Background
In today’s financial landscape, institutional investors and large corporations are increasingly interested in other factors beyond just the bottom line. Intensifying climate disasters worldwide, coupled with a renewed focus on social justice, have led companies to emphasize environmental, social, and governance (ESG) issues in their corporate strategy.[1] There is no single, universally agreed upon list of what factors to consider when looking into the ESG commitments of a given corporate entity.[2] However, there are certain specifics that most investors and corporate boards have coalesced around.[3] For the environmental prong, the most important items include climate change, biodiversity, carbon footprint, and water conservation. The social component includes human rights, diversity, racial justice, and labor standards. Finally, governance covers corporate structure, executive pay, corruption, and corporate political contributions.[4] In his 2018 letter to major chief executives, BlackRock CEO Larry Fink articulated a groundbreaking philosophy that, “[t]o prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”[5] Put simply, maximizing profits without concern for the wellbeing of others is unsustainable, and companies would do well to incorporate supplemental priorities.
Current Trends
In the last few years, investments in ESG focused funds have skyrocketed, and the returns have been strong. In 2020, companies with high ESG ratings outperformed non-ESG competitors as a group.[6] Compounding this, the two most successful equity funds in the United States that year were both ESG-focused, specifically in clean energy.[7] The upward tick in ESG investing is not limited to proactive searches for ESG-friendly companies. Investors are also divesting at a rapid pace from companies that do not comport with this ethos. Last year, Scottish Widows, a more than 200-year-old life insurance and pension fund announced its divestment of roughly $580 million from companies that do not live up to ESG standards in areas such as human rights and environmental sustainability.[8]
Investors are also taking cues from Washington.[9] After the U.S. Department of Labor announced in March 2021 that it would not prohibit or disincentivize pension funds from considering ESG in their investments, companies saw a record amount of approval for ESG proposals by their shareholders.[10] As companies take notice of the market’s budding preference for ESG-friendly investments, it is likely we will see ESG become ever more prevalent.
Disclosure
As ESG investing continues to grow, both institutional and small investors are looking for insight into the ESG practices of a diverse range of companies. Because of the relatively new focus in this area, many companies do not have sophisticated and standardized reporting mechanisms in place to indicate their ESG approaches.[11] Some have even called on the Securities Exchange Commission (SEC) to step in a establish a universal standard.[12] In a June 2021 speech on this topic, SEC Commissioner Elad Roisman discussed the unique difficulties in creating such a standard, primarily the fact that while ESG factors have some overarching commonalities, every investor is different, and is looking for different distinct criteria.[13] Commissioner Roisman emphasized the difficulty of this task, noting that the SEC may not be the proper body to handle it because the SEC is a slow-moving body that specializes in long-term planning. ESG preferences, on the other hand, are fast-changing and may be very different in a few years from now.[14] However, Roisman stressed that the Commission, in potentially requiring certain forms of disclosure, would consider the materiality of the information first and foremost.[15] This is consistent with longstanding caselaw holding that a piece of information is in fact material if a reasonable investor would consider it important in making an investment decision.[16] SEC Chairman Gary Gensler went even further, announcing that he had directed the Commission’s staff to review recommendations for implementing ESG disclosure requirements.[17]
Conclusion
Environmental, social, and governance related matters are showing no signs of decreasing in importance in the investment sphere. As more and more deep-pocketed investors shift their focus to ESG, we will likely continue to see a sea-change in the priorities and practices of companies seeking to catch the eye of savvy investors. The SEC will no doubt have its hands full with crafting an overarching yet detailed set of standards to protect investors.
[1] See Marc S. Gerber et al., ESG in 2020 So Far: An Update, Harv. L. Sch. F. on Corp. Governance (Sept. 18, 2021), https://corpgov.law.harvard.edu/2021/09/18/esg-in-2021-so-far-an-update/.
[2] Mark S. Bergman et al., Introduction to ESG, Paul Weiss (July 9, 2020), https://www.paulweiss.com/insights/esg-thought-leadership/publications/introduction-to-esg?id=37479.
[3] Id.
[4] Id.
[5] Larry Fink, A Sense of Purpose, BlackRock (2018), https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter.
[6] Michael Mackenzie, Green energy funds top league table in banner year for ESG, Fin. Times (Dec. 26, 2020), https://www.ft.com/content/cad6fcf9-f755-4988-9c75-d41a9b6ff6d8.
[7] Id.
[8] Garnet Roach, Scottish Widows Announces £440 mn ESG divestment plan, IR Magazine (Nov. 9, 2020), https://www.irmagazine.com/shareholder-targeting-id/scottish-widows-announces-£440-mn-esg-divestment-plan.
[9] See Gerber, supra note 1.
[10] Id.
[11] Id.
[12] Id.
[13] Elad L. Roisman, Can The SEC Make ESG Rules That Are Sustainable?, SEC (June 22, 2021), https://www.sec.gov/news/speech/can-the-sec-make-esg-rules-that-are-sustainable#_ftnref6.
[14] Id.
[15] Id.
[16] See Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
[17] Steven Arons, SEC Chairman Gensler Orders Review of Funds’ ESG Disclosures, Bloomberg (Sept. 2, 2021), https://www.bloomberg.com/news/articles/2021-09-02/gensler-orders-sec-to-review-funds-esg-disclosure-practices.
