Over the last few years the pages of P&I have charted the increasing focus by mainstream investors on environmental, social and governance factors. We were, therefore, surprised by your Oct. 15 editorial, "SEC must say no to ESG regulation," and felt it important to share our view as a diversified investment manager whose clients regularly ask us how we consider material ESG factors in pursuit of long-term investment performance.
Let us be clear: ESG factors already influence valuation, portfolio construction and engagement activities at many mainstream investment managers. One of the ways that we do this at Neuberger Berman is through proprietary ESG ratings that are based on a combination of company-disclosed data, specialist data sets, estimates and qualitative analyst judgment.
Unfortunately, that is an imprecise task because of the patchy and inconsistent level of disclosure by companies. We believe the lack of high-quality, comparable, decision-useful information on material ESG topics is making it harder for the market to efficiently allocate capital to sustainable companies that can generate strong long-term financial returns for savers.
This effort is exacerbated by "green washing," whereby companies spend heady sums publishing corporate social responsibility reports that are not decision-useful or comparable, and instead focus on financially immaterial issues. A review by the Sustainability Accounting Standards Board of more than 4,000 companies found that in FY2016 only 25% provided quantitative disclosure on every topic defined by SASB as material for their industry.
Fortunately there are leaders like CBRE, GM, jetBlue, Kellogg's, Nike and NRG that have demonstrated how cost-effective and straightforward it is for companies to disclose material ESG data to investors. Yet many executives still tell us that while they collect and monitor material ESG data internally, they will not disclose it to investors unless either their peers do so first or regulators require them to do so. They often say they fear being competitively disadvantaged or the subject of legal action if they move unilaterally.
SEC regulation, of course, is not the only way to solve this problem. Industry bodies could do more to bring companies together to adopt standardized disclosure. Shareholders can continue to engage broadly with companies to request disclosure. But it is not unreasonable for regulators to consider assisting by providing safe harbor rules for companies that do increase disclosure or by instituting comply-or-explain disclosure expectations. Any regulatory action needs to be carefully thought through so as not to lead to an increase in "green washing" and should provide flexibility for companies to publicly explain why they believe an ESG topic is or is not financially material for their business.
Historically, the SEC has sought to formalize disclosure requirements as and when de facto standards emerge and investor demand becomes clear. That was the case in 1992 when a broad public discussion of executive compensation was taking place and shareholder proposals on the topic garnered an average of 21% support at annual shareholder meetings. If P&I's coverage of ESG is anything to go by, we are having a similar level of public debate on the topic of ESG today, and shareholder support of material environmental and social shareholder proposals is significantly above 21%.
Indeed, when the SEC issued a Concept Release on Regulation S-K (which sets forth non-financial statement disclosure requirements) it received an overwhelming level of support from investors for improved sustainability-related disclosure — 80% of non-form sustainability-related comment letters were in favor of improved disclosure, with 68% of comment letters referring to frameworks aligned with the Sustainability Accounting Standards Board.
As a significant investor in both public and private companies, we are confident that were the SEC to provide a rule that set forth clear standards for disclosure on ESG factors, it would not disadvantage public companies. Indeed, leading private equity general partners —who operate with internal rates of return in mind — are increasingly focused on understanding financially material ESG risks and opportunities during diligence and value creation periods. Many are vocal in their support for the SASB.
At a time when regulators in many other major financial markets are providing guidance on material ESG disclosure, this is exactly the right time for the United States to provide the clarity and guidance that global companies require.
