sanner’s proposal, which still needs parliamentary approval, about 25-30% of portfolio companies will be cut. Though that sounds like a lot, it only represents about 2% of the fund’s total market value. Sanner says he wants to avoid investments in new emerging markets because they tend to have “weaker institutions, weaker protection of minority shareholders, less openness.”

The changes will make it easier to manage the vast portfolio, and reduce complexity and risk, Sanner said.

The fund, which returned 10.9%, or $123 billion, on its total investments last year, has followed strict ethical guidelines, including bans on certain weapons, tobacco and most exposure to coal, since 2004.”

Oil and gas stocks continue to heat up

In a April 9 piece, Oilprice.com noted the perceived incongruence of the ESG push in the markets and the concomitant fossil fuel-stock rebound:

“In the year to date, the energy sector on the S&P 500 has gained 29.4 percent, Palash Ghosh reported for Forbes. This makes energy the best-performing sector on the S&P 500, followed by finance as a distant second, with a gain of 17.6 percent.

The rally in oil stocks came on the back of improving oil prices, and oil prices improved on the back of, mostly, hopes that economies will soon begin returning to normal. Mass vaccinations in key oil markets did a lot to fuel this post-pandemic optimism about oil, pushing benchmarks above $60 a barrel and drawing investors to oil stocks.

Vaccines were, of course, not the only factor. OPEC+ also kept its production limited for longer than it had initially planned. The cartel decided at its last meeting to raise production gradually and the fact that this decision did not send prices plunging shows that expectations of a demand rebound are really strong right now….

All this is happening as pressure continues to mount on oil and gas companies to basically stop being oil and gas companies. What the surge in oil stocks is demonstrating, however, is that a lot of investors still prefer returns to clean energy promises. One early proof of this was BP’s share price drop after CEO Bernard Looney last year announced perhaps the most ambitious energy transition plan among Big Oil majors….

ESG investing may be all the rage these days, and solar stocks may be favorites among the ESG crowd, but oil hasn’t fallen out of grace yet.”

In the spotlight

Is ESG necessary? Research examines how climate risks are priced into markets 

In an article published April 9, Institutional Investor magazine reported on a new study conducted by Dimensional Fund Advisors that purports to show that the “E” portion of ESG is unnecessary and that marketsbeing in their view efficienthave already priced climate and transition risks into asset prices, across various investment-vehicle types:

“Although evidence is accumulating about the effect of climate change on everything from weather patterns to human health, scientists can still only paint a partial picture of the future. Nonetheless, stock, corporate and municipal bond, futures, and options markets are doing a good job of incorporating climate risks into asset prices, despite the complexity and uncertainty.

In recent research, which includes a review of outside academic studies, Dimensional Fund Advisors sought to address the question of whether and how well climate risks are priced into different markets. Dimensional looked at how the markets priced both physical risks and transitional risk, which arises as economies move away from fossil fuels and to a low carbon economy….

“Many of the effects are hard to predict, hard to quantify, hard to bring to the present in terms of value or cost,” Savina Rizova, the firm’s global head of research, told Institutional Investor. “First, financial markets do pay attention to these risks, despite the complexity and even the longer run effects of climate change. Second, companies have incentives provided by competitive financial markets to better manage their exposure to climate risks if they want to have a lower cost of capital.”…

Investors interested in owning securities that don’t contribute to climate risk may not need to own funds with an ESG label.”

Notable quotes

“Based on the Fama and French analysis this implies that if investors have a preference for highly rated ESG stocks then those stocks will offer lower average excess returns. Note that this conclusion is contrary to the views of many ESG advocates in the investment profession. For instance, Blackrock CEO Larry Fink (2020) states that, “Our investment conviction is that sustainability and climate integrated portfolios can provide better risk-adjusted returns to investors.” We find little support for this conviction in either the theory or empirical evidence. On the other hand, there is some good news for high ESG companies in that those lower expected returns mean lower discount rates and lower discount rate produce greater valuations.”

Bradford Cornell and Aswath Damodaran, “Valuing ESG: Doing Good or Sounding Good?” March 20, 2020.

Economy and Society: Greater fund disclosure on voting behavior

ESG developments this week

In Washington, D.C.

Greater fund disclosure on voting behavior

On March 17, then-acting-chair of the Securities and Exchange Commission, Allison Herren Lee, spoke to the Investment Company Institute, a fund trade group, on Commission plans to address the transparency of fund votes taken on shareholder proposals. She said:

“There are two key trends that have brought us to our current posture and which necessitate updates to our rules and guidance to reflect a new reality regarding proxy voting and corporate governance. First, is the growth in households invested in funds. It is estimated that in 2020, nearly 47% of US households owned funds, up from 6% in 1980….

A second key trend is the soaring demand for opportunities to invest in vehicles with ESG strategies. Millennials, in particular, are increasingly attuned to the specific ways in which funds and companies utilize their money, and their influence will only grow….

