Hedge Fund Carbon Accounting

How should short selling account for carbon? Does selling short impact cost of capital or engagement ? My friend Jason Mitchell discusses various views and in particular how regulators have started to think about carbon accounting with hedge funds.

We started talking about this in a podcast a while ago (link end), and you can now read some collected thoughts in the paper which is now publicly available.

Summary:
- Sustainable finance regulation has largely overlooked alternatives, particularly hedge funds, given the greater complexity of strategies and asset classes. However, regulators are now expanding their scope to recognize the role that hedge funds can play in #sustainable finance.

- The role of short selling in sustainable finance, especially in a net zero context, has been increasingly discussed and debated among regulators, market participants, investor initiatives, investor trade organizations, and #ESG data providers. There is a concern that hedge funds may, intentionally or unintentionally, employ short selling to misrepresent their real-world impact, which is distinct from exposure to financial risk.

- Short selling can affect the cost of capital and engagement as channels of influence on corporate behavior. However, there are nuances that should be considered, namely the efficacy of short selling among different asset classes to affect the cost of capital, the time-varying aspect of short selling, and the limitations that short sellers face when engaging corporates.

- UK, US, and EU regulators have each signaled their leaning in different manners. The EU, as the regulator with the most mature regulatory framework, appears to establish a compromise that balances safeguards against greenwashing with the mechanics of portfolio management and reporting.

Download paper here.

Podcast with Jason here.

FCA has published a collection of ESG/sustainability thought pieces

Recommended ESG reading. FCA has published a collection of ESG/sustainability thought pieces. I’ve had a first read today. You are unlikely to agree with all the pieces, but they argue for nuanced views and hit right at the tip of cutting edge debates in this area. So, I am going to suggest this is recommended reading for all those interested in ESG, sustainability issues, long-term investing and governance thinking overall. As part of a FCA consultation. Articles are:

  • Taking a holistic and purpose-led approach to net zero (Tayler, Aviva)

  • Using pay to create accountability for ESG goals (Gosling, LBS)

  • Transitioning to net zero: increasing investor confidence in corporate carbon Commitments (LSE research)

  • Adding purpose to principles and products (Eccles, Oxford) 

  • How to build an effective culture to support climate and sustainability-related objectives in the financial sector (Deloitte)

  • Board-level governance of climate-related matters (Chapter Zero)

  • How a Chief Sustainability Officer can most effectively support a firm in achieving its climate and sustainability-related objectives (Martindale, Cardano)

  • Governing climate transition implementation at banks (Mavraki)

  • Effective governance of investor stewardship to support net zero: a practitioner’s view (Chow, ICGN)

  • Preventing greenwashing: time to stop marking our own homework (Thompson, FCBI) 

Downloadable here and link to splash page here.


George Serafeim podcast transcript, Citywire with Algy Hall | Fix the Future

I made a transcript of the George Serafeim and Algy Hall (Citywire) podcast on ESG. Algy doesn’t challenge George on the push back on one of his key co-authored papers: Corporate Sustainability: First Evidence on Materiality (a summary commentary on the critique with links to it here - the comments are from noted statistician Andrew Gelman, but the orginal critique is from Luca Berchicci and Andy King). This was for many years a well quoted piece of evidence for ESG materiality. The case from academic papers is now more mixed with some of the strongest evidence (IMHO) remaining from the Alex Edmans employee satisfaction work and related work on “human capital” (a term that many non-accountants don’t like!), Caroline Flammer’s work on incentives, long-term, and CSR/ESG (using regression discontinuity design) and some of the work on material transparency.

Still, George is a leading business school voice on ESG/Sustainability and his comments on “Purpose and Profit” and the extra-financial factors that can drive business are useful to know.

(While I podcast myself, I find it much quicker to read transcripts more than listen when I’m going through a lot of work).

Podcast available at link here and below:

Fix The Future Show: ‘ESG was Never Meant to Save The World.’

George "There is a misperception about what ESG is as a management concept, as a governance concept, as an investment concept in business. ESG, at least in my mind, was never meant that it would save the world."

Algy (00:17):

That was George Serafeim, the Charles M. Williams Professor of Business Administration at Harvard Business School, who I'm talking to on this month's Fix The Future Show; the podcast where we explore ideas about how investors can do good in the world while making good money. I'm Algy Hall, the investment editor of Citywire: Fix the Future. Over the last decade, George has been a pioneer in developing the common sense ideas that underpin ESG. He has also been involved with much of the most influential research in the field and continues to push the subject forward including through his work on impact weighted accounts which we'll hear more about later. He's also the author of the recently released book, “Purpose and Profit: How Business Can Lift Up the World.” It's a book I can highly recommend. Hello, George.

George (01:10):

Hello. It's a great pleasure to be here with you.

Algy (01:12):

It's a great pleasure to have you here. I've been a huge fan of your work for many years.

George (01:19):

Thank you.

Algy (01:20):

Well, thank you, I should say. I thought a good place to start was just with your interest in transparency and where that came from in terms of your work. It seems to be a common theme which runs through everything really; this ability just to provide transparency on what's actually going on in companies.

George (01:46):

Yes. For me, that idea is an extremely important one. I like to take people back on the journey that we have traveled over the last hundred years. So if you think about it, the world that we have created, the economic system that we have created, and the society that we have created, a hundred years ago we didn't even have some basic financial reporting and control systems in markets. So if you wanted to get information about the profitability, the sales of a company and so forth, you would be getting very little information, if any information. So things that we take for granted right now were just not there a hundred years ago and a few decades ago in most markets actually around the world. Over time, what we decided as a society is that in order to have accountability over the management of financial resources inside that organization, it would be a good idea to create transparency and to have consistent comparable accounting standards. Then all the mechanisms around the production of accounting numbers, such as, for example, auditing of those, analysis of those and so forth in order to create an accountability structure that then what are the effects of that? Well, it can lead to better resource allocation, decisions, and management of those resources.

