Lucy’s Human: Remarks at Virtual Roundtable on The Role of Asset Management in ESG Investing Hosted By Harvard Law School and the Program on International Financial Systems
Sept. 17, 2020
Thank you, John [Gulliver] and thanks Hal [Scott] for inviting me to be part of this forum. It is a pleasure to be here with you all today. The views I express are my own and do not necessarily represent those of the Commission or my fellow Commissioners. For that matter, they may not represent the views of anyone else sharing this virtual conference hall.
During the COVID era, as has happened to many of you, a new dog came into my life. No, I have not adopted a dog. Much as I would love to have the company, my condo building has a prohibition on dogs with the exception of the large German Shepherd that somehow has negotiated an exemption. The dog I have developed a relationship with is smaller, but no less fierce than that German Shepherd. Her name is Lucy. She walks with her owner in the park during my morning runs. Lucy hates me. She did not always feel that way, but our relationship—along with so many others—COVID-cratered. During an attack earlier this week, her owner assured me that “She is just trying to say hello.” I did not stick around for the rest of the conversation. The source of her dislike of me seems to be my mask. I once ran by without one. Lucy was mildly friendly, but her masked human earnestly called me out for my exposed face and instructed me not to run if I could not do so with a mask. The second time I saw Lucy, her masked owner was wielding a large sign entreating me to: “Please wear a mask.” So now I wear a mask when I run by Lucy and Lucy lunges for me. What surprised me, however, is that her owner has stopped wearing one. To be fair, she does keep one hanging jauntily around her neck. So, here’s how it goes: I wear a mask when I pass Lucy and her owner, Lucy attacks me, her unmasked owner laughs at me while gently chiding Lucy, and I try to keep my cool by thinking about ESG, which is the only reason I told you this story.
Why ESG? Well, Lucy’s owner is a bit like an asset manager who talks the ESG talk, but doesn’t walk the ESG walk. Judging from her words and even from a few early actions, masks are very important to Lucy’s owner. But now that some time has passed, it is clear that masks are not all that important to her after all. (To be fair to Lucy’s owner, I am not masked the whole time I am running either.) Identifying asset managers who proclaim ESG, but don’t live it, is not so easy. Investors are pouring assets into ESG-labelled investment products, and asset managers are churning out new products in response. While the demand for these products is clear, less clear is what exactly these investors are buying.
My colleague Commissioner Roisman raised pertinent questions on this subject in a recent speech:
When an asset manager markets a fund as having an ESG strategy, it has an obligation to disclose material information about that fund to investors and potential investors. Additionally, it would make sense to me that asset managers who want to use these terms to name their funds or advertise their products should be required to explain to investors what they mean. How do the terms “ESG,” “green,” and “sustainable” relate to a fund’s objectives, constraints, strategies, and the characteristics of its holdings? Are “E,” “S,” and “G” weighted the same when selecting portfolio companies? Does the fund intend to subordinate the goal of achieving economic returns to non-pecuniary goals, and if so, to what extent?
I agree with Commissioner Roisman that funds must clearly disclose their investment strategies so that an investor can make informed decisions about whether a fund that claims to be an ESG fund is an ESG fund as that investor defines it. Asset managers who do not have to explain what they mean by using terms like “ESG” and “sustainable” can get a bit loosey-goosey with those terms.
Some observers would have us go one step further and standardize what it means to have an ESG strategy. Doing so would limit choices for investors, stifle innovation by funds, and put the SEC in the inappropriate position of deciding whether an asset manager’s strategy is, for example, sufficiently green or properly socially conscious. One person’s ecofriendly windmill is another person’s bird killer, and I do not want to insert myself in the middle of that debate. Better to let an asset manager describe its approach to funding green energy so that likeminded investors can select that asset manager and differently minded investors can go elsewhere.
Just as there is not one ESG asset management formula, there is not one set of metrics that asset managers and others can use to assess issuers’ commitment to ESG. Yet, here too, the Commission faces tremendous pressure from a variety of market participants to implement a standardized ESG disclosure framework. Most ESG reporting occurs outside of SEC filings, because companies are determining that the information is not material to an investment decision. Even looking to sustainability reports not filed with the Commission, we have not seen a coalescence around a single framework—which is not surprising given the unique circumstances facing individual companies and specific industries. Proponents of a single framework argue that only such a framework could ensure comparable information across companies. Some issuers, exasperated by the countless ESG surveys to which they must respond, would welcome such a framework to alleviate their overall reporting burden.
I understand the calls from issuers and investors for a nice, neat set of ESG metrics, but I suspect that the reality would not be as wonderful as some advocates imagine. First, a prescriptive ESG framework would run directly counter to our tried and true principles-based disclosure framework, which is rooted in materiality, rather than specific metrics. This principles-based framework is a significant source of strength for our capital markets. As a securities regulator, I see it as part of my job to defend our principles-based disclosure framework from attacks, even well intentioned ones that are clothed in “this time really is different” rhetoric. If we allow our disclosure regime to address the specific desires of each special interest group, we will increase the costs of being a public company, weaken our focus on investor protection, and stray from our agency’s mission. Under the existing framework, companies should be disclosing specific ESG measures that management uses to evaluate the company’s results and prospects. For example, our MD&A disclosure requirements require narrative disclosure enabling investors to see a registrant through the eyes of management. Additionally, we recently amended the business description requirement to include, to the extent material, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business. Moreover, I would expect that companies are regularly considering disclosures, ESG or otherwise, provided by their competitors when determining whether they are properly evaluating their business and providing material information to investors.