Retail investors need more meaningful insight into how their money is voted, and that insight is more important than ever with the growth of interest in ESG shareholder proposals. It’s hard to see how retail investors can formulate an accurate and reliable picture of how a fund votes on ESG issues when they are forced to parse voluminous forms that often use bespoke shorthand for shareholder proposals. Importantly, funds also stand to benefit from more effective disclosure as the fund landscape becomes increasingly competitive….

there is a lot of work to do in this area. And it is important work because it gets to the heart of ensuring that our system of shareholder democracy works. As investor preferences continue to transform, proxy voting will become an increasingly important component of that transformation. We must ensure that current incentives and rules for voting and voting disclosure are really serving the needs of investors today.”

In the states   

West Virginia Attorney General threatens SEC with lawsuit over ESG disclosures

On March 25, West Virginia Attorney General Patrick Morrisey (R) sent a letter to Allison Herren Lee, then-acting-chair of the Securities and Exchange Commission, asking her to abandon her plans to make climate change a greater part of the SEC’s mandate and to compel climate disclosures on companies. The plans, according to Morrissey, violate the SEC’s legal mandate and impose undue and unnecessary burdens on corporations. He threatened to sue the Commission, if it proceeds. He wrote:

“Going beyond requiring companies that disclose information that is material to future financial performance will unavoidably politicize the commission, detracting and distracting from other work. Private competition for customers and investors already leads companies to issue statements on a wide variety of matters of public interest without government compulsion….

If the commission proceeds down this pathway, states and other interested stakeholders will not hesitate to go to court to oppose a federal regulation compelling speech in violation of the First Amendment.”

Morrissey’s letter follows one sent previously by Senator Pat Toomey (R), ranking member of the Banking Committee, also opposing what he sees as the SEC’s shift in mission away from financial regulation to a policy-oriented role.

ESG opportunity and risk in state environmental laws 

In an article posted on March 9, Bloomberg Law Legal Analyst Dylan Bruce suggested that a recent series of what are described as environmental justice laws passed by states provide both an opportunity and, perhaps, an unforeseen ESG risk to companies doing business in those states. According to Bruce:

“These laws are giving regulators and communities new tools to mitigate negative environmental impacts that have historically and disproportionately affected minority and low-income communities.

Ten states have already codified environmental justice in some form—with Connecticut the latest to do so, in October 2020—while another 13 states have pending legislation.”

While Bruce suggests that companies that abide by ESG demands are well positioned in these 23 states, these laws, in his view, “[A]lso expose companies to new ESG-related risks, including enhanced enforcement, litigation, and possible disclosure requirements. For those reasons, ESG-conscious companies should be paying close attention to this trend.”

Student activism and divestment in Nebraska

On April 4, the Lincoln Journal-Star reported on the efforts of Veronica Miller, the student representative on the Nebraska Board of Regents, to compel her school, the University of Nebraska-Lincoln, to divest its remaining funds from fossil fuels. Although the University’s endowment is already invested using ESG methodologies, it still holds a small amount of fossil fuel companies:

“[W]hen she became the University of Nebraska-Lincoln’s students’ voice on the Board of Regents, Miller said the groundwork was there to push for a change.

“The ask was already there,” said Miller, who will graduate next month with degrees in Spanish and political science. “There was a conversation about how we get this done and how we work through this.”

At its April 9 meeting, the Board of Regents will consider adding an “environmental, social and governance criteria” policy — commonly referred to as ESG — for investing the roughly $370 million in Fund N, the endowment funds controlled by the university.

Currently, only about 2% of the investments held in Fund N are in fossil fuel companies, down from 6.5% a year ago, the university said.

The rest of the university’s $1.7 billion endowment is managed by the NU Foundation, which also uses an ESG criteria when considering investments, a foundation spokeswoman said.”

On Wall Street and in the private sector

Will the ‘Flight to Value’ hurt ESG long term?

The Wall Street Journal noted on April 2 that ESG funds have taken a hit as a result of a cyclical change several years in the making. Equities markets have, over the last few weeks begun shifting from growth stocks to value stocks:

“Growth stocks propelled the outperformance of many environmental, social and governance (ESG) funds in recent years. But those same types of stocks now are turning into potential headwinds for the funds, as investors pivot more to stocks the market sees as undervalued….

High-growth companies that ESG funds have often skewed toward in recent years include Apple Inc., Google parent Alphabet Inc. and Microsoft Corp. The tech giants and other growth stocks flourished last year despite a challenging economic environment. That performance, in turn, helped ESG funds. A basket of 94 U.S. ESG exchange-traded funds ended last year up more than 20% on average, according to Dow Jones Market Data, beating the bellwether S&P 500’s gain of more than 16%.

