The profound focus on ESG and sustainability continues to intensify across global asset management. Brown Brothers Harriman & Co. were delighted last week to announce that we have joined both the United Nations-supported Principles for Responsible Investment (PRI) and the United Nations Global Compact.
As we’ve previously noted, ESG policymaking is one of the most active areas of active discussion. To that end, I’ll have the opportunity to discuss these themes next week at the SIBOS virtual roundtable “The Triple Bottom Line as a Driver for Sustainable Business and a Better World.” What follows are three global ESG issues that have freshly sprung up:
Choppy ESG Waters in the United States?
Even if their implementation is different in content and tempo, financial regulators in Europe and the U.S. generally share overarching goals: increased transparency, consumer protection, and lower transaction costs. But one area where the two have recently seemed to be heading in completely opposite directions is the increasingly important question of sustainable finance.
While the European Union has made sustainability a fundamental requirement for investment managers, a series of U.S. rule changes and proposals have been aimed at limiting the use of environmental, social, and governance criteria in making investment decisions, despite ESG having gained wider acceptance among investors and managers alike. In fact, sustainable funds attracted nearly $27 billion in AUM so far this year, already well above the record level of $20 billion inflows set in 2019 , according to research firm Morningstar.
While there appears to be no question about the inevitable integration of sustainability into the capital markets in Europe, in the United States the debate is not so cut and dry. The political climate certainly plays a role, but it is also healthy to debate these nuanced points to ensure that revisions are only conducted after an appropriate level of debate and dialogue. While the US market continues to see increasing demand and focus on ESG integration, two recent U.S. ESG policy revisions make it apparent that beginning sustainable investing in the U.S. means it’s entering choppier waters than perhaps we are seeing in the European Union.
- SEC Proxy Voting Proposal
Last week, the Securities and Exchanges Commission (SEC) voted 3-to-2 (along expected political lines: three Republicans in favor, two Democrats opposed) to approve amendments to its Rule 14a-8, which governs who is eligible to submit proposals to a shareholder vote.
In response, many ESG and shareholder rights advocates have publicly suggested that the changes go against the growing sentiment for corporate stewardship and sustainability focused matters by allowing all kinds of stakeholders to interact with companies in which they invest. ESG advocates suggest the rule change undermines investors’ ability to have their say on ESG matters and influence management to behave more responsibly on matters such as climate, diversity, and human rights through the shareholder proposal process. The SEC countered by suggesting that this is not a seismic shift to existing requirements, but it does reduce the costs to investors overall by making the proxy voting process more streamlined and efficient by having less proxy voting matters to administer. In fact, one Commissioner even suggested that the proposals do not go far enough, and that the SEC shouldn’t meddle in interactions between companies and their investors and that consideration ought to be given to Rule 14a-8 being decommissioned.
There was evidence presented by industry bodies on the costs of having to administer so many proxy voting matters and that those costs add up when companies and investors (including asset managers and fund boards) must repeatedly review the exact same proposals year after year.
By changing the thresholds of those who can and cannot submit proposals to appear on proxy votes means that smaller investors will find it more difficult to table ESG matters to be voted, especially related to issues of climate change and corporate governance.
The new rule means that higher thresholds on investment amounts and holdings periods are now prescribed which dictate who can put forward proposals for proxy voting. These are:
- Investors with at least $2,000 invested must hold those shares for at least three years before they are eligible to submit a proposal to be voted upon
- Investors with at least $15,000 invested must wait two years
- Investors with $25,000 or more need to wait a year
Anyone with less than $2,000 is not permitted to submit proposals, but that is consistent with existing practice.
There are also new requirements put in place to limit proposals being resubmitted ad nauseum without support. The threshold changes are as followed:
- One-time proposals tabled in last 5 years must receive a favorable vote from 5% of investors (up from 3% previously)
- Proposals issued twice during that period must be supported by 15% of investors (up from 6% previously)
- Proposals that have appeared three or more times must have been supported by 25% of voters (up from 9%)
Other elements of the changes are that investors are no longer permitted to aggregate or pool their shares for the purpose of submitting ballot proposals and anyone submitting proposals must be willing themselves to meet with company officials after they submit their ideas.
The adopted amendments will apply to any proposals submitted for meetings scheduled after January 1, 2022.
- DOL ESG Proposals
In June 2020, the US Department of Labor (DOL) announced a proposed rule to provide further guidance for Employee Retirement Income Security Act (ERISA) plan fiduciaries interested in ESG investing. The proposal at its core suggested that plan fiduciaries should focus on financial returns rather than “nonpecuniary” factors, at a time when many plan managers have begun exploring socially responsible investment options for defined contribution and defined benefit retirement plans. The DOL suggest that ESG should be avoided if it would lead to diminshed investment returns or increased risk “for the purpose of non-financial objectives.”
