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Economy and Society: Regulatory scrutiny over ESG-related sustainability claims intensifies

ESG Developments This Week

In Washington, D.C., and around the world

Regulatory scrutiny over ESG-related sustainability claims intensifies

As was noted in last week’s newsletter, the SEC is investigating DWS (the asset management arm of Deutsche Bank) for alleged ESG-related fraudclaims DWS rejects. Many ESG observers believe that the DWS probe is the beginning of a larger SEC crackdown on potentially deceptive ESG promises. On September 1, for example, Bloomberg Green noted the following:

“Pressure is increasing on managers of ESG-labeled investment funds to show they’re being truthful with customers about what they’re selling.

The heat was really turned up last week when the U.S. Securities and Exchange Commission and BaFin, Germany’s financial regulator, initiated a probe into allegations that Deutsche Bank AG’s DWS Group asset-management arm has been misstating the environmental—and possibly the social—credentials of some of its ESG-labeled investment products. Regulators have signaled the review is at an early stage, and DWS has rejected claims it overstated ESG assets.

Since then, researchers have raised questions about the credentials of money managers who claim they are marketing funds designed to address the climate crisis and social injustice.

A London-based nonprofit called InfluenceMap said more than half of climate-themed funds are failing to live up to the goals of the Paris Agreement….

InfluenceMap found that 55% of funds marketed as low carbon, fossil-fuel free and green energy exaggerated their environmental claims, and more than 70% of funds promising ESG goals fell short of their targets.

The SEC formed a task force in March aimed at investigating potential misconduct related to companies’ sustainability claims. Gary Gensler, who took over the agency in April, has said his staff is working on a rule to boost climate disclosures by stock issuers, and that the regulator remains focused on ESG issues.”

On September 3, Bloomberg’s market-news division reported that asset management firms didn’t have to wait long to learn whether DWS would be a one-off investigation or the start of a trend on the federal government’s part:

“U.S. regulators have long said they’re dubious about the green and socially conscious labels that Wall Street applies to $35 trillion in so-called sustainable assets. Now, the watchdogs are hunting for proof that they’re right.

For several months, Securities and Exchange Commission examiners have been demanding that money managers explain the standards they use for classifying funds as environmental, social and governance-focused, said people familiar with the matter. The review is the SEC’s second into possible ESG mislabeling since last year — showing the issue is a priority for the agency and a reason for the industry to worry about a rash of enforcement actions. 

The SEC is following the money: Few businesses are booming in high finance like sustainable investing, as governments, pension plans and corporations all seek to lower their carbon footprints and be better public citizens. Amid the rush for dollars, more and more ESG insiders have started sounding alarms that a lot of the marketing is hype, a term known in the industry as greenwashing.

Letters that the SEC sent out earlier this year point to some of the agency’s top concerns, said the people who asked not to be named because the correspondence isn’t public. 

Investment advisers were asked to describe in painstaking detail the screening processes they use to ensure assets are worthy of ESG designations, one of the people said. The SEC also wants to know how firms are grappling with different jurisdictions’ requirements. For instance, Europe has specific standards that money managers must adhere to in making sure assets are green or sustainable. But in the U.S., it’s much murkier. 

Another SEC query sought information about ESG compliance programs, policies and procedures, a different person said. The SEC additionally asked about statements made by managers in their marketing materials or regulatory filings. 

The SEC has shown it’s keen to bring cases, forming a taskforce of enforcement lawyers in March whose focus includes fund managers’ ESG disclosures.” 

Both of these stories followed an August 26 piece published by MarketWatch (a Dow Jones & Company financial news site), also suggesting that the DWS matter would be the start of a something longer:

“This is the first of many more to come,” Amy Lynch, a former SEC regulator and president of FrontLine Compliance, told MarketWatch. “The SEC has been letting the industry know that this is an area they’re looking into for the past year. They’ve given every warning.”…

Under the chairmanship of Gary Gensler, the SEC has made it a top priority to regulate what public companies must disclose about risks related to climate change and the environment, new information about its workforce policies and other policies that impact social issues.

At the same time, it has telegraphed its intention to hold investment managers responsible for clearly disclosing the principles they use to develop sustainable investment funds.

“When it comes to sustainability-related investing…there’s currently a huge range of what asset managers might mean by certain terms and what criteria they use,” Gensler said in a speech last month. “I think investors should be able to drill down to see what’s under the hood of these funds.”

Meanwhile, in the United Kingdom

On September 5, London’s Mail on Sunday newspaper reported that British Prime Minister Boris Johnson has decided to heed the advice of Tariq Fancy’s advice to make climate change finances issues a government matter, while, at the same time, maintaining the idea that investments can power a more sustainable economy. Fancy is a former CIO for sustainability at BlackRock, who has spoken publicly about his belief that ESG investing is, at best, in his view, what he describes as a dangerous distraction. The paper reported that:

“Boris Johnson will meet pension and insurance bosses in Downing Street next month to thrash out plans to channel billions of pounds of retirement funds into ‘green’ projects. 

A source said there will be in-depth discussions about how pension cash can be diverted into initiatives such as installing solar panels in homes and providing charging points for electric cars. 

More than £1trillion is sitting in defined contribution pensions – including workplace schemes.

The Government is hoping to unlock more of this to invest in Britain’s green economy and ‘build back better’ initiative. Another £2trillion is in annuities and defined benefit schemes. 

The agenda is expected to include more detail on funnelling pension money into various projects to reach ‘net zero carbon’ by 2050 – the commitment to reduce greenhouse gases to offset carbon emissions in order to combat climate change. 

Sources said the trade body the Association of British Insurers is separately meeting with City Minister John Glen this week to talk over the new push.

A source said: ‘This needs a scheme, and the Government is probably best placed to do it because you need a supply chain lined up including investment and the people to implement projects. There is a need to coordinate and get the right types of projects going.’ 

But the plans are expected to spark controversy as many of these investments are illiquid – meaning they are difficult to buy and sell – which could leave pension savers with some of their cash trapped in assets.”

In the Spotlight

Wages before sustainability?