Second, even a mandatory set of metrics does not guarantee consistency. For example, there would likely continue to be inconsistencies in the way that ESG measures are disclosed, because each company will be applying them against the backdrop of its unique operations, judgments, and assumptions. A recent GAO report on ESG disclosures noted this phenomenon: companies using the same ESG framework failed to disclose ESG topics in a consistent manner. People like to point us toward accounting standards as a model, but the historical proliferation of country-specific GAAPs suggests that a common framework does not promise to yield consistent, comparable outputs.
Third, we should not assume that if the SEC were to crown a specific private metric creator with FASB-like status, the remaining ESG standard setters would simply fade away. There is a lot of money being made by these firms, so they likely are here to stay. One need only to look at the use of non-GAAP measures to understand that markets do not simply consume SEC-approved disclosure standards.
Fourth, there is no clear winner among private standard setters. Even within industries, consistency is lacking. As an example, one industry that has embraced ESG reporting, mostly outside of SEC reports, is real estate. However, there are clear differences of opinion among REITs as to which framework, or how many frameworks, to use when providing ESG information. In 2019, for the top 100 REITs based on a percentage of equity market capitalization, 67% aligned their reporting to CDP, 53% to GRESB, and 52% aligned to GRI. Even for this industry, which is engaged in ESG reporting, it would be imprudent for a regulator to step in at this stage to declare some or all of these metrics to be material and to require a specific framework. Companies across the industry are still expressing substantially different views on the subject.
Let me close with some suggestions for productive conversations on a topic that may divide us. First, tailor your requests to the SEC. The term ESG is too broad; it encapsulates myriad issues under its umbrella and deprives us of substantive and worthwhile discussions on individual issues. My door is always open, however, if you want to explain to me why a specific measure or metric is material across all companies or across all companies within a specific industry. Second, be willing to explore and explain the relationship between ESG investing and investment returns. In a recent proposal, the Department of Labor foreclosed ERISA plan fiduciaries from investing in ESG vehicles when doing so would sacrifice investment returns. I am somewhat surprised by some asset managers’ unfavorable reactions to the proposal given the common refrain that ESG investing generally outperforms the market. People making these claims should be prepared to back them up. Underscoring my first suggestion, I suspect that doing so convincingly will require focusing on particular metrics, rather than groups of metrics.
ESG issues are not going away. I look forward to today’s discussion and many productive future conversations on ESG disclosure issues. Please feel free to reach out to talk with me after today’s panel to talk ESG or to suggest sustainable face masks—by which I mean that they are suitable for placating Lucy and her human.
 Elad Roisman, Commissioner, SEC, Keynote Speech at the Society for Corporate Governance National Conference (July 7, 2020), https://www.sec.gov/news/speech/roisman-keynote-society-corporate-governance-national-conference-2020.
 See Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operation, Release No. 33-8350 (Dec. 19, 2003), https://www.sec.gov/rules/interp/33-8350.htm. The Commission proposed to codify this specific piece of guidance into the description of MD&A objectives. See Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, Release No. 33-10750 (Jan. 30, 2020), https://www.sec.gov/rules/proposed/2020/33-10750.pdf.
 Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-10825 (Aug. 26, 2020), https://www.sec.gov/rules/final/2020/33-10825.pdf.
 GAO Report, Public Companies: Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them (July 2020) at 33, https://www.gao.gov/assets/710/707949.pdf.
 See Nareit, REIT ESG Dashboard (finding that 92% of REITs with an equity market capitalization greater than $10 billion, 93% of REITs $5 billion – $10 billion, and 71% of REITs less than $5 billion engage in ESG reporting), https://www.reit.com/investing/reits-sustainability/reit-esg-dashboard.
 Nareit, REIT Industry ESG Report (June 2020) at 8, https://www.reit.com/sites/default/files/media/DataResearch/Nareit_ESG_Report_2020_Final.pdf.
 Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39113 (proposed June 30, 2020), https://www.federalregister.gov/documents/2020/06/30/2020-13705/financial-factors-in-selecting-plan-investments.
 See Esther Whieldon, Michael Copley, & Robert Clark, Major ESG Investment Funds Outperforming S&P 500 During COVID-19, S&P Global Market Intelligence (Apr. 13, 2020), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/major-esg-investment-funds-outperforming-s-p-500-during-covid-19-57965103; Jon Hale, U.S. ESG Funds Outperformed Conventional Funds in 2019, Morningstar (Apr. 16, 2020), https://www.morningstar.com/articles/973590/us-esg-funds-outperformed-conventional-funds-in-2019. But see Amy Whyte, Academics Attack ESG for Failure to Outperform During Crisis, Institutional Investor (Aug. 20, 2020) (discussing findings of Elizabeth Demers, Jurian Hendrikse, Philip Joos, & Baruch Lev, ESG Didn’t Immunize Stocks Against the COVID-19 Market Crash, NYU Stern School of Business (Aug. 17, 2020)), https://www.institutionalinvestor.com/article/b1n0tqh3vbj123/Academics-Attack-ESG-for-Failure-to-Outperform-During-Crisis.