On Tuesday, the Brookings Institution held a panel discussion regarding the role that the SEC should play in ESG investing. In describing the event, Brookings said that ESG issues “continue to climb in importance for many investors and policy makers. What role should public policy and financial regulation play in response to ESG concerns? These questions are of particular importance for the [SEC] tasked with protecting America’s capital markets and American investors.” You might have assumed that Brookings would have invited as the speaker one of the SEC’s fervent advocates for more prescriptive ESG disclosure regulation, such as Commissioner Allison Herren Lee. But instead, Brookings invited the contrarian Commissioner Hester Peirce as the SEC representative. As an opponent of the SEC’s venturing into the mandatory ESG metrics disclosure business, Peirce came prepared to engage, armed with a voluminous speech consisting of 10 theses, footnoted to the hilt. Recognizing that “whether and how we will move toward a more prescriptive ESG disclosure framework” is now front and center on the SEC’s current agenda, Peirce offered ten theses “without much sugar-coating” in the hopes of catalyzing “a textured conversation about the complexities and consequences of a potential ESG rulemaking.”
Peirce’s ten theses are summarized below:
- “ESG as a category of topics is ill-suited, and perhaps inherently antithetical, to the establishment of clear boundaries and internal cohesion.” Peirce’s first thesis highlights the absence of a clear definition of ESG. While issues such as carbon emissions and employee turnover clearly fall into the ESG bucket, other issues are ESG in the eyes of one speaker but perhaps not another. In her view, as “more and more issuers and asset managers are grasping for the ESG label, they likely will press to expand the number of topics further to make it easier for them to justify calling themselves ESG. However, the broader the issue set gets, the more difficult for the SEC to prescribe precise ESG rules.”
- “Many ESG issues lack a clear tie to financial materiality and therefore do not warrant inclusion in SEC-mandated disclosure.” Her second thesis raises the recurrent refrain about the attenuated relationship of ESG to financial materiality. Peirce’s argument here is that if, as many argue (see, e.g., this PubCo post), ESG is financially material, why isn’t it captured by the current disclosure requirements? (See this PubCo post.) “Materiality matters,” she contends, “Mandating that issuers provide [investors] with information that does not contribute to assessing the prospect for investment returns costs them in, among other things, bills for lawyers and consultants to prepare the disclosures; employee, management, and board time and attention; and potential litigation expenses. Why would we want to impose these costs on shareholders without providing them with the offsetting benefit of material information? …If specific ESG metrics are material to every company in every sector across time, we can identify them one-by-one for incorporation in our rules, but throwing out materiality or stretching it to encompass everything and anything would harm investors.”
- “The biggest ESG advocates are not investors, but stakeholders.” Third, she contends that the SEC’s mission is to protect investors, not stakeholders, but in her view, many “non-investors have tried to repurpose the SEC’s investor-oriented disclosure tool to get information of interest to them and ultimately to shame issuers into changing their behavior. In a few instances, they have been successful. Pay ratio disclosure, for example, is of greater interest to the curious general public than to investors.” ESG advocates “hope to use the securities laws to force issuers to make disclosures about ESG issues important to them and ultimately to compel companies to make behavioral changes. They know that requiring public disclosures about particular employment or environmental activities might cause issuers to avoid those activities altogether, regardless of the costs of those changes to the investor. Investors stand to lose from these changes.” But to the extent that management comp is tied to achievement of ESG metrics, it dilutes “accountability to shareholders for financial performance,” she argues, and management stands to benefit. Finally, she argues that asset managers who advise pension funds or fund complexes are not investors bur rather fiduciaries who are obligated to put their clients’ interests first. In her view, they may take ESG factors into account, “but only if certain circumstances are met, including that the ESG factors have a clear link to risk-adjusted returns or to objectives that the client has chosen to override financial returns.”
- “ESG rulemaking is high-stakes because so many people stand to gain from it.” Fourth, she maintains that the “potential breadth and novelty of ESG issues” creates “particularly lucrative money-making opportunities” arising out of ESG rulemaking. Because many that are pushing ESG stand to profit from it, the financial incentive may make it hard for the SEC to “get objective input.” In Peirce’s view, just about everyone can profit from ESG—consultants, standard-setters and raters, auditors, lawyers, sustainability professionals and “other rent seekers.” Asset managers will benefit financially from the reduction in their legwork. Even issuers “have an incentive to shape the rules to make themselves look as good, and their competitors look as bad, from an ESG perspective as possible.”