For much of its history, ESG has been nearly synonymous with the idea of what is often called by its advocates sustainable investing. However, according to a recent study by Cerulli Associates, an American asset management research company based in Boston, when affluent American retail investors identify the factors that most influence their investment decisions, they prefer companies that pay what they deem are fair wages over companies that are keenly environmentally aware. It’s not that they don’t appreciate environmental friendliness, according to the study. It’s just that they appreciate what they deem the fair treatment of workers more:

“While the majority (53%) of affluent respondents indicate that investing in an environmentally responsible firm is important to them, 65% of respondents favor investments in companies that pay their workers a fair/living wage. “This result highlights one of the biggest challenges in promoting ESG or sustainable investing products,” says Smith. “When presented with these offerings, investors and advisors get hung up on the ‘E’ and rarely consider the ‘S’ or ‘G.’” Particularly notable in these results are indications of interest 16 to 25 percentage points higher among respondents in the three oldest cohorts compared with their overall ESG interest levels.”

Economy and Society: SEC probes Deutsche Bank’s DSW sustainability claims

ESG Developments This Week

In Washington, D.C.

SEC, Justice Department probe Deutsche Bank’s DSW sustainability claims

In the August 3, 2021, edition of this newsletter, we noted that Deutsche Bank and its asset management arm, DSW, were the subject of criticism by a former director of sustainability, Desiree Fixler, who had recently left the firm and had been publicly critical of the way DWS has performed on ESG, especially by comparison to the way, in her view, it markets its products. 

On August 25, the Wall Street Journal reported that the Securities and Exchange Commission (SEC) and the U.S. Attorney’s office in Brooklyn (New York) are now investigating Fixler’s charges. The Journal reported as follows:

“U.S. authorities are investigating Deutsche Bank AG’s DB 1.14% asset-management arm, DWS Group, after the firm’s former head of sustainability said it overstated how much it used sustainable investing criteria to manage its assets, according to people familiar with the matter.

The probes, by the Securities and Exchange Commission and federal prosecutors, are in early stages, the people said. Authorities’ examination of DWS comes after The Wall Street Journal reported that the $1 trillion asset manager overstated its sustainable-investing efforts. The Journal, citing documents and the firm’s former sustainability chief, said the firm struggled with its strategy on environmental, social and governance investing and at times painted a rosier-than-reality picture to investors….

The probes indicate regulators’ interest in money managers’ efforts to offer products related to climate change, social issues and corporate governance risks. The SEC earlier this year established an enforcement task force to look for misleading ESG claims by investment advisers and public companies.

The Wall Street Journal reported earlier this month that DWS told investors that ESG concerns are at the heart of everything it does and that its ESG standards are above the industry average. But it has struggled to define and implement an ESG strategy, according to its former sustainability chief and internal emails and presentations.

For instance, DWS said in its 2020 annual report released in March that more than half of its $900 billion in assets at the time were invested using a system where companies are graded based on ESG criteria. An internal assessment done a month earlier said only a fraction of the investment platform applied the process, called ESG integration. The assessment added there was no quantifiable or verifiable ESG-integration for key asset classes at DWS.

Desiree Fixler, at the time DWS’s sustainability chief, told the Journal that she believed DWS misrepresented its ESG capabilities.

A DWS spokesman said the firm stood by its annual report and that an investigation by a third-party firm found no substance to Ms. Fixler’s allegations. He said standards for defining ESG assets are constantly evolving, and that DWS has been seen by the market as being more conservative than most of its competitors in the definition.”

On Wall Street and in the private sector

Former ESG advocate turned critic continues criticism 

Tariq Fancy, the former CIO for sustainability at the world’s largest asset management firm and ESG pioneer BlackRock, was back in the news last week with further criticism of ESG. This time, he targeted green debt instruments specifically:

“A report published in July, looking at five of the world’s top markets, said that this type of investing had $35.3 trillion in assets under management during 2020, representing more than a third of all assets in those large markets. And the trend is not showing any signs of slowing down.

But Tariq Fancy, who was BlackRock’s first global chief investment officer for sustainable investing between 2018 and 2019, warned that there were some fallacies associated with this area.

“Green bonds, where companies raise debt for environmentally friendly uses, is one of the largest and fastest-growing categories in sustainable investing, with a market size that has now passed $1 trillion. In practice, it’s not totally clear if they create much positive environmental impact that would not have occurred otherwise,” Fancy said in an online essay posted last week.

This is because “most companies have a few qualifying green initiatives that they can raise green bonds to specifically fund while not increasing or altering their overall plans. And nothing stops them from pursuing decidedly non-green activities with their other sources of funding,” he added….

He also argued that financial institutions have an obvious motivation to push for ESG products given these have higher fees, which then improves their profits….”

Asset management firm issues warning about ESG and increasing capital costs

A senior credit analyst at a British asset management firm has issued a warning that ESG mandates and practices are making the currently predominant forms of energy more expensive in what is perceived as an already inflationary environment. By increasing the costs of raising capital, the warning argues, ESG is making fossil fuel exploration and recovery a more costly pursuit:

“ESG concerns are rapidly raising the cost of borrowing for oil companies as interest in hydro-carbon investment wanes and fund mandates become ever more restrictive, according to Aegon Asset Management’s Eleanor Price. [sic]

Eleanor Price, Senior Credit Analyst at AAM, says that while many oil companies are in better health from a credit perspective than they have been in recent years, having seen their balance sheets bolstered by strengthening oil prices in 2021, they are finding it increasingly difficult to raise financing as the pool of willing investors shrinks and banks bow to pressure to decarbonise their lending operations….

Price says that with most new client mandates requiring an increasingly stringent ESG focus, it is unsurprising that investors are shying away from such an environmentally unfriendly sector. However, she believes it is significant that this shift is happening so quickly at a time when oil companies offer solid credit fundamentals and attractive coupons. 

“In a market hungry for yield, it’s a brave investor who would completely eschew all hydro-carbon investment, but for the issuers it must feel like an ongoing game of musical chairs as their available investor bases continue to shrink,” she says. “This is not just a High Yield phenomenon – the pool of available lending banks is also shrinking as institutions come under increasing pressure to decarbonise their lending operations.””

