Don’t Force a One-size-fits-all Framework On Social Investors

Don’t Force a One-size-fits-all Framework On Social Investors
(AP Photo/Richard Drew)
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Interest in environmental, social, and governance-themed, or ESG, investing has seen significant growth in recent years, but it has been matched by persistent complaints from some market participants. Chief among these is a lack of clear definitions for what constitutes a “socially responsible,” “green,” or “sustainable” investment product. While a desire for systemic clarity is understandable, investors and analysts need to acknowledge that many aspects of ESG investing simply cannot be forced into a one-size-fits-all framework. Accepting that reality is the smart and reasonable path forward, both for investors and for government officials.

Securities and Exchange Commission (SEC) Chairman Gary Gensler, in remarks this July before the United Nations-affiliated Principles for Responsible Investment, said, “Investors are looking for consistent, comparable, and decision-useful disclosures.” He likened the desired data to the scores given to Olympic athletes. We can compare the performance of a sprinter from another continent or from a century ago to one competing today, because we know they both ran the same distance. Thus, we should also be able to compare how different companies manage ESG-related risks if they are all required to disclose the same types of data.

Chairman Gensler’s Olympics analogy is useful, though it may not support his position in the way he imagines. The International Olympic Committee (IOC) only has jurisdiction over athletes who choose to compete under its auspices and to follow its rules. Anyone is free to host a figure skating tournament with scoring standards different from the IOC’s. What Gensler is suggesting for public companies would be more like a cartel with a single standard-setter, the equivalent of the IOC taking control of every other sports league and federation, including the NBA, the NCAA, FIFA, and others. Many vibrant and innovative nonprofit organizations in the ESG space issue their own guidelines and recommendations — an SEC takeover would all but put them out of business.

Other Commission members have taken a more restrained view of the agency’s ability to create the kind of definitions that would supposedly solve this problem. In a recent speech hosted by the Brookings Institution, SEC Commissioner Hester Peirce reminded the audience that “[the] ‘good’ in ESG is subjective, so writing a rule to highlight the good, the bad, and the ugly will be hard.”

For instance, a policy that advances an environmental goal — increasing renewable energy use — can be undesirable from a social perspective if it makes energy supplies more expensive or less reliable. A policy that is desirable for one environmental reason could also be undesirable for another, as when increasing the number of electric vehicles on the road results in an increase in mining, refining, and shipping of minerals like cobalt and lithium. A disclosure framework premised on firms trying to prioritize one set of values over another, rather than seeking to balance them, would mislead rather than educate.

It’s also an open question whether the Commission’s rules would actually yield such a uniform set of data. In the same speech in which he called for consistent and comparable corporate disclosures, Chairman Gensler mentioned that he has asked agency staff to consider establishing “certain metrics for specific industries, such as banking, insurance, or transportation.” This echoed a statement by then-Acting Chair Alison Herren Lee from March, in which she solicited feedback on creating “different climate change reporting standards for different industries.” The Sustainability Accounting Standards Board, mentioned by name as a possible model for future SEC disclosure rules, recognizes 77 different industries, each with its own set of ESG disclosure guidelines. This suggests that producing “one simple set of data” will not be the result of this process.

Even if it were, a uniform ESG disclosure framework would privilege some topics over others, cement the conventional wisdom of the moment, and create a complex and expensive legal burden on every public company. Forcing every company to disclose on every imaginable sub-topic would be excessively laborious, but choosing topics for particular industries and firms doesn’t address the supposed need for consistent data—which was intended to be the whole point of the exercise.

By contrast, an evolving market for disclosures, in which investors reward firms that provide useful, in-demand data and punish those that fail to do so, could provide the necessary incentives and flexibility that a government mandate will inevitably lack.

Tradeoffs between values like environmental quality, economic growth, shareholder profits, and rising wages are inherent in any debate over ESG investing and metrics. No expert panel—not even the SEC’s professional staff—can arrive at an equation for a “correct” balance. Only the people who own and manage our nation’s companies—their shareholders and directors—can do that, and they don’t agree on which data points are the most relevant and material. If they did, we would already have a voluntary consensus standard.

Investors should demand that quantitative disclosures by corporations be accurate and verifiable, but only a nimble, evolving market can deliver the balance of qualitative information and contextual analysis that best meets the ever-shifting demands of a diverse group of investors.

Richard Morrison is a research fellow at the Competitive Enterprise Institute.



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