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SEC Commissioner's Speech Rankles ESG Industry

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Impact investing took a direct hit with a speech by Securities and Exchange Commissioner Hester Peirce delivered recently to the American Enterprise Institute, just before the July 10 Financial Services House Committee hearing on Building a Sustainable and Competitive Economy: An Examination of Proposals to Improve Environmental, Social and Governance Disclosures.

The speech, which took on environmental, social and governance ratings and proxy voting especially, was seen by some in the impact investing business as anything from surprisingly uninformed to a call to action for the ESG industry to do better.

“As ESG investing has seen significant uptake among a variety of investors [such as UBS, TIAA, Blackrock, State Street] it’s importance and legitimacy have grown too,” said Jonas Kron, director of shareholder advocacy for Trillium Asset Management, which specializes in ESG investing. “As we’ve seen more of that, we’re also seeing pushback from corners that want to keep the marketplace in the 20th century. In that sense [the speech was] not a surprise.”

More direct was Jon Hale, global head of sustainable investing research for Morningstar, “One thing I’ve noticed about critics of sustainable investing is that they often seem to have no idea what they’re talking about,” he wrote in his blog, calling Peirce’s speech hardly “appropriate given the office she holds,” and “delivering an over-the-top broadside against ESG.”

One ratings agency leader was more sanguine: “The ESG industry can be happy the SEC talks about us. That’s a positive.”

Scarlet Letter?

Peirce, one of the republican commissioners on the SEC, likened ESG ratings to painting a scarlet letter on corporations that don’t comply.

“We are seeing a similar scarlet letter phenomenon in today’s modern, but no less flawed world,” Peirce said. “I will focus specifically on the way in which corporations are assessed according to [ESG] factors. Here too we see labeling based on incomplete information, public shaming, and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on people.”

The gist of Peirce’s comments, other than to disavow ESG investing, was focused on the lack of standardized ESG ratings — a complaint many in the industry agree with. She also noted that proxy voting pushed by ESG ratings firms was a problem and has hurt corporations.

Hale would have none of it, stating “ESG evaluations are all about trying to gather facts and understanding their context,” he wrote. “ESG ratings are based on systematic frameworks and a plethora of indicators. They are focused on financial materiality and peer-group comparisons. The whole enterprise is about bothering a lot about facts and circumstances. The goal is to produce actionable information for investors. No one would take ESG ratings seriously if they didn’t ‘bother much’ about facts and circumstances.”

The data ratings leader saw the speech more as a “call to action,” in which he noted there are a lot of rating differentials. “This is something we have to do as an industry.”

Fran Seegull, executive director of the U.S. Impact Investing Alliance, told ThinkAdvisor that Peirce had some points, such as the need for “common terms, common standards, and in managing and disclosing information.”

In a webinar focused on investor-driven ESG disclosure the same week as Peirce’s remarks, Matthew Welch, president of the Sustainability Accounting Standards Board, noted that with the “huge gap between book value of a company and market value, investors are looking for information not contained in the annual report. ESG is a big part of that.”

State Street’s Ali Weiner, also on the panel, agreed, stating that the industry needs “good data that’s financially material. Investors want standardization of data.”

In defense of where ESG reporting is, Kron said “It’s not like GAAP [Generally Accepted Accounting Principles] reporting sprang forth fully formed; it took time before we got to this point … and we’re still even debating why we do quarterly reporting today. It’s not like ESG is the Wild West and neither is GAAP reporting set in stone. It’s important to remember that ESG is relatively new.”

Peirce also questioned that if firms with ESG investment strategies performed as well as those that don’t, “why, then, must the word ‘ESG’ be used at all? … If ESG disclosures mean disclosing what is financially material, there is little controversy, but the ESG tent seems to house a shifting set of trendy issues of the day, many of which are not material to investors, even if they are subject of popular discourse.”

The last part is what threw Hale, who said, “Now she’s back to just making stuff up. No one who does ESG investing, and I mean no one, is asking companies to disclose information that is not material. Apparently she is unfamiliar with the work of SASB, which is unconscionable for an SEC commissioner opining on materiality and ESG. Materiality has been the watchword for ESG disclosure for years now and SASB has developed industry-specific recommendations for what should be disclosed.”

Hale especially took to task the commissioner’s comment about “a shifting set of trendy issues,” saying, “The rise of customer data privacy and security as an issue for social media and online retailers? Or climate change … [or] maybe she’s taking about gender-diversity issues like equal pay and putting more women on corporate leadership. By calling these issues ‘trendy’ she’s trivializing them and arguing that they shouldn’t be material to investors.”

Shareholders Matter

Another main gripe of the commissioner was the industry’s impact on shareholder voting and the growing influence of proxy voting firms on corporate proposals. Hale says “this was never a big concern until proxy advisors started recommending occasional positive votes on matters related to ESG. Of course they have. As an ESG issue becomes material, it would be irresponsible for proxy advisors to issue blanket recommendations of opposition.”

He adds that his experience is that asset managers are not relying on proxy advisors when it comes to significant shareholder votes around ESG issues.

Seegull notes that Peirce seems to want to “tamp down on investor choice, which will stymie a market that is rapidly growing from retail to institutional investors.”

Hale agrees, “At a time when there is growing support for corporations to focus on the big picture — long-term sustainable growth and accentuating their positive impact on society — it would be exactly the wrong thing to limit the voice of shareholders who want to encourage them to do so.”

The irony of this speech in front of the AEI wasn’t lost on Kron, who said it actually showed “hostility toward the free market.”

Hale adds that Peirce makes corporations out to be “helpless victims of ESG activists. Nothing could be further from the truth. For one thing, corporations can take care of themselves … We’re entering a new era where corporations can and should be a force for good beyond the important basics of job and wealth creation. When you can do good and do well, what’s the big issue with that?”

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