In the Spotlight

Wal-Mart website features FY21 ESG summary 

Wal-Mart, one of the world’s largest companies, has begun an effort to highlight what it touts as its environmental record and waste-cutting initiatives. Last week, Waste360 reported the following:

“Walmart is now cataloging its progress regarding key ESG metrics in a new, “living” digital format on the company’s website.

The interactive document includes the Arkansas-based retailer’s FY21 ESG summary and data tables in its journey to become more circular.

Kathleen McLaughlin, executive vice president and chief sustainability officer, Walmart Inc., announced the accessibility of the data, saying: “The briefs will be refreshed online periodically, providing our stakeholders with timely information. We have updated our list of priority issues based on recent stakeholder engagement, reflecting stakeholder expectations, relevance to our business, and Walmart’s ability to make a difference in four broad themes of opportunity, sustainability, community and ethics and integrity.””

Economy and Society: SEC weighing human capital disclosures

ESG Developments This Week

In Washington, D.C., and around the world

SEC weighing human capital disclosures 

On August 18, SEC Chairman Gary Gensler tweeted to explain to investors, asset managers, and corporations what is next on the SEC’s ESG agenda. He wrote:

“Investors want to better understand one of the most critical assets of a company: its people.

I’ve asked staff to propose recommendations for the Commission’s consideration on human capital disclosure….

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

For the last few months, ESG advocates have focused on expanding the nature of disclosures on which corporations should concentrate, arguing that the “E” (environmental) aspect of ESG should not be allowed to overwhelm the “S” (social) aspect. 

Chinese companies resisting ESG debt

According to Bloomberg, Chinese companies are resisting the global trend toward sustainability-target-linked debt. Most of the rest of the worldand most of the rest of Asiahave embraced debt instruments that adjust interest rates in accordance with measured compliance with ESG metrics and promises (i.e. the closer you are to the metric, the lower your rate; the further you are, the higher the rate). Bloomberg speculates on the reasons for the resistance from Chinese-based companies:

“Chinese firms are lagging their regional peers in a key funding method to meet sustainability goals, even as the world’s second-biggest economy pushes to become carbon neutral by 2060.

So-called sustainability-linked loans usually offer creditors extra margins if borrowers fail to meet their environmental goals, giving firms an incentive to make an extra effort. While the volume of such debt has climbed at a record pace in the rest of Asia Pacific, few deals are being done in China….

The volume of sustainability-linked loans is floundering in China partly because, in a market that’s keenly focused on official pronouncements, policy makers have said little about them even while encouraging other forms of sustainable financing. Guidelines for environmental lending by the People’s Bank of China released in late May emphasized green borrowings, for example, while not mentioning sustainability-linked debt.

Chinese borrowers may also be reluctant to risk harming their green reputation by missing targets specified by the loans.”

Report suggests ESG risks higher for Asian companies

Over the weekend, the Federation of Korean Industries (FKI) released its analysis of a recent Sustainalytics report tracking the ESG risks of thousands of companies around the world. According to FKI, the report demonstrates that Asian companies are considered to have higher ESG risks, trailing European countries significantly:

“Asian companies have higher environmental, social and governance (ESG) risks than companies in Europe, the Federation of Korean Industries (FKI) said Sunday.

The FKI released an analysis of the ESG Risk Ratings of 3,456 companies around the world released earlier this month by research company Sustainalytics. The FKI used raw data from Sustainalytics for its “Global Companies ESG Risk Map.”

ESG risks refer to issues that could affect a company’s performance and value. A company’s ESG Risk Rating score can vary by different rating agencies because each weighs factors differently….

Companies listed on stock markets in Greater China had the highest ESG risk level in the world, with an average of 36.1 points for companies listed on the Shanghai Stock Exchange, 32.9 points for companies on the Shenzhen Stock Exchange and 30.5 points for companies on the Hong Kong Stock Exchange.

Companies listed on the Korea Exchange had the fourth highest ESG risk, with an average of 30.1 points. Companies listed on the National Stock Exchange of India were the fifth highest, with 28.6 points.

The lowest scores came from European countries, with 20.6 points for companies listed on Euronext and 21.6 points for companies on the London Stock Exchange. They were followed by the Nasdaq with 22.1 and 22.4 for the Taiwan Stock Exchange.”

On Wall Street and in the private sector

The UN’s climate report and ESG

Earlier this month, the United Nation’s Intergovernmental Panel on Climate Change released a summary of the first part of its latest report on climate change. It is already having an effect on ESG investment professionals:

“The assessment by the Intergovernmental Panel on Climate Change, released on Monday, should prompt investors to “review their commitments to tackling climate change and to take action,” said Fiona Reynolds, chief executive of the UN-backed Principles for Responsible Investment….

Praxis Mutual Funds, one of the oldest socially responsible investment firms, which manages about $2 billion, said the IPCC report shows the need to move faster in the short-term and invest in green debt that can have greater real-world impacts. “It changes the calculus,” said Chris Meyer, manager of stewardship investing research and advocacy. “We will need to have a sharper focus. This report shows that investors aren’t moving quickly enough.”…

Schroders is among the fund managers that have committed to establishing a pathway to net zero. The adoption of these goals hasn’t yet led to lowered emissions, as the IPCC report makes clear. “Finance alone cannot solve the climate threat. This is ultimately a question of every group making significant and sustained steps to cut emissions,” said Andy Howard, the head of sustainable investment at Schroders. “Anyone looking at the same picture and data must surely reach a similar conclusion.”

With the scientific consensus now making clear that the average global temperature is very likely to rise at least 1.5° Celsius above pre-industrial levels by 2040, investors may need to pay even more attention to their contribution to limiting warming. That’s where temperature-alignment metrics come in. These grade portfolios based on their holdings’ projected greenhouse gas output.