More recent months, however, have seen a shift in investor appetites. In expectation of an economic recovery, investors have piled into companies that are seen as undervalued relative to their earnings potential. Meanwhile, there is less appetite for growth companies. For the year, the Russell 1000 Value index is up nearly 12%, versus the Russell 1000 Growth’s rise of 2.4%.

A similar trend can be seen in the performance of ESG funds.”

In a note to clients posted the previous day, however, a Bank of America Quant analyst suggested that ESG’s value-related pullback should be temporary:

“One critique of ESG investing is that it tends to favor growth stocks at the expense of value-oriented sectors,” Savita Subramanian, an equity and quant strategist at Bank of America, said in a research note dated April 1. “But our analysis of US-domiciled ESG fund holdings presents a different picture.”

BofA found that ESG funds are overweight industrials, materials and real estate relative to the S&P 500 index SPX, 1.47%, “with significantly more exposure to these pro-cyclical sectors than mutual funds broadly,” according to the note. ESG funds have meanwhile avoided growth-oriented, communication services stocks, Bank of America found.

Long-only fund investment managers generally have been moving into value-oriented sectors, boosting bets on financial and energy companies in recent months while trimming weightings to growth-oriented, technology and communication services sectors, according to BofA. Value stocks trounced their growth counterpart in the first three months of 2021 after suffering a decade of ineptitude….

ESG funds may be poised to benefit from a further rotation into value, as they remain “significantly underweight” energy and utilities even after increasing their exposure to these areas in recent months, the bank’s research note shows.”

Pershing Square declares ESG a life (and world) saver

Hedge-fund investor and CEO of Pershing Square Capital, Bill Ackman, declared recently that capitalism can save the world, and ESG, in his view, is the manifestation of its world-saving capacity. March 29, Ackman and Pershing published a 115-page letter that expressed his beliefs, summarized as follows by Yahoo Finance:

“Billionaire activist investor Bill Ackman, the CEO of the $13 billion hedge fund Pershing Square Capital, made a case that capitalism is “the most powerful potential source” for solving society’s biggest challenges — and ESG investing is ushering in that change.

“With the benefit of substantial philanthropic and investing experience, I have come to believe that capitalism is likely the most powerful potential force for good in addressing society’s long-term problems. A successful business operating ethically and sustainably can create many thousands of high-paying jobs, deliver high long-term returns for pensioners, long-term savers and other investors, and provide goods and services that materially increase its customers’ quality of life, broadly defined. That said, capitalism is far from perfect,” Ackman wrote in a shareholder letter published on Monday.

Ackman, 54, a high-profile activist investor usually known for picking up large stakes in publicly-traded companies and effectuating corporate change, pointed to the elevated importance of environmental, social, and governance (ESG) issues boardrooms and managements need to examine and tackle.

“We believe that good ESG practices are fundamentally aligned with running a successful business. As consumers and other corporate customers have become increasingly educated on matters of ESG, they have begun to avoid companies that contribute to climate change or do not treat their employees well, while rewarding companies with their business that have sustainable and responsible policies. Similarly, a growing number of investors have become increasingly concerned about the risks of companies which do not take ESG issues seriously. These investors avoid investing in companies which do not meet high ESG standards, reducing the valuations and investment returns of these businesses, negatively impacting their cost of capital,” Ackman added.”

In the spotlight

Agency theory in the United Kingdom

In the March 23 edition of Economy and Society, we reported that Canadian companies are implementing ESG-performance-based pay for corporate managers. According to S&P Global, the same process is underway in the UK, although perhaps even more rapidly:

“Nearly half of the U.K.’s 100 largest companies now use an environmental, social and governance measure when setting targets for executive pay, a sign of the growing acceptance of sustainability metrics in corporate boardrooms, according to a new report.

Growing pressure from investors and other groups has persuaded more companies to shift their ESG emphasis from more traditional areas such as employee engagement and risk to newer concerns such as climate change, the environment and diversity. The study was authored by London Business School and PricewaterhouseCoopers, based on ESG targets disclosed in the pay plans of FTSE 100 companies’ 2020 annual reports. The FTSE 100 is an index of the U.K.’s 100 largest companies by market capitalization.

According to the analysis, published March 18, 45% of FTSE 100 companies currently have an ESG measure in either their annual bonus targets or their long-term incentive plans, also known as LTIP. Of the 100 companies, 37% include an ESG measure in their bonus plan with an average weighting of 15%, while 19% include them in their LTIP with an average weighting of 16%. The weighting indicates how much of the pay measure is linked to ESG performance. FTSE 100 companies that link ESG performance to pay include Unilever PLC, Standard Chartered PLC, Royal Dutch Shell PLC and BP PLC.”

According to S&P Global, roughly half of all American S&P corporations state executive pay is tied to ESG matters, although it also quotes Willis Towers Watson, the company that conducted the survey, as noting that “few [American companies] give them the importance it deserves.” Additionally, only 2% of American S&P 500 companies tie executive pay to carbon emissions, below the 11% in Europe. 

