SEC Investor Advisory Committee Highlights Inherent Challenges with ESG Reporting

December 14, 2018

Yesterday, the U.S. Securities and Exchange Commission (SEC) Investor Advisory Committee met to discuss how the Commission should deal with the increasing prevalence of investors using environmental, social and governance (ESG) factors, in addition to traditional financial reporting, in their decision-making. Participants generally agreed that the current company disclosure practices the ESG ratings assigned to companies often fail to provide investors with useful information about the actual risks those companies face, and do not allow for apples to apples comparisons amongst companies.

This consensus tracks with the findings of an American Council for Capital Formation report which also found that ESG ratings are not standardized, that there is a bias toward larger companies, European companies, and companies in specific industries, and that the ratings fail to predict risk.

Today’s discussion centered around whether the SEC should move forward to address some of these issues by proposing rules that would mandate companies to disclose certain information related to ESG risk. While members of the investment community such as CalPERS and State Street were eager to see the SEC move forward with such a rule, others expressed apprehension about the costs that such requirements would impose on companies and whether requirements would hamper innovation.

SEC Chairman Clayton expressed concern about mandating disclosure in his remarks and noted that a one-size-fits-all requirement may not take into account the unique circumstances of any given company or industry:

“Although third party standards relating to ESG topics may allow for comparability across companies, that does not mean that issuers should be required to follow these frameworks in order to comply with SEC rules. Each company, and each sector, has its own circumstances, which may or may not fit within a standard framework.”

SEC Commissioner Hester Pierce also expressed a concern voiced by retail investors – are ESG issues truly related to a company’s bottom-line or is it about promoting political and social issues? According to Pierce, “ESG means a lot of different things” and there are situations where investor and shareholder money could be spent on things that aren’t actually beneficial for shareholders and “enable stakeholder graft.”

Yahit Cohn, the Associate General Counsel for The Travelers Companies, Inc., verified Pierce’s concerns and described how the growing ESG trend has impacted her company:

“…without a universally understood definition, that term, ESG, has been highjacked by certain special interests to mean something else to move away from shareholder value. As a result of the different spins on ESG, companies are pulled in countless different directions. They are asked to provide disclosure on issues that may or may not be relevant to shareholder value, and are pressured to make business decisions that are at best unrelated to shareholder value and at worse can be detrimental to shareholder value.”

Cohn’s sentiment is also in line with the findings of a study conducted by two leading economists, Professor Joseph Kalt of Harvard University and Dr. Adel Turki, Senior Managing Director at Compass Lexecon, which found that there is no connection between environmental, social and political resolutions and increased shareholder value. Instead, the study found that companies that are targeted by such resolutions are often faced with increased costs.

The discussion around ESG investing at yesterday’s Investor Advisory Committee reiterated why the members of the Main Street Investors Coalition feel strongly that use of ESG must be directly tied to shareholder value, unless investors opt into a fund that specifically promotes an ESG investment strategy. If companies are increasingly burdened by institutional investors with issues unrelated financial growth of those companies, retail investors will pay the price and ultimate receive lower returns on their investments.

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