It can be helpful “in evidencing what is a fair share that a given company needs to be doing to meet the carbon budget and how exposed companies may be to value impact from the transition,” said Christopher Kaminker, head of sustainable investment research and strategy at Lombard Odier Group.”

The perceived conflict between those who now feel that ESG investors must be more committed than ever to addressing what they describe as a climate crisis and those who (as documented above) believe that ESG can and should focus more on social impact and social justice will present investors with both uncertainties and opportunities, according to Pensions & Investments:

“It is possible for investors to meet the challenge raised in the IPCC report, said Gordon L. Clark, professorial fellow at Oxford University’s Smith School of Enterprise and the Environment. “The climate crisis presents an enormous opportunity for investors with a 15-, 20-, or 30-year horizon. It is an opportunity that long-term investors will embrace and are embracing. You see that already in U.K. and European pension funds” investing in alternative energy solutions, Mr. Clark said. “It is incumbent on pension trustees to invest in the future.””

In the Spotlight

More pressure—and rewards—for ESG performance

One ESG tactic highlighted recurrently in this newsletter is the application of alignment theory to ESG performance. For decades, companies have rewardedor punishedmanagers and directors for business performance by linking their compensation to their companies’ success (or lack thereof). Most commonly, executives and others have been compensated with shares in their company, meaning that they will be rewarded if the company does well and attracts investment and will do poorly if the inverse occurs. Over the past year or so, many companies have begun moving alignment theory in a different direction, tying executive compensation to performance on ESG measures instead of (or in addition to) stock-market performance.

In Europe, this trend has taken a new dimension, focusing on the financial industry’s role in advancing ESG, as Bloomberg reports:

“European bankers will soon have to show they’re contributing to a cleaner environment, a better society and good governance — or face a smaller pay package.

In the latest sign that ESG is reshaping finance, most of the 20 major European banks surveyed by Bloomberg said they were either working on, or already had, a model that links staff remuneration to a firm’s performance on sustainability metrics. That’s as European regulators explicitly add ESG risks to pay guidelines, with the change due to take effect by the end of 2021.

Nicole Fischer, who advises German financial institutions on pay at Willis Towers Watson, said the industry is now “in a transformation phase where ESG is being anchored firmly in remuneration.”

The development opens another avenue through which policy makers in Europe are trying to redefine capitalism. The ultimate goal, ideally, is to make it financially attractive to be good.”

Economy and Society: SEC approves Nasdaq board-diversity proposal

ESG Developments This Week

In Washington, D.C.

The SEC and diversity

On Friday, August 6, the Securities and Exchange Commission approved a plan set forth by the Nasdaq stock exchange to promote diversity among the companies it lists. Late last year, Nasdaq suggested that all listed companies would either have to have underrepresented minority groups on their boards of directorsor would have to explain why they are unable, at this time, to have such minority representationor they would be delisted. The Wall Street Journal explained the decision and its impact as follows:

“In an order released Friday afternoon, the Securities and Exchange Commission agreed to Nasdaq’s proposed rule changes. But in a sign of the political divisions over the proposal, the SEC’s two Republican commissioners registered their opposition, with one voting against the decision and the other giving only partial support.

Under the proposal, Nasdaq-listed companies would need to meet certain minimum targets for the gender and ethnic diversity of their boards or explain in writing why they aren’t doing so.

For most U.S. companies, the target would be to have at least one woman director, as well as a director who self-identifies as a racial minority or as lesbian, gay, bisexual, transgender or queer. Companies would also be required to disclose diversity statistics about their boards. Nasdaq found in a review conducted before submitting its plan late last year that more than three-quarters of its listed companies wouldn’t have met its proposed requirements.

“These rules will allow investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions that best serve their shareholders,” SEC Chairman Gary Gensler said in a statement….

Critics of Nasdaq’s plan have warned that it could be challenged in court. Some conservative groups have argued that the exchange’s diversity rule, if implemented, would violate the U.S. Constitution and civil-rights laws.

“The proposed rule is racist and sexist in that it mandates that firms establish quotas and discriminate based on sex, skin color, ethnicity or sexual orientation,” David Burton, a senior fellow at the Heritage Foundation, told the SEC in a January letter….

Nasdaq argued that its proposed rule change would benefit investors. The exchange operator cited studies that found companies with more diverse boards tended to have stronger corporate governance and financial performance.”

Skeptics of ESG have argued that the movement’s interpretation of diversity is superficial and potentially violates the law as well as, in their view, best business practices. Proposals like Nasdaq’s, in their opinion, are damaging to business and capital markets over the long-term. For example, in his book The Dictatorship of Woke Capital, market commentator Stephen Soukup wrote the following:

“Many companies lack diversity in various aspects of their operating structure, from employees to man­agers to executives to directors. And many of these companies could benefit from a more diverse workforce or board. There is no question that employing people from diverse backgrounds, diverse experiences, diverse educational environments, etc. can be beneficial to a company. Varying histories and personal narratives contribute to varying thought patterns and problem-solving strategies. That much is largely inargu­able. Nevertheless, one of the most important aspects of such beneficial diversity is viewpoint diversity, which is to say diversity in approaches to life, to government, to politics, to business, and so on. Diversity in itself is a noble social goal, but diversity without viewpoint diversity tends to take many of the strictly business-related benefits of the diversity strategy off the table.”

Soukup continues, arguing that, in his view, superficial diversity programs imposed from the top-down as quasi-regulatory measures are, technically, in contravention of the law:

“The law in question—the Securities Exchange Act of 1934, as amended in 2009—requires listed companies to disclose and describe their diversity policies for the nomination of direc­tors in their annual proxy statements. In its final rule on the implementa­tion of the diversity question, the SEC specifically and intentionally did not define what diversity should mean, believing that such decisions were best left up to the listed companies. The SEC wrote that it had voted to:

require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. . . .We recognize that companies may define diversity in various ways, reflecting different perspectives. For instance, some companies may conceptualize diversity expansively to include differences of viewpoint, professional experi­ence, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin. We believe that for purposes of this disclosure requirement, companies should be allowed to define diversity in ways that they consider appropriate.”

