The tip of the regulatory iceberg?
The Securities and Exchange Commission today announced the creation of a Climate and ESG* Task Force in the Division of Enforcement. The task force will be led by Kelly L. Gibson, the Acting Deputy Director of Enforcement, who will oversee a Division-wide effort, with 22 members drawn from the SEC’s headquarters, regional offices, and Enforcement specialized units. The Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct. The task force will also coordinate the effective use of Division resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations.
What this means, in short, is that things are getting tougher for companies that are part of the global warming crisis or want to profit from investors who wish to support firms that are run on an environmentally friendly basis. Environmental, social, and governance (ESG) criteria are an “increasingly popular way for investors to evaluate companies in which they might want to invest,” said the SEC. In the financial markets, mutual funds, brokerage firms, and robo-advisors now offer products that employ ESG criteria. ESG criteria can also help investors avoid companies that might pose a greater financial risk due to their environmental or other practices. (AutoInformed on BorgWarner Cops SEC Plea for Materially Misstating Financial Statements Concerning Asbestos Litigation)
The initial SEC focus will be to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. The task force will also analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies. Its work will complement the agency’s other initiatives in this area, including the recent appointment of Satyam Khanna as a Senior Policy Advisor for Climate and ESG. As an integral component of the agency’s efforts to address these risks to investors, the task force will work closely with other SEC Divisions and Offices, including the Divisions of Corporation Finance, Investment Management, and Examinations.
“Climate risks and sustainability are critical issues for the investing public and our capital markets,” said Acting Chair Allison Herren Lee. “The task force announced today will play an important role in enhancing and coordinating the efforts of the Division of Enforcement, the Office of the Whistleblower, and other parts of the agency to bolster the efforts of the Commission as a whole on these vital matters.”
In addition, the Climate and ESG Task Force will evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues, and provide expertise and insight to teams working on ESG-related matters across the Division. ESG related tips, referrals and whistleblower complaints can be submitted here.
*Environmental, social, and governance (ESG) criteria are an increasingly popular way for investors to evaluate companies they might want to invest in.
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There is really no historical precedent for the magnitude of the shift in investor focus that we’ve witnessed over the last decade toward the analysis and use of climate and other ESG* risks and impacts in investment decision-making. That’s not to say that investor focus on issues that also have social or ethical significance is new. In the U.S., we can trace it back to 18th century efforts to align investing with religious principles, and see where it gained traction in the 1960s with respect to Civil Rights, and in the 1970s with respect to environmental issues.[1] But for a long time so-called impact or socially-responsible investing was perceived or characterized as a niche personal interest – the pursuit of ideals unconnected to financial or investment fundamentals, or even at odds with maximizing portfolio performance.
That supposed distinction—between what’s “good” and what’s profitable, between what’s sustainable environmentally and what’s sustainable economically, between acting in pursuit of the public interest and acting to maximize the bottom line—is increasingly diminished. Not only have we seen a tremendous shift in capital towards ESG and sustainable investment strategies, but ESG risks and metrics now underpin many traditional investment analyses on investments of all types – a dynamic sometimes referred to as “ESG integration.” In other words, ESG factors often represent a core risk management strategy for portfolio construction.[2]
That’s because investors, asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, and other financial market participants have observed their significance in terms of enterprise value.[3] They have embraced sustainability factors and metrics as significant drivers in decision-making, capital allocation, and pricing.
This last year has helped to clarify why the perceived barrier between social value and market value is breaking down. COVID has driven focus on worker safety. Protests in the wake of the senseless killings of George Floyd and others have driven focus on racial justice. In both of these narratives we can also see connections to climate risk. With COVID, we saw supply chain disruptions similar to that which climate events can cause. We know climate presents heightened risks for marginalized communities, linking it to racial justice concerns. We saw in real time that the issues dominating our national conversation were the same as those dominating decision-making in the boardroom.[4]
Human capital, human rights, climate change – these issues are fundamental to our markets, and investors want to and can help drive sustainable solutions on these issues. We see that unmistakably in shifts in capital toward ESG investing, we see it in investor demands for disclosure on these issues, we see it increasingly reflected on corporate proxy ballots, and we see it in corporate recognition that consumers and investors alike are watching corporate responses to these issues more closely than ever.[5]
That’s why climate and ESG are front and center for the SEC. We understand these issues are key to investors – and therefore key to our core mission. And just as we recognize that these issues do not observe artificial distinctions between society and financial markets, we recognize that climate and ESG transcend other boundaries as well. Geographical boundaries for one. These are global challenges for global markets that demand global solutions. Regulatory boundaries for another. Climate, for instance, is not just an EPA, Treasury, or SEC issue – it’s a challenge for our entire financial system and economy.