The industry responses to the DOL proposal are noteworthy for two reasons:
(1) The volume of responses
(2) The level of industry consensus in opposing the proposal
In terms of volume, despite a shortened consultation timeframe (industry had asked for more time), the DOL received 8,737 public comments, far in excess than the norm and the first indicator of the strength of feeling across US plan sponsors, asset manager, asset owners, and ESG and investor advocacy groups.
The second notable factor was the high degree of consensus on submissions and the strength of feeling in the comments opposing the DOL’s proposal. Several responses went so far as to request that the DOL withdraw its proposal in full rather than amend it because of existing adequate regulations for plan fiduciaries and investment managers, making this proposal unnecessary and redundant.
As for common themes of respondents, many believe the proposal should not be rushed and a longer period of consultation is necessary to flesh out the arguments. Several responses suggest that the DOL assertion that ESG automatically results in higher risk or sub-optimal investment returns are inherently flawed and that ESG integration in the investment process in fact does the opposite (e.g.: reduces risk and enhances portfolio performance). Linked to that point, several respondents pointed to a lack of evidence supporting the proposition that ESG is being misused or is proving detrimental to plans and that in presenting the proposal, the DOL fails to cite examples of ERISA fiduciaries allocating any investment on the basis of ‘nonpecuniary’ criteria, much less any investigations or enforcement based on these concerns. There are other points too, but you get my drift: the industry feels the proposal is trying to address concerns that do not exist and may even constrain plan fiduciaries from better outcomes for their plans.
It may be that the proposal may never see the light of day as a final regulation, considering the vociferous industry opposition, a looming contentious election, not to mention talk of legal challenges to the proposal. However, the DoL proposal does highlight that the journey towards integration of ESG across investment markets and investment market segments is not without its challenges.
2. EU Regulators Consult on ESG Document Templates
The three major European Supervisory Authorities (ESAs), the EBA for banks, EIOPA for insurers, and ESMA for asset managers published a public ESG survey last week seeking feedback on how to best present the disclosures required under the sustainable finance disclosure regulation (SFDR) within standardized product templates. Having standardized templates for investor disclosure documents allows for a greater degree of comparability of different financial products, giving investors the ability to truly make “apples to apples” comparisons of various ESG products. However, prior experience in this regard has been challenging. Consider PRIIPs KIDs for example, which has struggled to allow the comparison of funds, banking, and insurance products to the degree intended. Getting the presentation of disclosures right in terms of the right amount of detail and the ability to compare will be crucial to ESG product growth.
The survey even provides three “mockup” versions of how the investor documents might look for review and the process also incorporates a consumer testing exercise which will run at the same time as the survey period. The survey is open for comments until October 16, 2020 which shows once more that the timelines to deliver the various aspects of the EU ESG regulatory agenda remain very aggressive.
3. The “Big Four” Team Up on Global ESG Accounting Standards
One of the specific challenges in the integration of ESG and sustainability across asset management is trust. That’s to say the threat of “greenwashing,” a practice in which the product provider purports to have ESG principles enshrined for marketing and positive customer sentiment, but doesn’t actually follow through in executing those principles, can hamper overall trust in the concept. A critical factor in the general trust levels of financial services lies in its robust audit and assurance practices. Of course, audit cannot ensure there are never any issues, but it certainly provides a level of due diligence.
The leaders of the “Big Four” accounting firms (Deloitte, EY, KPMG, PwC) announced last week a rather novel joint initiative to create an ESG reporting standards framework. In launching the initiative, Punit Renjen, CEO of Deloitte, said the agreed framework could help promote ESG across the board, and given the Big Four audit the vast majority of large corporations globally, they have a fair degree of influence over these client firms to provide required disclosures:
“Right now, there is an alphabet soup of metrics. It is important for us to have a common set of standards and if there is widespread adoption it will lead to change in behavior.”
This could be a step towards an element of global continuity on ESG reporting which has been lacking in many regards to date. The proposal suggests disclosure of 21 core metrics and 34 expanded metrics within annual financial statements using four high level pillars: Governance, Planet, People, and Prosperity.
Critics of the proposals suggest that, yet another non-binding proposal adds an additional layer of complexity onto existing initiatives such as SASB framework and the regulation such as the EU SFDR which already prescribes financial statement disclosures. The most cynical responses suggest it allows the Big Four to benefit commercially on assisting with the implementations across their client base. It remains to be seen how many global companies will ultimately adopt the broad new standards, with several commentators already warning about difficulties for US companies to report on social metrics due to potential liability risks.
What these three different but related stories show is that ESG is an important, dynamic, and at times emotive topic and that there is a fair degree of debate and rulemaking ahead before we have a final global framework in place to facilitate the integration of ESG across global markets.