Additionally, Soukup notes that up until just a few months ago, viewpoint diversity and the rejection of superficial diversity measures were considered standard good business practices by many in the capital markets:

“[Superficial diversity programs] are also contradicted by the recommendations for “Common Sense Governance Principles” that were authored and supported by some of the biggest names in American business in 2016. Among the “authors” of these principles were some of the biggest and most powerful players in the capital markets, including four who have already been mentioned in this book: Jamie Dimon of JP MorganChase, Larry Fink of BlackRock, Bill McNabb of Vanguard, and Ronald O’Hanley of State Street.60 Toss in the Oracle of Omaha himself, Warren Buffett, and the list of the authors of these common-sense principles reads like a Who’s Who of finance. And they defined “diversity” as follows: “Directors should have complementary and diverse skill sets, backgrounds and experiences. Diversity along multiple dimensions, including diversity of thought, is critical to a high-functioning board. Director candidates should be drawn from a rigorously diverse pool. . . .While no one size fits all—boards need to be large enough to allow for a variety of perspectives.””

When the SEC approved Nasdaq’s request, Republican-appointed Commissioners Hester Peirce and Elad Roisman voted against it, and Roisman specifically questioned the wisdom of involving a state actor:

“A serious concern is that the SEC—without any doubt, a state actor—may need to take future action in which the agency must consider disclosure of the racial, ethnic, gender, or LGTBQ+ status of individual directors. After all, the Commission is the adjudicating body for exchange delisting decisions. I think that the Approval Order should have included more analysis of whether the Proposal could implicate state action through the Commission’s downstream enforcement responsibilities, or why the Commission believes this is unlikely.”

On Wall Street and in the private sector

Details emerge about Buffet and BlackRock battle over ESG

Last week, CNBC disclosed the details of a battle between one of the world’s best-known investors and the world’s biggest asset management company, Warren Buffett and BlackRock, respectively. Buffett is known in the investment world for being an opponent of ESG; as a firm believer in the inviolability of shareholder rights. He is, as a result, also known as one of the few celebrated investors who stands in the way of ESG advocates. During this past shareholder meeting season, Buffet’s shareholder traditionalism brought him into direct conflict with BlackRock, among others:

“Berkshire Hathaway is one of the best-run public companies of the 20th century, with the financial performance to prove it. But as the 21st century brings a new generation of investors shifting from pure shareholder capitalism to the stakeholder capitalism aligned with environmental, social and governance mandates, is Warren Buffett’s company positioned to be an ESG leader or laggard? The answer isn’t so simple….

[B]y some operating business measures, Berkshire Hathaway — just by doing what it does — is delivering on ESG. Berkshire Hathaway Energy, its utility company, is the biggest producer of wind energy in the U.S. Buffett’s largest stock holding, Apple, is consistently ranked among the best ESG companies in the market. On diversity, Berkshire just elevated the first-ever female CEO to run a U.S. railroad company, at Burlington Northern. Its board includes a Black director (Ken Chenault), an Indian director (Ajit Jain) and four women….”


“None of the Berkshire attributes that can be judged as ESG favorable was a factor for BlackRock, the world’s largest asset manger [sic] and the biggest force in ESG investing, when it came time to vote in the just-passed proxy season. BlackRock voted against two Berkshire directors — the directors of its audit and governance committees. And it voted with shareholders on requirements that the company produce a climate report and its holding companies produce diversity reports. BlackRock singled out Berkshire Hathaway — a step it takes with only a select group of companies in its annual investment stewardship report — as a company that left it with no choice but to vote against management.

“Berkshire Hathaway has a long history of strong financial performance; however, we had concerns related to our observation that the company was not adapting to a world where sustainability considerations are becoming material to performance.”

Meanwhile, Tariq Fancy, the former head of sustainability for BlackRock continued his press tour, criticizing his former employer and arguing that the company and its CEO, Larry Fink, are engaged in what he describes as a deadly distraction:

“They misrepresent what they are doing. It is the idea that ESG factors can be included in all these processes to achieve better returns and better social outcomes at the same time. I felt that the value of ESG data for most investment processes is very limited.

It’s a potentially dangerous placebo, a lot of marketing that answers the inconvenient truth with useful fantasy. .. ..There is no proof of that [ESG investing] Beyond the burning time, I insist, I did anything.

If you believe in ESG treatises that responsible companies are better, you argue that the best we can do is not just say it and then invest money. It’s really about making sure the regulations are smarter. In particular, by punishing irresponsible behavior at a systematic level to far support ESG products….

There is no compelling reason to believe that it surpasses non-ESG strategies, so I don’t think it should be done. In addition, there is no impact on the actual environment or society….

To make matters worse, overall, you will help contribute to a huge social placebo and delay government action.”

Economy and Society: House Democrats urge repeal of Trump administration ESG rule

ESG Developments This Week

In Washington, D.C.

House Democrats urge repeal of Trump administration ESG rule

On July 29, 13 Democratic Members of the House of Representatives sent an open letter to Labor Secretary Marty Walsh asking him to take the Labor Department’s actions on ESG investments one step further.

The Trump Labor Department enacted a rule late last year that directed retirement-fund managers to assess investments governed by the Employee Retirement Income Security Act (ERISA) using pecuniary factors only. Although the rule did not preclude ESG investments altogether, its aim was to make their inclusion in retirement investment funds far more complicated than it would otherwise have been and thus far less likely.

Upon taking office, President Biden called for that rule to be reexamined by Labor, and, on March 10, the Labor Department’s Employment Benefits Security Administration announced that, until further notice, the Trump administration rule would not be enforced.

In their July 29 letter, the House Membersincluding Andy Levin (MI) and Suzan DelBene (WA), who have introduced legislation touching on this subject​​asked Secretary Walsh to take the next step:

“While ending that rule’s enforcement is a necessary first step, we feel it is just that – a first step. A new rule is essential to eliminate the aforementioned chilling effect and allow plan fiduciaries to incorporate ESG factors into their investment strategies without fear of legal consequences.

