Thomson Reuters Foundation News: Why the SEC should consider corporate and investor ESG disclosures
All eyes have been on the U.S. Securities and Exchange Commission (SEC) following the agency’s recent invitation for public comments on how it should approach climate change and environmental, social, and governance (ESG) disclosures.
Hundreds of investors, companies, sustainability advocates and civil society organizations voiced their support for the agency’s efforts to “[facilitate] the disclosure of consistent, comparable, and reliable information” on these topics.
As we wrote in our comment letter to the SEC, climate change and other ESG issues have a significant impact on the health of the financial system and investors’ portfolios.
In the letter, we highlight how investment strategies can ultimately shift risk to workers and communities in the forms of lower quality jobs and the deterioration of quality and affordable goods and services.
These issues “fall squarely within the SEC’s mandate to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.”
However, many of these risks stem from activities not only at the corporate level, but investor level, as well. The narrow focus on corporate disclosures, while not also including investor disclosures, can result in the oversight of important activities.
Higher risk, low yield boomerang
As we highlight in our recent working paper, ESG 2.0: Managing & Measuring Investor Risks Beyond the Enterprise Level, there is strong evidence to show that both investors and companies engage in a range of activities that create negative impacts for the economy, which boomerang back to investors’ portfolios in the form of higher risk and lower return.
For instance, investors can influence a company’s capital structure in ways that restrict or support that company in managing ESG risks.
In private equity and certain high-risk investments, this dynamic can manifest as a result of overleveraging companies, putting them in a situation in which they must cut costs related to the quality of jobs or delivery of essential goods and services.
Similarly, the growth in corporate debt and weakening of underwriting standards has increased concern about a potential corporate debt crisis. Disclosure about leverage practices and their ESG implications could disincentivize financial engineering that puts both markets and stakeholders at risk.
Tax havens and waivers
As another example, ESG frameworks increasingly cover disclosures about corporate issuers’ tax practices, with emerging guidance from organizations including The Principles for Responsible Investment, the B Team, and Global Reporting Initiative.
However, fund managers also often domicile funds in tax havens, adopt fee and carry waivers, among other strategies to avoid paying taxes.
The weakening of the tax base reduces governments’ resources to regulate and oversee markets, as well as to support both markets and the real economy in times of financial distress.
There is growing concern, for instance, about how governments will pay for the fiscal and monetary interventions to support recovery from the COVID-19 pandemic. Given investors have benefited handsomely from such government support, it is arguably appropriate that they should contribute to replenishing these funds and ensuring their availability for future incidents.
To be sure, the SEC interventions on ESG are about disclosures, not direct regulation of tax practices. While some may argue that disclosure itself is not a solution to tax avoidance, such disclosures would help to better inform multi-stakeholder discussions with investors, issuers, civil society, academics, and policymakers and regulators to co-create more specific solutions on policy and regulation to prevent tax avoidance.
Lobbying and $600m campaign contributions
Unfortunately, it is difficult to make progress on this and so many other issues because policymakers and regulators are also inhibited from governing democratically due to the influence of private sector lobbying and political spend.
The private equity industry, which manages approximately 200 lobbyists, has made nearly $600 million in campaign contributions over the past decade. Some efforts have been to protect tax avoidance schemes. Others have been to protect additional activities that may run counter to a fund’s stated ESG goals. For instance, vast sums have been spent on the protection of surprise medical billing.
As noted by Commissioner Allison Herren Lee, political spending disclosure is necessary for investors to adequately test the claims of company management. Yet, according to recent research by Preventable Surprises, the asset management industry does a poor job when it comes to transparency on lobbying and policy capture.
For instance, of the 50 asset managers included in the research – representing a combined $66 trillion in assets under management – only 16 provide public information on their trade association affiliations.
Investors and their activities are the foundations of markets – comprising the “plumbing” upon which businesses and communities operate. Requiring corporate disclosure on ESG issues without also addressing structural issues relating to investor-level activity will leave markets with a “swiss cheese” style and incomplete understanding of risks.
For an effective disclosure framework, it will be critical to consider the entire market landscape, which is comprised not only of companies, but also investors. Fortunately, we are seeing some movement on this dimension of the markets with the announcement that the SEC will mandate disclosure of diversity, equity, and inclusion (DEI) information by investors. This is a serious step forward to celebrate. And hopefully the first of many.
This opinion piece is part of the Thomson Reuters Foundation’s work, Amplifying the “S” in ESG, which aims to promote wide adoption of social criteria in investment strategies.