*Environmental, social, and governance (ESG) criteria are an increasingly popular way for investors to evaluate companies they might want to invest in.
Footnotes from Allison Herren Lee comments
[1] See Timo Busch, Peter Bruce-Clark, et al., Impact investments: a call for (re)orientation, SN Business and Economics 1:33 (2021); Morningstar, ESG Investing Comes of Age.
[2] See, e.g., Bank of America/Merrill Lynch, Equity Strategy Focus Point, ESG Part II: a deeper dive (June 15, 2017) (“Prior to our work on ESG, we found scant evidence of fundamental measures reliably predicting earnings quality. If anything, high quality stocks based on measures like Return on Equity (ROE) or earnings stability tended to deteriorate in quality, and low-quality stocks tended to improve just on the principle of mean reversion. But ESG appears to isolate non-fundamental attributes that have real earnings impact: these attributes have been a better signal of future earnings volatility than any other measure we have found.”); see also Mozaffar Khan, et al., Corporate Sustainability: First Evidence on Materiality, 91 Acct. Rev. 1697 (2018) (“Using both calendar-time portfolio stock return regressions and firm-level panel regressions we find that firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on these issues.”); Gunnar Friede, Timo Busch & Alexander Bassen, ESG and financial performance: aggregated evidence from more than 2000 empirical studies, 5 J. of Sustainable Fin. and Inv. 210 (2015) (finding that a majority of studies show positive correlations between ESG and financial performance); Robert G. Eccles, Ioannis Ioannou, and George Serafeim, The Impact of Corporate Sustainability on Organizational Processes and Performance, 60 Mmgt. Sci. 2835 (2014) (“[W]e provide evidence that High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance.).
[3] See, e.g., Blackrock, Toward a Common Language for Sustainable Investment (Jan. 2020) (“Our investment conviction is that sustainability-integrated portfolios – composed of more sustainable building-block products – can provide better risk-adjusted returns to investors. With the impact of sustainability on investment returns increasing, we believe that sustainable investment will be a critical foundation for client portfolios going forward.”); Bank of America, 2020 Annual Report (“Research team has found, companies that pay close attention to environmental, social and governance (ESG) priorities are much less likely to fail than companies that do not, giving investors a significant opportunity to build investment portfolios for the long-term. And — through research and our own lived experience — we know that ESG commitments can translate into a better brand, more client favorability and a better place for our teammates to work.”); State Street Global Advisors, The ESG Data Challenge (Mar. 2019) (“Asset owners and their investment managers seek solutions to the challenges posed by a lack of consistent, comparable, and material information. Investors increasingly view material ESG factors as being critical drivers of a company’s ability to generate sustainable long-term performance. In turn, ESG data has increasing importance for investors’ ability to allocate capital most effectively.”); Fitch Ratings, Fitch Ratings Launches ESG Relevance Scores to Show Impact of ESG on Credit (Jan. 7, 2019); Morningstar, Morningstar Formally Integrates ESG into Its Analysis of Stocks, Funds, and Asset Managers (Nov. 17, 2020); see also Mark Carney, Governor of the Bank of England, The Road to Glasgow (Feb. 27, 2020) (“Every major systemic bank, the world’s largest insurers, its biggest pension funds and top asset managers are calling for the disclosure of climate-related financial risk through their support of the Task Force for Climate-related Financial Disclosures (TCFD)”); TCFD Supporters (representing a market capitalization of over $12 trillion and including issuers, credit rating agencies, and index providers as well); Principles for Responsible Investment (PRI) (representing over $90 trillion in assets under management).
[4] See Tom Zanki, SEC Urged to Upgrade Disclosures on COVID-19, Diversity, Law360 (June 30, 2020) (“Gary Cohn, a former director of the National Economic Council for President Donald Trump, predicted that social matters will be a bigger topic in corporate boardrooms once the economy settles. ‘We are going to switch very quickly to a lot more of these social issues: the hiring practices, the wage scale, living wages, and diversity of the workforce,’ Cohn said. ‘It’s here to stay and it’s not going anywhere. Outside of the fact that businesses are fighting for survival, this would occupy 95 percent of their time right now.’”).
[5] See Kevin Stankiewicz, CEOs are offering plans and investments to address racial inequality after George Floyd death, CNBC (June 11, 2020); Large corporations cut off political donations after Capitol siege, AXIOS (Jan. 14, 2021).