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On the Money

When ESG meets the SEC

When crafted well, financial regulations can maintain confidence, ensure stability and protect investors.


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"Geen short selling meer," or something to that effect, likely read the first recorded financial regulation, a ban on short selling, the practice of betting that a particular stock will go down. A lot has changed since the Dutch banned stock shorting in 1608.

A lot, also, has not.

Our financial system is something of a collective hallucination, with a connective tissue of trust holding the ongoing project together. Prior to the Truth in Securities Act of 1933, the U.S. financial market could be a lucrative one for those unencumbered by verifiable truth. Fast-forward to today’s ESG space, whose boom is still echoing and, well, history doesn’t repeat itself, but it can rhyme.

Gary Gensler, chair of the U.S. Securities and Exchange Commission, has been unequivocal about his intention to bring transparency and credibility to ESG investments in the United States while we keep our eyes set on Europe’s progress on these fronts. So, as the SEC takes on ESG, what do those working on the frontlines of ESG investing see as an optimal outcome?

When crafted well, financial regulations can maintain confidence, ensure stability and protect investors.

Like many events of 2020-21, the regulatory horizon for sustainable investing lacks precedent. As Alexandra Mihailescu Cichon, executive vice president at RepRisk, told me, "We know this regulatory growth is a good sign for ESG, as it will help bring clarity and comparability over time, but that doesn’t mean it’s not a painful process for those in the space."

Keep it competitive

When crafted well, financial regulations can minimize the aforementioned pain by maintaining confidence, ensuring stability and protecting investors. But setting rules and regulations for ESG in the U.S. market is tough for a host of reasons, including the alphabet soup of existing disclosures and frameworks, a lack of consensus on metrics and standards and lobbying efforts by fossil-fuel incumbents to thwart progress.

Maintaining a competitive advantage for the U.S. financial market should be a shared goal when considering the SEC’s disclosure mandate, hyperpartisanship and ideology aside. After all, the investor class does not lean red or blue.

As Sanjay Patnaik, director of the Center on Regulation and Markets at the Brookings Institution, shared with me: "The Europeans moved on carbon pricing. The rest of the world followed, and the U.S. stayed behind completely. We really can’t afford to be behind on the financial market regulatory side, too. So many of these companies operate globally and they don’t like dealing with a patchwork of regulations."

Part of the noncontroversial value ESG provides is that it’s simply more information to use in investment decision-making. But on the other side of that coin, there is a whole lot under the hood in ESG — as Glen Yelton, head of ESG client strategies, North America and EMEA at Invesco, explained: "The issues that are embodied by the ESG acronym don’t naturally coexist."

It’s the climate, stupid

True, some components of the ESG edifice are considerably more sturdy, tangible and measurable than others, although folks in the industry are hard at work trying to address this.

Back to the SEC’s role. "In social science, there are differing philosophies. The different take on ESG from [SEC] Commissioner Hester Peirce and Chair Gensler is a classic example of these social science paradoxes," explained Pooja Khosla, executive vice president at climate analytics firm Entelligent. However, she noted, we should not forget the science behind the E of ESG: "We are not talking about differences of opinion. We need to scientifically solve an existential risk that threatens the entire future of Earth-originating intelligent life."

The SEC’s call for comments on disclosure earlier this year asked us Earth-originating intelligent beings: "In addition to climate-related disclosure, the [SEC] staff is evaluating a range of disclosure issues under the heading of environmental, social and governance, or ESG, matters. Should climate-related requirements be one component of a broader ESG disclosure framework?"

I heard across most conversations: Yes! Start with climate! I didn’t hear grumblings about any socialist wishlist caricature that’s sometimes leveled at the broad ambitions of the S pillar of ESG, but I certainly heard concerns about climate taking precedence among other E and S issues. However, it was also telling that many of those I asked about this didn’t want to be quoted by name. Talking about climate, it seems, is still a third rail for some finance professionals when it comes to discussing policy issues.

A reporting lead at an American asset manager, who asked not to be named, told me, "Climate should definitely be its own bucket and should be the start for mandated reporting. ... I don’t think we can wrap all that ESG encompasses into a useful mandatory disclosure, or maybe just not at this point. We simply don’t have time on climate."

There are plenty of pithy sayings in support of pragmatism — "Let’s not let perfect be the enemy of the good" is a classic — but what some read as pragmatism here, others likely read as more of the incrementalism or timidity that got us to Code Red in the first place.

Everything and nothing

A more fundamental issue here may be that just as you can’t manage what you don’t measure, you can’t measure what you can’t define.

Going back to my conversation with Yelton at Invesco, he told me, "ESG as a product is just not the same as ESG as a strategy. Taking advantage of asymmetric information to find alpha, that is not under attack and it shouldn’t be. The ESG label itself is now part of the problem."

Or as Erika Karp of Pathstone once shared with me, in Zen koan form: "ESG is everything and nothing at the same time."

Bloomberg says that ESG assets are on track to exceed $50 trillion by 2025, while back here in 2021 roughly 1,721 webcasts are asking "What is ESG?" Which is to say that ESG is experiencing similar challenges to "sustainability" in that it lacks a solid, and legal, definition. (To Karp’s point, if a tobacco company uses clean energy for its operations, is it "sustainable"?).

Climate change disclosure is unambiguously on the SEC’s short-term rulemaking agenda. Whether mandatory climate reporting lands in 10-K filings, is mandated as a discrete disclosure on climate or includes requirements for broader ESG disclosure, a common theme from those on the frontlines is that the financial community is desperate for definitions.

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