ESG investing is growing at a tremendous rate. In 2020 alone, $51.1 billion in net investments went into sustainable funds, nearly double the previous annual record. We believe this is evidence of workers’ desire to make sure that their retirement investments reflect their values. This desire is backed up by evidence that shows that investments that consider ESG principles generally performed as well or better than comparable conventional investments. Workers do not have to make a trade-off between getting a return on their investments and their principles, and the rules and regulations governing pension investments should not force them to. Instead, those rules should provide clarity so that sustainable investing is not burdensome.”

The Members did not ask Walsh for a specific response or a date by which they would like to hear back from him, only that they look forward to working with him on the issue.

Who wants greater disclosure?

In a July 28 post at the website of the Cato Institute, Jennifer Schulp, Director of Financial Regulation Studies, advanced an argument made previously by SEC Commissioner Hester Peirce about the alleged investor demand for new, mandatory ESG disclosures from publicly traded companies. Whereas Peirce recently drew a distinction between investors and activists, Schulp articulates the potential differences between professional investors and individual investors, between Wall Street and Main Street:

“[T]here’s no denying the current interest in ESG.

Those who want public companies to be required to disclose ESG information point to this investment behavior as a sign that the “crowd” agrees. During his confirmation hearing, SEC Chairman Gary Gensler cited the “tens of trillions of dollars in assets” as proof that investors “really want to see” climate risk disclosure, which is part of the “E” in “ESG.” SEC Commissioners Lee and Crenshaw also have both pointed to investor demand as supporting SEC efforts to mandate ESG-related disclosure. But do we understand this “investor demand?”

[T]he common refrain that “investors are demanding ESG disclosures” fails to address who those investors are. Investors, of course, are not a monolith, but the conclusions drawn from empirical research in the space often treat them as such. That research tends to ignore individual investors and focuses on professional investors, including many who themselves offer ESG-related products. That research also has largely been conducted by organizations, such as Blackrock, Ernst & Young, and Natixis, that themselves have an interest in the promotion of ESG.

The emphasis on investment professionals is certainly warranted as they are an important constituency to understand. Many of these professionals are making decisions that affect individual investors through mutual funds, ETFs, or the direct management of retirement assets. But even where fiduciary duties are supposed to ensure that these professionals are acting in their clients’ interests, Wall Street and Main Street may not necessarily see eye to eye. While surveys generally show professional investor interest in ESG, few have asked about individual investors. Those that have found that individual investors show only some interest in ESG investing, which largely disappears during economic stress, and individual investors broadly view ESG disclosures as irrelevant when making investment decisions. It’s a stretch, then, to say that investor interest in ESG issues applies uniformly to different investor types.”

On Wall Street and in the private sector

Investors get creative

According to MBH Corporation, a UK-based financial services company, investors are so consumed by the desire to find good smaller companies with solid ESG qualifications that they are willing to look almost anywhere and to accept almost any positive data as evidence of a company’s qualifications:

“A lack of publicly available information on companies’ ESG credentials is prompting investors to turn to overlooked sources to acquire data, new research shared exclusively with City A.M. reveals.

Figures from MBH Corporation shows 89 per cent of UK based professional investors think employee satisfaction platforms will provide crucial information on the validity of firms’ adherence to good environmental and governance initiatives.

MBH Corporation said investors are combing through employee reviews published on sites such as Glassdoor and Vault for ESG information to evaluate whether to invest in a company….

Vikki Sylvester, chief executive of Acacia Training and executive director of MBH Corporation, said…

“Investors are so hungry for information and will reference relevant websites for clear insights into companies.””

In the spotlight 

Ben and Jerry’s governance 

According to Effi Benmelech, a finance professor at Northwestern University’s Kellogg School of Management, the recent decision by the Ben and Jerry’s ice cream company to end its license with its current Israeli affiliate has left its parent company, Unilever, in a very tough spot, one that might end up costing it:

“In the U.S., 33 states have passed laws that restrict government investment or contracting in companies that boycott Israel; if Unilever does not act to reverse the board’s decision, it could face divestment and losses.

When founders Bennet Cohen and Jerry Greenfield (a.k.a., “Ben and Jerry”) turned the company over to Unilever in 2000, the acquisition agreement laid out a unique governance structure that retained the company’s independent board of directors, responsible for protecting the company’s brand and pursuing ESG efforts. And in their view, the board is acting exactly as intended. As they wrote in a recent Op-Ed, “[W]e unequivocally support the decision of the company to end business in the occupied territories… While we no longer have any operational control of the company we founded in 1978, we’re proud of its action and believe it is on the right side of history.””

As Professor Benmelech notes, Ben and Jerry’s is, in his words, a practitioner of “ESG with no G.” Benmelech concludes that, in his opinion, the only solution for Unilever is to terminate Ben and Jerry’s special conditions and impose some “G” on its subsidiary, whether it likes it or not.

Economy and Society: ESG pioneer fires back at SEC Commissioner

ESG Developments This Week

In Washington, D.C., and around the world

ESG pioneer fires back at SEC Commissioner

As noted last week in Economy and Society, on July 20, SEC Commissioner Hester Peirce “delivered an address at the Brookings Institution in which she again made the case that the SEC’s current leadership is overstepping both its regulatory mandate and the bounds of what is objectively knowable about corporations and their impact on aggregate measures of environmental, social, and corporate governance (ESG) well-being.”

In response to Commissioner Peirce’s address, Robert Eccles, a former professor at Harvard Business School and an ESG investing pioneer, offered a rebuttal, of sorts at Forbes.com. Eccles, who was the Founding Chairman of the Sustainability Accounting Standards Board (SASB) and one of the founders of the International Integrated Reporting Council (IIRC), and who has thus been pressuring the SEC on this issue over three presidencies, is frustrated with the Commission’s pace on reform:

“One week ago today on July 20, 2021 Trump appointee SEC Commissioner Hester M. Peirce (R) gave a 4,725 word speech to the Brookings Institution titillatingly titled “Chocolate-Covered Cicadas.” The purpose of this cute title eludes me because I never figured out where the chocolate-covered comes from. The only time it’s mentioned again is the snide closing line of her speech in which she says that in 2038 “perhaps even the chocolate-covered cicadas will be net-zero carbon.”