SEC announces all-agency approach to ESG

Environment, Social, and Corporate Governance by Ballotpedia

ESG developments this week

In Washington, D.C.

SEC announces all-agency approach to ESG

Last week, the Securities and Exchange Commission launched a new page on its website, a page dedicated to ESG and to tracking the Commission’s action on the subject. According to the site: “As investor demand for climate and other environmental, social and governance (ESG) information soars, the SEC is responding with an all-agency approach.”

The announcementand the page launchcame roughly a week after the SEC announced that it was requesting public input on ESG matters from “investors, registrants, and other market participants on climate change disclosure,” and three weeks after the announcement of the launch of a new task force on ESG matters, to be located in the Commission’s Enforcement Division. 

Republican Senator presses SEC on ESG goals

On March 25, the office of Senator Pat Toomey (R-Pa.), the Ranking Member on the Senate Banking Committee, and opponent of what he sees as the SEC’s shift in mission away from financial regulation to a policy-oriented role, released the contents of a letter sent to acting-Chair Allison Herren Lee, asking her to brief him on her and the Commission’s climate-change-related plans. The Hill reported the story as follows:

“The top Republican on the Senate Banking Committee is pressing the Securities and Exchange Commission (SEC) for more information about the agency’s climate change agenda.

In a letter to the SEC released Thursday, Sen. Pat Toomey (R-Pa.) asked the agency’s acting chief for a briefing on its plans for a new task force and enforcement priorities regarding climate-related financial risks.

“These announcements appear to presage major changes in longstanding practices on disclosure and enforcement matters at the SEC. Such changes would be premature,” Toomey wrote in a letter dated March 24 to acting SEC Chairwoman Allison Herren Lee, a Democrat.

“In order to better understand the scope and intention of this new task force and the SEC’s ‘enhanced focus’ on climate and ESG-related priorities, I am requesting a staff briefing on this subject by no later than the week of April 5, 2021,” he continued.”

In the states   

ESG pushback in energy-producing states

Pew Trusts reported on an effort among legislators in several states to highlight what they see as ESG’s role in the increasing cost of business insurance in their states. The legislators mostly Republicanspropose legislation that would cut ties with businesses that shift to ESG-heavy energy plans, asset managers that demand sustainability planning from the companies they hold, and banks that, in their view, punish energy companies with punitive rates or that are declining their business altogether. Pew Trusts reported as follows:

“In Alaska, North Dakota, Texas and other energy-producing states where fossil fuel taxes support state budgets, some lawmakers are introducing legislation that would force states to stop investing in companies that use sustainable strategies to make financial decisions and to cut ties with asset managers, banks and insurers that are doing the same.

The mostly GOP lawmakers argue that investment decisions should be made solely based on the likely financial returns, not so-called ESG—the environmental, social and governance criteria that socially conscious investors use. Instead of embracing ESG, several states want to double down on investments in oil, gas and coal. Otherwise, they say, the very industries they depend on face collapse.

It’s already difficult for fossil fuel projects to find insurance, financing and other backing if they don’t meet some of the sustainability standards, said state Sen. Jessica Bell, a Republican in North Dakota who has sponsored one of the bills that would keep her state from making ESG-driven investments.

“They’re denied access to capital. They are denied access to loans. They are refusing to do business with them. Our insurance rates have gone up,” Bell said. “I mean, you name it, ESG has already negatively affected us.”…

James Leiman, the new commissioner of the North Dakota Department of Commerce, said his department is neutral on the legislation. But he did tell North Dakota’s Senate Energy and Natural Resources Committee that the ESG movement represents “the greatest challenge to the North Dakota economy since the Great Depression.”

North Dakota’s energy and agricultural sectors can’t grow if they can’t borrow money or access insurance because they don’t meet ESG standards, Leiman said. Coal plants in North Dakota are closing because of market shifts as well as regulatory changes driven by other states that have established goals to reduce greenhouse gas emissions. North Dakota also faces a new federal regulatory environment, as the Biden administration is much less friendly to the fossil fuel industry than the Trump administration was.”

On Wall Street and in the private sector

Vanguard further ramps up ESG efforts

Vanguard, the largest passive asset manager in the world and the second-largest asset manager overall, has been slower than its passive-investment competitorsnamely BlackRock and State Street—to embrace ESG and to make it a focus of its investment operations. But that appears to be changing.

Earlier this month, Barron’s reported that Vanguard has been increasing up its ESG-related hiring, in an attempt to catch up to its competitors:

“Kaitlyn Caughlin, who oversees the firm’s portfolio review, wouldn’t say whether or when to expect new products, but noted the firm is doing “a lot of additional research right now.”

