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Keeping you in-the-know on environmental, social and governance developments

A couple months ago, I saw an estimate that the number of ESG investment options exceeds 600. I don’t know about that, but I am confident the number is well north of 300. Investors have been a driving force – if not the driving force – behind the growth in ESG during the past three years. This growth has implications for both their universe as well as that of the companies in which they invest.

What’s In a Name?

Investment firms are rushing to ride the wave by launching a bewildering array of ESG-themed options. But not all the options are what they seem. Last April, the SEC took the unusual step of issuing a Risk Alert concerning “observations of deficiencies and internal control weaknesses from examinations of investment advisers and funds regarding ESG investing.” The conclusion:

… firms should ensure that their approaches to ESG investing are implemented consistently throughout the firm where relevant and are adequately addressed in the firm’s policies and procedures and subject to appropriate oversight by compliance personnel.

This happened three months ago, so old news, right? Not so fast. In the UK yesterday, the Financial Conduct Authority (FCA) penned a letter to fund managers expressing similar concerns:

We have seen numerous applications for authorisation of investment funds with an ESG or sustainability focus. A number of these have been poorly drafted and have fallen below our expectations. They often contain claims that do not bear scrutiny. Also, we would have expected questions raised at the authorisation stage to have been asked (and addressed) in the product design phase. Such applications are likely to fail to meet the applicable requirements as set out further in the annex to this letter. We expect to see material improvements in future applications. We also expect clear and accurate ongoing disclosures to consumers where funds make ESG-related claims, and we want to see funds deliver on their stated objectives and/or strategy. We include in this letter a set of guiding principles that explains our expectations in this area.

The letter also sets forth some examples of funds that fell “below [their] expectations” as well as offers guiding principles for “funds that make specific ESG-related claims, not those that integrate ESG considerations into mainstream investment processes.”

What This Means

The message seems clear for investors, but there is potentially welcome subtext for companies besieged with investor questionnaires and surveys: you might not need to complete ESG information requests from all investors. If an investor isn’t actually using information that took you meaningful time, effort and opportunity cost to gather and report, perhaps you needn’t expend that effort. It might take a little effort to determine how (or if) a particular investor uses your ESG information, but that pales in comparison to responding to the survey or questionnaire. The same logic doesn’t apply to ESG ratings agencies, however.

There is a cautionary tale here. A recent study from the University of Chicago Booth School of Business

… found a positive correlation between ESG score and how many metrics a firm disclosed, which supports their hypothesis that ESG scores don’t objectively convey CSR performance. Firms get a score boost for disclosing a greater number of metrics, but the score is not associated with the performance ranking of the firm within their industry.  

So the more information you disclose to a particular investor or rater, the better your score generally in comparison to investors/raters to whom you disclose less information. Assuming, of course, the information you provide is actually used/processed.

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The Editor

Lawrence Heim has been practicing in the field of ESG management for almost 40 years. He began his career as a legal assistant in the Environmental Practice of Vinson & Elkins working for a partner who is nationally recognized and an adjunct professor of environmental law at the University of Texas Law School. He moved into technical environmental consulting with ENSR Consulting & Engineering at the height of environmental regulatory development, working across a range of disciplines. He was one… View Profile