In her speech Peirce notes a request from her fellow Commissioner Allison Herren Lee for comments on climate change. Yes, Commissioner Peirce, climate change is real. Peirce thought it helpful to point out that Lee’s request came on the Ides of March. In her typical soft dig sleight of hand, Peirce points out that “it was not a Commission request.” Nor did the SEC request Peirce to give her speech and here she gives the standard disclaimer “that the views I represent are my own views and not necessarily those of the SEC or my fellow Commissioners.” For this we can count our blessings.

Once again, the Commissioner camouflages her hard-right ideological views by couching her remarks in the pretext of sparking “a textured conversation about the complexities and consequences of a potential ESG rulemaking.” Perhaps in hope of brandishing some green credentials, Peirce plays the naturalist by beginning with an endearing tutorial on the 17-year Cicadian cycle which she somewhat incoherently links to ESG rulemaking.

The construction of her speech nicely maintains the charade of wanting to have a conversation. She organizes it in terms of 10 “theses” (her own rendition of a slimmed down Diet of Worms) supported by 63 (!) footnotes. In this piece I will respond to each of her theses.”

Meanwhile in London…

The International Organization of Securities Commissions, a global organization of securities and futures regulatorsincluding, for example, the Securities and Exchange Commission released a paper asking member organizations and states to begin the process of consolidating ESG ratings services and regulating the uniformity of those ratings.

“ESG raters and data providers are largely unregulated, lack transparency in their methods, offer uneven coverage and harbour potential conflicts of interest, said the International Organization of Securities Commissions (IOSCO)….

Asset managers running ESG focused funds increasingly rely on about 160 raters globally to help pick stocks and bonds, raising investor protection questions, IOSCO said. Users, however, generally do not conduct any formal verification of the ratings, calling the process a “black box”.

“Users have signalled that having multiple ESG ratings and data products can cause confusion, raising serious questions about relevance, reliability and greenwashing,” said Ashley Alder, who chairs IOSCO and heads Hong Kong’s securities watchdog.

IOSCO’s consultation paper recommends that regulators consider formally regulating the sector, echoing similar moves with credit rating agencies (CRAs) in the aftermath of the global financial crisis over a decade ago when similar concerns were aired.

Regulators could encourage industry to develop and follow codes of conduct, the watchdog said.”

…And in Brussels

In January, the European Commission introduced new climate-investing benchmarks, which are beginning to draw interest from asset managers who are interested in standardized green investments and are leery of greenwashing. Bloomberg reports that only a small fraction of ESG funds are benchmark-aligned at present, but the amount is growing and expected to continue to grow:

“ESG asset managers are accelerating their use of new climate-investing benchmarks created by European authorities, in a development that’s set to make it harder to get away with greenwashing.

While only about $1.2 billion is now tied to gauges that meet European Commission requirements — a tiny fraction of the $35 trillion of ESG assets worldwide — inflows have more than doubled since January, according to the European Securities and Markets Authority.

That suggests investors are looking for some guardrails as they navigate a market rife with anxiety about greenwashing, which is the term that’s been given to exaggerated, false or deceptive claims about a product’s fidelity to climate goals, such as those set in the landmark 2015 Paris agreement. EVestment, a unit of Nasdaq, estimates that there are more than 890 ESG dedicated strategies and another 7,400-plus that integrate ESG into the investment process.

Before the creation of the new benchmarks “you could have smacked that label on a product and gone, ‘Paris Aligned,’ and there could be anything going on in that index,” said Jas Duhra, the EMEA head of environmental, social and governance indexes at S&P Global, which makes and markets such gauges. Now, asset managers making ESG claims “can’t just have an index that’s formed of IT companies and media companies.””

Additionally, Alicia Carspeck, the head of research at Fabric RQ, made the case that the European Commission’s new ESG regulations will, in her view, “transform the global standard for risk management.”

“The EU’s Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March, is designed to drive capital toward sustainably-oriented investments. It is widely considered the broadest regulatory action in sustainable finance to date. And for U.S. firms trying to keep up with the blistering pace of ESG-related transformations within the financial sector, the SFDR could offer some clarity.

The SFDR was initiated by the European Commission as part of a broad EU action plan, announced in 2018, to encourage sustainable investing throughout the EU financial system and to put ESG issues on-par with traditional financial risk indicators. It is broad in its scope covering nearly all asset managers, investment product providers, and financial advisors that operate within the EU. The first phase of reporting standards is already in effect and increasingly detailed reporting obligations will phase in over the coming months and years….

Under the SFDR, all EU asset managers (whether or not they are focused on sustainability) are now asked to publicly disclose: their approach to incorporating sustainability considerations their investment decisions; any “adverse impacts” investments may have on environmental or social factors; and, any sustainability risks that may impact investment performance….

Financial advisors will now be required to counsel clients on the sustainability implications of their investments — including the potential impact (whether negative or positive) on the financial performance of their investments.

The SFDR will act as a mandate for participants in financial markets to “do no harm” to society and the environment while also safeguarding investors from exposure to undue risk stemming from poor ESG positioning of their investments. The regulations are written to make sustainability considerations a routine addition to existing financial disclosure and risk-management requirements.”

While the SEC continues its internaland externaldiscussions about materiality, the European Commission is moving ahead with reforms that preemptively alter those standards by imposing the SFDR’s requirements even on “Non-EU managers and advisors that market financial products into the EU or provide advice to EU firms.” These include large American asset management firms like BlackRock, for example.

On Wall Street and in the private sector

Former ESG investment professional critical of industry

Joining former BlackRock head of Sustainable Investing Tariq Fancy and a handful of other former ESG insiders, Desiree Fixler, the now-former head of sustainability for DWS (Deutsche Bank’s asset management arm) has called out her firm for alleged ESG duplicity. While Fixler has not carried out a public campaign similar to Fancy’s, according to the Wall Street Journal, she has nevertheless been critical of the way DWS has performed on ESG, especially by comparison to the way it markets its products. DWS implied, in return, that the problem was Fixler’s, not the firm’s:

“Deutsche Bank AG’s DB -3.02% asset management arm, DWS Group, DWS -0.30% tells investors that environmental, social and governance concerns are at the heart of everything it does, and that its ESG standards are above the industry average.