The firm recently created an ESG product category team in the U.S. with two dedicated ESG product managers and three support staff. In Europe there is a head of ESG strategy who leads a group of product specialists who are largely, though not solely, dedicated to ESG. Those teams will collaborate with others in Vanguard, both related to ESG product and ESG integration in conventional products.”

Last week, ETF Strategies reported that Vanguard has now also launched its first ESG ETF in Europe:

“The Vanguard ESG Global All Cap UCITS ETF is designed to serve as a core building block for ESG-aware portfolios, providing broad diversification while screening out undesirable issuers based on FTSE Russell’s ‘Choice’ framework.

An ESG guide for Annual Meeting Season

Over the weekend, The Financial Times identified the ESG shareholder-proposals to watch during the upcoming Annual General Meeting season. The paper identified one activist shareholder group that is focusing its energy this year on a strategy targeting large asset management firms for past voting records and encouraging them to be more ESG-friendly:

“PepsiCo, Amazon and Citigroup have been named alongside a small group of global companies to watch during this year’s annual meeting season, as investors demand businesses step up on issues from climate change to employing diverse workforces.

ShareAction, the responsible-investment charity, said the “13 most important ESG resolutions” of 2021 included a proposal calling on General Motors to disclose its lobbying around climate change, a resolution calling on the board of Walt Disney to strengthen oversight of workforce equality issues including racial and gender pay equity, and a vote on biodiversity at Amazon.

The list comes at a time of intense scrutiny over how asset managers vote at annual meetings, with widespread concern that big investors often proclaim their ESG credentials but fail to back resolutions on issues such as climate change.

“Shareholder voting works. Resolutions can deliver everything from decarbonisation targets to healthy eating strategies,” said Guy Opperman, minister for pensions and financial inclusion in the UK.

[T]the group argued the resolutions on its list for 2021 were “high quality, high-impact proposals” and called on asset owners and asset managers to back the proposals. The list also includes resolutions on climate change at Barclays, the UK bank, healthy eating at supermarket group Tesco and on human rights at Wendy’s International, the fast-food chain.

Citi said it was “acutely focused on addressing racial inequity, especially in terms of the wealth gap it creates”….

General Motors said it “believes climate change is real and we are advocates for climate action”.”

In the spotlight

ESG and Bitcoin on a collision course?

Over the weekend, HedgeWeek reported on comments made recently by Robert Furdak, the chief investment officer for ESG at Man Group about what he sees as the inevitable conflict between Bitcoin and ESG. The two, Furdak argues, are not merely the two hottest investment trends but also, in his view, all but guaranteed to crash into one another at some point in the not-too-distant future:

“The two major investment trends looming large over the hedge fund and asset management world – bitcoin’s stratospheric surge and investors’ rush towards responsible investing across all mandates – are now set for a “head-on clash”, Furdak said.

Hedge funds are continuing to profit from the ongoing surge in the cryptocurrency sector, as more managers pour money into digital assets’ record rise this year. At the same time, though, an increasingly large number of investors are calling for hedge funds to take a sustainability-based stance and implement ESG-compliant factors in their portfolios.

In an in-depth market commentary this week, Furdak – ESG CIO at London-listed global hedge fund and alternative investments giant Man – explored how bitcoin is already bumping against the range of environmental, social and governance factors that investors increasingly look for in their allocations.

On the environmental theme, Furdak noted how bitcoin mining will continue to require substantial energy consumption for as long as the digital currency’s price remains high, both in absolute and relative terms. He added that the majority of bitcoin mining takes place in south-east Asia, where coal-fired power stations remain dominant.

“Currently, one bitcoin transaction requires the same energy as processing 500,000 Visa transactions,” Furdak observed, highlighting a study by the University of Cambridge’s Centre for Alternative Finance which estimated that bitcoin mining energy now exceeds the annual consumption of countries such as the Netherlands and the United Arab Emirates, and is approaching that of Norway and Pakistan.”

Economy and Society: SEC broadening definition of materiality

ESG developments this week

In Washington, D.C.

SEC broadening definition of materiality

In a March 15 speech given to the Center for American Progress, Acting SEC Chair Allison Herren Lee said that she was grateful for the opportunity “to reflect on the enhanced focus the SEC has brought to climate and ESG” and “on the significant work that remains.” Lee indicated that the Commission will utilize a much broader definition of materiality (which measures the relative financial importance of a factor among a company’s ESG considerations) over the course of its next term. Lee did not indicate whether this change in definition will be formalized or will be accomplished through informal attention to ESG-inspired disclosure rules. Lee stated the following:

“The most fundamental role that the SEC must play with respect to climate and ESG is the provision of information – helping to ensure material information gets into the markets in a timely manner. Investors are demanding more and better information on climate and ESG, and that demand is not being met by the current voluntary framework. Not all companies do or will disclose without a mandatory framework, raising the cost, or resulting in the misallocation, of capital. Investors also aren’t getting the benefits of comparability that would come with standardization. And there are real questions about reliability and level of assurance for the disclosures that do exist. Meanwhile issuers are assailed from all sides by competing and potentially conflicting demands for information. That’s why we have begun to take critical steps toward a comprehensive ESG disclosure framework aimed at producing the consistent, comparable, and reliable data that investors need….