- “‘Good’ in ESG is subjective, so writing a rule to highlight the good, the bad, and the ugly will be hard.” Fifth, she argues that there is a lot of debate over best ESG practices and results. That’s why ESG ratings firms are inconsistent in their results. One of her examples: a “company’s decision to switch from fossil fuel production to renewables. The renewables do not produce carbon dioxide, but windmills might kill bats, birds, and insects, and solar panels are very difficult to recycle.” To Peirce, although “a rule that mandates the disclosure of ESG metrics by issuers need not explicitly embody ESG value judgments, choices about which metrics to require can indirectly reflect such judgments.” The question is equally complex in the context of evaluating funds that promote themselves as sustainable, raising questions the SEC has “no business asking or answering.”
- “An ESG rulemaking cannot resolve the many debates around ESG models, methodologies, and metrics.” Peirce’s sixth thesis is that issuers take a variety of approaches to ESG reporting, and there is no “consensus among investors on which framework should be used to report key metrics”; as a result, “to codify something that is in flux and subject to much disagreement, the SEC would have to engage in substantive judgments about the reliability and accuracy of different approaches.” It’s even difficult to assess individual issuer’s risks arising out of climate change. She also takes issue with the perspective of some that ESG metrics are comparable to “standard accounting metrics and susceptible to financial-type audits.” That, she argues, “ignores the messier reality,” such as the uncertainties associated with calculating Scope 3 emissions and the unsettled treatment of carbon offsets. (See this PubCo post and Peirce’s comment letter to the IFRS Foundation.) Moreover, she contends, “the SEC is not particularly well-suited to make judgments about which climate metrics should be reported by whom.” Perhaps the EPA would be better suited to “making these judgments and, indeed, are already doing so.” For example, the EPA “requires GHG emission data at the facility level from [only] the largest GHG emitters, but some are advocating that the SEC require GHG emission data from every single U.S. company, public or private. What does the SEC know about emissions that the EPA does not?” To be sure, if we don’t have confidence in the metrics, what is the point? Where the goal is stated to be “comparability, reliability, and accuracy, codifying rough directional estimates would not accomplish the goal.”
- “Emotions around ESG issues may push us to write rules outside our area of authority.” Seventh, Peirce contends that fears and guilt over climate and other ESG topics “can tempt us to wander outside our limited regulatory mission to address any number of issues that deeply concern us.” However, she argues, emotions are a “poor guide to problem solving.” Moreover, “[h]astily conceived ESG disclosure rules” can be impediments to the efforts of “cool-headed human ingenuity” to address these issues “by cutting off capital to places where it can be most effective at solving the world’s most intractable problems.”
- “ESG issues are inherently political, which means that an ESG rulemaking could drag the SEC and issuers into territory that is best left to political and civil society institutions.” Eighth, in Peirce’s view, “ESG mandates would place political issues front and center at corporations, and the SEC along with them.” But accountable Congress and legislatures are the right bodies to address these political and social issues, not companies or an SEC that has not been authorized to do so by Congress, she asserts. Without a delegation of authority by Congress, she argues, an expansion by the SEC of its authority would raise “serious democratic legitimacy concerns,” and would be compounded by delegation to one or more “unaccountable third-party standard-setters.”
- “ESG disclosure requirements may direct capital flows to favored industries in a way that runs counter to our historically agnostic approach.” Peirce’s ninth thesis opposes efforts to direct “capital flows to green uses,” which she claims is “unabashedly at the heart of international ESG standard-setting efforts.” Involving the SEC in that shift would be a new role for the agency, which has historically focused on disclosure and has not advised investors where to allocate their capital: “A very prescriptive climate disclosure framework for issuers together with standards for asset managers that key off that framework would change behavior and move capital to companies and investment products that perform well according to the selected metrics and away from those that do not.”
- “An ESG rulemaking could play a role in undermining financial and economic stability.” Her tenth and final thesis is that the “growing global concentration of capital in certain sectors or issuers deemed to be green could destabilize the financial system.” In Peirce’s view, establishing ESG metrics based on our current knowledge of climate and other ESG problems and solutions and using those metrics to allocate capital could precipitate instability and “would be a mistake: The entire twentieth century teaches us that centralized capital allocation does not work, and there is no reason to think that centrally developed ESG metrics—even if comparable, reliable, and accurate (and that is a big if)—will be the exception.” A single-minded focus on sustainability, she argues, could also have unintended consequences of denying “developing countries the technologies they need to modernize so that their citizens can enjoy food, water, security, and good health.”
In conclusion, Peirce advocates that, instead of adopting prescriptive ESG rules, the SEC “could work within our existing regulatory framework. We could put out updated guidance to help issuers think through how the existing disclosure regime already reaches many ESG topics and to address frequently asked questions that arise in connection with the application of the existing disclosure regime. We also might consider whether we can give any Commission-level comfort about forward-looking statements.”