But behind closed doors, it has struggled to define and implement an ESG strategy, at times painting a rosier-than-reality picture to investors, according to its former sustainability chief and internal emails and presentations seen by The Wall Street Journal….

Frankfurt-based DWS said in its 2020 annual report released in March that more than half of its assets under management—€459 billion, equivalent to $540 billion—have run through a process it calls ESG integration. In such a process, companies are graded on ESG criteria, which helps inform fund managers if the investment faces any risks related to these standards.

According to an internal assessment of the company’s ESG capabilities a month earlier, “only a small fraction of the investment platform applies ESG integration,” adding there is no quantifiable or verifiable ESG-integration for key asset classes at DWS….

The same month, Desiree Fixler, DWS’s sustainability chief, made a presentation to the executive board saying the firm had no clear ambition or strategy, lacked policies on coal and other controversial topics and that ESG teams were seen as specialists rather than being an integral part of the decision-making, according to the presentation, which was reviewed by the Journal.

That contrasted with what DWS told investors in its annual report: “As a firm, we have placed ESG at the heart of everything that we do,” it said….

Ms. Fixler was fired on March 11, one day before the annual report was released. Ms. Fixler said she believes DWS misrepresented its ESG capabilities. She said revisions and verbal objections she had made to the annual report before publication, including how many assets were under ESG integration, were never included. She said she was fired because she was too vocal about problems and has filed an unfair dismissal case against DWS in a labor court in Germany.

“As chief sustainability officer, as a proponent of ESG, how could I not speak up on wrongdoing,” she said in a statement sent to the Journal. “Posturing with big statements on climate action and inclusion without the goods to back it up is really quite harmful as it prevents money and action from flowing to the right place.”

 DWS, which is majority owned by Deutsche Bank but maintains its own stock listing, said in a statement that it has always been transparent to investors and clients, and it stands by its annual report, which was audited by KPMG.

It said that standards for defining ESG assets are constantly evolving, and that DWS has been seen by the market as being more conservative than most of its competitors in the definition. It said the sustainability office led by Ms. Fixler didn’t gain the expected traction on creating or showing an action plan.”


Does ESG differentiate companies?

A recent analysis conducted jointly by the Wall Street Journal and the Drucker Institute indicates that corporations are generally unable to differentiate themselves from other companies through their ESG efforts. This, in turn, according to analysis, suggests that whatever their interest in or dedication to ESG practices, corporations seeking greater investor interest are likely to be disappointed by the results their ESG efforts yield:

“Companies have a lot of good reasons to pay close attention to environmental, social and governance factors: attracting talented employees who want to work at a place that is making a positive impact on the world; responding to regulators who are demanding more ESG-related transparency; and pleasing major investors who are pushing them to be sustainable for the long haul.

But there’s at least one thing that being ESG-minded may not do: help a corporation stand out from the crowd as much as other actions might.

That’s the big takeaway from our latest analysis of the Management Top 250….

In all, we evaluated 886 large, publicly traded companies last year through the lens of 33 indicators that fall into five categories: customer satisfaction, employee engagement and development, innovation, social responsibility and financial strength.

In our most recent research, we wanted to see where companies were setting themselves apart, thereby shedding light on the richest opportunities for firms to build a distinct reputation or brand identity.

The runaway winner was innovation, where the spread between the highest-scoring company in our universe ( Amazon.com Inc. AMZN -7.56% at 135.9) and the lowest ( Apartment Investment & Management Co. AIV 0.87% at 36.5) is a whopping 99.4 points….

[T]the configuration within social responsibility is striking. It has by far the narrowest span—50 points—between the highest-scoring company ( Microsoft Corp. MSFT -0.55% at 78.9) and the lowest-scoring firm ( Seaboard Corp. SEB -0.73% at 28.9). The differential is 67.3 points in customer satisfaction, 73.4 points in employee engagement and development and 76.3 points in financial strength.”

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

ESG Developments This Week

In Washington, D.C.

SEC continues internal debate about its role in ESG investing

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

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

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

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

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

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

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

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

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

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

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

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

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

On Wall Street and in the private sector

European ESG assets take a tumble—by design

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

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

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

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

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

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

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

The Financial Times reports two stories of dissent

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In the Spotlight

Moody’s launches new ESG ratings service

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

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

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

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

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

ESG Developments This Week

In Washington, D.C.

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

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

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

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

Those days are over….

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

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

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

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

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

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

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

Enhance Board Diversity….

Increase Board Expertise….

Inspire Management Success….”

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

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

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

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

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

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

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

In the States

Bucks County dips its toes in the ESG Waters

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

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

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

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

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

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

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


Are ESG returns about to fall?

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

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

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

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

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

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

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

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

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

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

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

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

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

ESG Developments This Week

In Washington, D.C.

SEC Chairman signals deeper look into ESG investing 

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

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

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

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

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

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

Country’s largest pension plan now offers ESG funds

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

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

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

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

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

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

On Wall Street and in the private sector

Activist hedge fund that won three Exxon Mobil seats launches ETF

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

In the spotlight

Alignment theory, again

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

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

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

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

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

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

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

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

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

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

Economy and Society: House passes ESG disclosure act

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C.

House passes ESG disclosure act

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

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

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

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

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

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

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

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

Tech companies push back against new disclosure standards

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

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

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

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

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

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

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

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

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

Activists prepare for greater ESG disclosure

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

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

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

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

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

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

On Wall Street and in the private sector

Inflation and ESG are reported primary investor concerns

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

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

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

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

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

Fidelity nearly doubles its ESG offerings

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

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

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

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

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

Companies plan for uncertain ESG future

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

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

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

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

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

In the spotlight

ESG and Bitcoin, again

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

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

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

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

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

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

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