…two weeks ago, we announced the formation of the first-ever Climate and ESG Task Force within the Division of Enforcement. The Task force will work to proactively detect climate and ESG-related misconduct, including identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules and analyzing disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”

Senator Pat Toomey (R, PA), the Ranking Member on the Senate Banking Committee, responded to the pre-release of Lee’s comments, tweeting, “This would be a total abuse of power and a politicization of SEC’s disclosure standard. What matters is whether an issue is financially material to a reasonable investor, not if it conforms to the woke Left’s opinion about what’s best for humanity’s general welfare.”

On Wall Street and in the private sector   

Former BlackRock official voices ESG criticism

On March 16, Tariq Fancy, former CIO of sustainable investing for BlackRock, the largest asset management firm in the world and a driver of the ESG investment trend, wrote an op-ed for USA Today that was critical of ESG and the sustainable investment movement more generally. He wrote:

“The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not….

As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community….”

That same day, Fancy also appeared on CNBC, stating, in his opinion, “There is no evidence that any ESG ETF has any positive social impact.”   

ESG’s higher management fees

On March 16 the Wall Street Journal featured a piece on ESG investing’s higher management fees: 

“Sustainability has been good for Wall Street’s bottom line.

Exchange-traded funds that explicitly focus on socially responsible investments have 43% higher fees than widely popular standard ETFs.

The environmental, social, and governance funds’ average fee was 0.2% at the end of last year, while standard ETFs that invest in U.S. large-cap stocks had a 0.14% fee on average, according to data from FactSet.

“ESG creates a fantastic revenue possibility for large firms,” said Dr. Wayne Winegarden, a senior fellow at the Pacific Research Institute.

Even a seemingly small increase in fees can have a big impact at scale. A firm managing $1 billion in a typical ESG fund, for example, would garner $2 million in annual fees versus managing the standard ETF’s $1.4 million.

“It’s fresh, feels good and new,” said Andrew Jamieson, global head of ETF product at Citigroup Inc., of ESG. “But it’s not any different than anything else. These things aren’t any more expensive to run.””

The Journal noted that other categories of ETFs charge even higher fees than the ESG funds but none as prevalent or as massively capitalized.

Research estimates one-in-four dollars invested in ESG

Last week, the investment banking and research firm Cowen claimed that its estimates show that roughly one-in-four dollars invested in American markets is now invested directly in an ESG vehicle. The firm also expects that the growth in the ESG sector over the last few tears will continue for the next few as well:

“Investors poured record amounts of money into environmental, social and governance-based funds in 2020 as the pandemic, climate disasters and racial injustice came into sharp focus.

That momentum will grow in 2021 and beyond, according to Cowen.

The firm noted that roughly one in four dollars in the U.S. is now invested through an ESG lens. If two equities offer similar expected risks and returns, investors are increasingly likely to choose the name that screens better on sustainable investing scores.

Indeed, sustainable funds attracted a record $51.1 billion in inflows in 2020, according to data from Morningstar. That figure more than doubled 2019′s prior record.”

Putting the “S” in ESG

Last week a group of ESG advocates and investorsAs You Sow, Sustainable Investments Institute, and Proxy Impactreleased the joint annual proxy preview. Confirming earlier reported expectations that 2021 would be the year that “s” in ESG began to play a much more prominent role in the investment movement, the groups reported that “of 435 shareholder resolutions already filed, about 300 are headed for votes at spring corporate annual meetings.” While the number of such proposals focusing exclusively on climate change fell from 87 to 78, the “number of proposals on workplace diversity more than doubled from 2020.”

Vanguard increasing its ESG capacity      

Vanguard, the second-biggest asset management firm in the world (by assets under management) and the manager with the largest passive investment portfoliowhich according to some analysts has been slow in following the ESG trendrecently begun putting together the workforce and other resources it will need to remain competitive in the ESG investment world:

“Vanguard isn’t known for its broad suite of environmental, social and governance investment funds. It has just five available in the U.S., versus dozens at rival Blackrock and other firms.

But as billions of dollars have flowed into rival firms’ ESG products in the past year and a half, the fund giant may be shifting its stance as it adds expertise in the area.

Kaitlyn Caughlin, who oversees the firm’s portfolio review, wouldn’t say whether or when to expect new products, but noted the firm is doing “a lot of additional research right now.”

The firm recently created an ESG product category team in the U.S. with two dedicated ESG product managers and three support staff. In Europe there is a head of ESG strategy who leads a group of product specialists who are largely, though not solely, dedicated to ESG. Those teams will collaborate with others in Vanguard, both related to ESG products and ESG integration in conventional products.

