Politics, economics shape advocacy

Comments in opposition to ESG in the political realm tend to center on concerns about states’ economic prospects, especially those that rely to greater degrees on activities related to fossil fuel energy or firearms industries for tax revenues and jobs.

For example,19 state attorneys general (AGs) recently wrote to one asset manager that manages ESG-based strategies. “Based on the facts currently available to us,” the AGs state, the firm “appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote.”

The AGs also initiated a probe into whether Morningstar Inc. violated consumer-protection laws with its evaluations of companies’ ESG performance. In addition, AGs from 24 states, wrote to the Securities and Exchange Commission (SEC), calling a proposed climate-related disclosure rule “an ill-advised misadventure into environmental regulation.” (See “SEC Proposes Climate-Related Reporting Requirements.”)

A group of 15 state treasurers raised concerns about what they said was the Biden administration’s hostility toward the oil and gas industry. Certain states are refusing to do business with selected investment managers that favor ESG approaches, select ESG-oriented investment funds and other financial firms.

More than a dozen treasurers opposed a potential Department of Labor rule to allow retirement plans to consider risks from global warming in their investment strategy. In a blow to environmentalists, the U.S. Supreme Court ruled that Congress did not give the Environmental Protection Agency the statutory authority to impose a cap on power plants’ carbon dioxide emissions. Seventeen states joined the suit against the EPA.

In a letter to the editor of The Wall Street Journal (the Journal), Breckinridge President Peter Coffin said, “At bottom, ESG is not a product. ESG data is important non-financial information that can be extremely helpful in analyzing a security issuer’s future prospects.

“We believe in a systematic approach that integrates ESG analysis with fundamental research. If grounded in materiality and investment-relevance, the addition of ESG research can provide a more holistic view of potential long-term risks and costs, shifting the sightlines of investors a little further out on the horizon beyond short-term considerations.”

Investment regulators seek to strengthen ESG disclosures

Regulatory scrutiny of ESG focuses more specifically on execution and investor information.

In 2022, SEC Regulators proposed two new rules that focused on greenwashing, which occurs when businesses or investment funds make misleading or unsubstantiated claims about environmental performance about products or activities.

Peter Coffin acknowledged the validity of greenwashing concerns in his letter to the Journal, saying “These practices are regrettable and speak to the need for greater scrutiny of ESG products they should do nothing to diminish the importance of considering ESG factors.”

SEC-proposed rule changes in May intended to address ESG claims of funds under the so-called Names Rule and enforce more standardization of disclosures.

Under the pending Names Rule change, registered investment companies offering funds with names that suggest a focus on a particular type of investment must invest at least 80 percent of the value of their assets in those investments.

The second proposal would increase disclosure, require additional disclosures of ESG strategies in prospectuses, reports, and brochures, implementing disclosure approaches for ESG funds intended to ease comparisons of fund for investors, and require environmentally focused funds to disclose the greenhouse gas (GHG) emissions associated with their investments.

Greenwashing is not the only target of SEC proposed rulemaking in 2022. In addition to its proposed rule on climate-related disclosures, SEC enforcement division lawyers asked some firms for proxy voting information, including whether they recall shares lent out before corporate elections. The initiative may relate to ESG funds voting proxies in a manner that is inconsistent with their mandates. Failure to recall loaned shares raises the prospect of fund shares being voted by short-sellers contrary to ESG interests.

Investment industry weighs in on ESG investing

Within the investment industry, despite widespread acceptance and adoption of ESG research, some still challenge the materiality of ESG factors while others question why, after a decade plus, ESG hasn’t made more progress away from the concerns that are common to ESG approaches and the concept of sustainability. Some critics focus on fees while others point to what they characterize as overstatements by asset managers who offer ESG-oriented investment strategies.

Lending perspective to the discussion, Chris Fidler, Senior Director, Global Industry Standards at the CFA Institute, said in a recent interview, “… there are many different types of investors. And there are many different types of products. We all need to allow for the fact that different people can take different approaches. And maybe we should do a little less judging and maligning of people who are taking different approaches. That might be healthy.”[1]

Erika Karp, Executive Managing Director and Chief Impact Officer at Pathstone, adviser on $40 billion of assets for families, foundations, and endowments, offered the following perspective, “The term Environmental, Social and Governance (ESG) describes an analytical approach. This discipline is an integral and essential part of comprehensive and thorough investment research.”

Breckinridge’s ESG perspective remains consistent over the past decade plus

For its part Breckinridge maintains the stance that it adopted more than a decade ago when it integrated ESG into its investment process. Driven by its investment research team, Breckinridge integrates material ESG issues to identify and assess long-term and idiosyncratic risks.

The firm believes that a thoughtful and forward-looking assessment of risk would be incomplete without the inclusion of material ESG factors. It also believes ESG factors can provide useful insights into the character and caliber of an issuer’s of management team.

Breckinridge’s ESG integration methodology combines a quantitative assessment of ESG factors alongside a rigorous review of qualitative ESG considerations to derive a composite sustainability rating.

“In addition to financial data, we look at ESG metrics because it’s supplementary data that we believe to be material to varying degrees across issuers and sectors,” explained Breckinridge Co-Head of Research Nick Elfner. “ESG, like many things today, is being heavily politicized and that is likely to continue and perhaps intensify. We stay true to our messaging by focusing on materiality and its investment merit.”

Commenting on the current public examination of ESG by regulators and practitioners, Breckinridge Co-Head of Research Adam Stern said, “Scrutiny is a justified and healthy development for the emerging ESG investment space. ESG investment products have proliferated at a rapid clip in recent years, and as with any fast-emerging financial product, a degree of skepticism is warranted from investors and regulators, alike.”

He added, when considering the politically and sometimes culturally charged tone of some commentary, “It would be a disservice to many if poorly conceived Wall Street financial products or ambitious politicians taint the reputation of ESG before more investors can benefit from it.”

 

[1] “Q&A: CFA’s Chris Fidler on different types of greenwashing,” Investment News, August 5, 2022

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