The hiring shows Vanguard is expanding into the space….”

In the spotlight

Agency theory and Canadian corporate governance

Our March 9 edition of Economy and Society highlighted the aspect of agency theory that advocates alignment of corporate managers’ self-interest with the interests of the corporation, specifically by tying executive compensation to company performance. To date, this practice is only rarely used regarding ESG matters, although that is starting to change.

As it turns out, according to a report from Bloomberg, the concept is already an integral part of Canadian corporate governanceor at least it is at Canadian banks:

“Canada’s six largest banks have all added ESG components to their chief executive officers’ compensation frameworks, putting them in a small minority of companies that tie executive pay to such measures.

How environmental, social and governance matters affect pay varies by firm, as does the percentage of compensation involved. Still, the Canadian lenders stand out because only 9% of the 2,684 companies in the FTSE All-World Index tracked by researcher Sustainalytics in a 2020 study had tied executive pay to ESG.

The moves, disclosed in the banks’ proxy circulars earlier this month, put them at the front of a push by activists and investors to establish incentives for actions like reducing emissions and diversifying workforces. At Canadian Imperial Bank of Commerce, the impetus to make changes also came from within, said Sandy Sharman, head of the bank’s people, culture and brand team.

“We didn’t want this to be something that we just report on and it’s a check-box,” Sharman said. “We actually wanted to drive accountability, and we also wanted to put areas in there that we wanted to improve. You need that healthy tension to move up your game.””

Notable quotes

“Imagine the planet is a cancer patient, and climate change is the cancer. Wall Street is prescribing wheatgrass: A well-marketed, profitable idea that has no chance of curing or even slowing down the cancer. In this scenario, wheatgrass is the deadly distraction, misleading the public and delaying lifesaving measures like chemotherapy. But like giving false hope to unproven cures in the midst of a pandemic, the consequences of such irresponsibility are all too obvious. And motivation for why the industry continues to greenwash is all too obvious.”

Economy and Society: SEC announces enforcement task force on ESG issues

ESG developments this week

In Washington, D.C.

SEC reviewing ESG disclosure practices of publicly traded companies

Late last month, the Securities and Exchange Commission, led by acting Chair Allison Herren Lee, announced that it has started reviewing ESG disclosure practices and demands among the publicly traded corporations it regulates. According to Lee, “Now more than ever, investors are considering climate-related issues when making their investment decisions…It is our responsibility to ensure that they have access to material information when planning for their financial future.”

Lee’s statement suggests a potential change in SEC policy and a concomitant issue on the Commission over the definition of materiality, the financial elements deemed fundamental to the long-term success of a company’s ESG strategy. In a statement released just over a year ago, just after the SEC’s Divisions of Corporation Finance and Economic and Risk Analysis and Office of General Counsel released new recommendations on efforts to modernize and enhance financial disclosures, Commissioner Hester Peirce wrote:

Thanks in part to an elite crowd pledging loudly to spend virtuously other people’s money, the concept of materiality is at risk of degradation. We face repeated calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality. The proposed amendments and companion guidance do not bow to demands for a new disclosure framework, but instead support the principles-based approach that has served us well for decades.

SEC announces ESG enforcement task force

Last week, the SEC announced that it will create a new task force targeting those who engage in fraudulent ESG behaviors. To be housed in the Commission’s enforcement division, the new, 22-person task force will be charged with ensuring that corporations are complying with existing ESG-friendly disclosure rules and will play a much more significant role if new rules are added. According to Reuters, the task force will be run by Kelly L. Gibson, currently the acting deputy director of SEC’s enforcement division. Reuters also notes that Satyam Khanna, the Commission’s newly appointed senior policy adviser for climate and ESG, declared that the task force is evidence that the SEC intends to take an integrated approach to enforcement of climate-related issues, rather than simply assigning the matter to one small group within the Commission. The announcement, Khanna said, is evidence that the new administration and its appointees are “taking an ‘all of SEC approach’ to climate and ESG risks.”

ESG in Sweden

On March 5, the Swedish Society for Nature Conservation released a report accusing the nation’s state-backed pension funds of failing to meet their obligations and to keep their promises regarding climate change and other ESG matters. Specifically, the Society accused pension fund managers of remaining invested in fossil fuel companies, which, it claimed, is a violation of promises made, both to activists and pensioners. Fossil fuel investment accounts for less than 1% of the funds’ total assets under management. According to Bloomberg:

The AP funds, which oversee about $250 billion in assets and have all committed to environmental, social and governance goals, continue to invest in fossil-fuel companies that are contributing to a dangerous rise in temperatures, the Swedish Society for Nature Conservation said Friday in a report.

“Not a single one” of the fossil-fuel companies held by the AP funds has set climate goals that live up to the Paris Agreement, the group said….

The comments mark the latest clash between a financial industry keen to tout its ESG credentials, and climate protection groups who say their strategies do little more than pay lip service to the idea. That’s as the industry stretches the definition of sustainability to include companies that pollute now, but say they have plans to cut their emissions in the future.

Despite cuts in the AP funds’ holdings of fossil-fuel companies last year, they still have about $1.8 billion invested in 66 of the world’s 200 biggest polluters, the Swedish Society for Nature Conservation found.

On Wall Street and in the private sector   

Putting the ‘S’ in ESG

Last week the investment news site Seeking Alpha suggested that the rise of Black Lives Matter and other social movements may have triggered greater concern among investors about the ‘S’ in ESG:

While the reflection on environmental and governance factors remains at the forefront of asset owners’ interests, social issues such as health and safety, human rights, labor rights and equality have recently been pushed into the spotlight.

Our 2020 ESG Manager Survey showed an uptick in social factors, when compared to the previous years’ responses….

While environmental and governance factors have been in focus for a number of years, the coronavirus pandemic, along with the Black Lives Matter movement, #MeToo movement and campaigns for equal pay, have increased the focus on social factors.

ESG in Asia

While much of the analysis and discussion around ESG investing focuses on the United States, United Kingdom, and Europe, Asia’s financial sector is moving quickly and significantly into the ESG space. In the recently published results of its global institutional investor survey, MSCI, an American finance company, noted the following about the Asian ESG market:

Around 79% of investors in Asia-Pacific increased ESG investments “significantly” or “moderately” in response to Covid-19, according to a recent MSCI 2021 Global Institutional Investor survey.

That is a slightly larger share than the 77% of investors globally who upped sustainable investments during the period. Overall, the figure rose to 90% for the largest institutions, or those with over $200 billion of assets, the survey found.

Meanwhile, 57% of Asia-Pacific investors expect to have “completely” or “to a large extent” incorporated ESG issues into their investment analysis and decision-making processes by the end of 2021.

“Once an issue for ‘green funds’ and side-pockets, ESG and climate are now firmly established as high priority issues,” Baer Pettit, MSCI president and chief operating officer, said in the report. “2020 marked a profound shift in the way institutions invest as many investors have recognized that many companies with strong environmental, social and governance practices outperformed during the pandemic.”

In the spotlight

Agency theory in ESG

Agency theory, as it evolved during the 1970s, focused on improving the performance of a corporation by aligning the interests of the corporation and its managers. In their work “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Michael Jensen and William Meckling argued that alignment between corporate and managerial interests would greatly and swiftly advance managerial performance. Later, Jensen and Kevin Murphy suggested that paying managers with company shares would cement the alignment and ensure that managers would constantly and permanently try to maximize the company’s value to its shareholders. 

Currently, there are some attempting to apply agency theory and corporate alignment practices to ESG. For example, Environment and Energy Leader reported last Friday that Chipotle Mexican Restaurants has announced that it is attempting to lead this agency movement:

Chipotle Mexican Grill has gone public with its intention to tie executive compensation to its environmental, social and governance (ESG) goals. The company has introduced a new ESG metric that will hold its executive leadership team responsible for making business decisions that prioritize corporate responsibility. Ten percent of the annual incentive bonus for officers will be tied to the company’s progress toward achieving those ESG goals.

The announcement comes following a year in which a litany of disrupters boosted the profile of corporate responsibility issues. With the pandemic, social injustice, extreme weather and wildfire events setting a magnifying glass over how ESG influences the global economy in 2020, such topics will continue to play out on a larger stage in 2021, S&P Global Ratings said earlier this year.

Meanwhile, Bloomberg Business reported that Cevian Capital, described as “an activist investor with sizable stakes in some of Europe’s biggest companies,” is advocating the same alignment tactics in Europe. Bloomberg noted:

The new campaign is intended to address growing concerns that too many firms are touting environmental, social and governance goals without always living up to their promises.

“Several of our companies are not currently where they need to be, including larger ones such as ABB, CRH and Ericsson,” Cevian Managing Partner Christer Gardell told Bloomberg.

Cevian wants the matter to be put to shareholder votes in its portfolio companies at annual general meetings next year. Those companies that have yet to take ESG seriously need to “start,” while the rest need to “accelerate” strategies already in place, it said in a statement….

The investor plans to “hold companies and their directors to account” through a combination of voting on director elections and compensation plans.

Notable quotes

“[I]f capitalists are unable to reform capitalism, it will be reformed for them. The American public is already distrustful of big business, and only half of American adults under 40 view capitalism favorably — down from two-thirds in 2010. Companies that don’t adapt will find themselves at odds with their customers, employees, investors, and regulators.

Michael O’Leary and Warren Valdmanis, “An ESG Reckoning Is Coming,” Harvard Business Review, March 4, 2021