If you take that paradigm and apply to what is happening right now in terms of sustainability, you can ask the question, "What are those resources that then we're interested in to understand the efficient and effective management of those?" I think the world has changed and now more and more of the competitors of organizations depend on the management of human capital, intellectual capital, social capital, natural capital, and so forth. So I think we're asking the same basic question which is, "How can we create an accountability structure and a governance structure around the proper management of those resources?" And what I always say is that without transparency, you're not going to get there. It's not a sufficient mechanism, but it's a necessary mechanism for us to be able to get to that accountability structure.

Algy (04:15):

It's the kind of first step on the journey, but vital to get on that journey. I'm going to say you've been at this a long time, but actually it's probably only just over a decade you've really been devoting yourself to this. In terms getting that message across and getting people to understand that idea that there are things which just aren't being measured which are really important to investment, and ESG can do that, or non-financial metrics can do that or play a role in it. How has that evolved from not being listened to early on to suddenly the huge interests that we saw kind of from around 2019, I guess? That's what it felt like to me.

George (05:07):

I think there is a very interesting reframing perspective that I think has happened and it's happening and will continue happening. So I think if you say-- And I have been saying that for a very long time, Algy. Which is if you actually say to a lot of people, "Should you care about ESG issues and sustainability issues and so forth?" Some people might say yes, some people might say no because they have their own interpretation of what that means. So I think you need to make it to people very, very specific. I will give you a very simple example of that. How much money firms are spending on actually hiring, retaining, and growing human capital inside the organizations? Then when you ask that question and you say, "How much actually do we know about how effective that process actually is other than getting one financial statement item in the income statement which says how much money you have spent on this?" But then when you look at it you say, "Well, actually there are organizations--" When you're actually observing what's happening inside organizations-- “There are organizations that are spending an enormous amount of resources to actually screen and hire the right type of people inside organizations. They spend an enormous amount of resources that are spending to actually grow people internally and promote people internally inside the organization.” 

Now, there are other organizations that are following a very different model and a very different strategy which is they primarily hire externally, especially for more senior positions. As a result, they're much less likely to internally promote people. Now, these are two different models. This is a fundamental aspect of what I would say ESG under the S which is the development of human capital inside organizations. It has tremendous implications we're finding in our research in terms of the future financial performance of organizations because it relates to the ability to be productive inside organizations, to be innovative inside organizations, and the cost structure of inside organizations. But when you put it in this context where you say, "Actually, how do you create value? How do you drive performance? How do you get the necessary talent side organization and how the organizations have different models that have fundamental implications for how much you are paying for the talent? It has fundamental implications for employee turnover, for ability to create a strong culture and alignment inside organizations and drive productivity innovation." That is actually something super important. You can actually ask the question, "Do we have the data to do this analysis?" Again, the answer goes back and says, "No, most organizations actually don't provide."

So for example, what we have been doing, we have been using big data and machine learning and artificial intelligence to construct very large data sets that allows us to understand the internal promotion versus external hiring patterns across thousands of organizations. Now, I can apply the same exact topic to, for example, decarbonization. Do you actually know apart from the high level statement of two organizations saying, "We'll get to net zero?" Okay, that is a good intention and a very aspirational intention. But do you have actually good information about how effective and productive those organizations are at actually navigating that journey? How much is coming from energy efficiency? How much is coming from energy substitution? How much is coming from circularity? How much all of those things are costing and which ones are actually leading to product innovation that might lead to revenue growth by greening your products, for example, and green product innovation?

The answer, I guess, is that we have very little information about this. So we are in the early stages of understanding those things. But I think when you're actually reframing them around how they're actually affecting risk and growth inside organizations, and future revenues, and costs inside organizations which goes to the idea of how those issues are becoming financially material and how those issues are likely to have different strategic relevance across different industries, geographic context, and firm specific strategies, then people are actually starting to develop an analytical model of how those issues are actually relevant for the competitive organizations.

Algy (09:56):

It is fascinating because there's just so much we don't see from the accounts. Investors understanding of capital seems to be developing massively with this realization that so much is intangible. Also, which goes hand in hand with the fact that tangible assets don't have the same relevance anymore, I guess. I suppose just in terms of them talking about materiality, I think one is fair to describe it is a kind of landmark piece of research which you were responsible for two colleagues. Look to that issue in, I think 2016, on the materiality of ESG and just that question of, "If people are doing the stuff that matters, does it matter to their share price and does it matter to their performance in the business?" This sounds from what you're saying you are doing now, that idea seems to be in a real genesis in terms of your work.

George (11:05):

Yeah. This is an important idea for several reasons. The first one is that organizations cannot do everything. I always like to say that because it's that much that you can actually do inside organizations. You cannot spread your organization very thin trying to actually satisfy everybody. So what we say is that the classic old return on management is a very, very important idea which is you really need to actually allocate management attention to the most critical issues that the organization is facing. So for example, if you are a mining firm, you really need to pay attention on health and safety inside the mines and community relations around the mines that are fundamentally giving you the ability and the license to operate. So as a result, for example, if you're running a gold mine, waste issues that are huge actually around mines are also very, very critical.

If you are actually running a pharmaceutical firm, for example, access to health and access to innovation and how you are thinking about access issues are becoming very, very important. If you are running basically very high carbon emitting industrial and manufacturing processes and so forth, those issues are becoming very, very important with increasing basically carbon regulation, awareness in society, customers demanding lower carbon products to satisfy their own aspirations to lower the carbon footprint and so forth. So there is actually a systematic process through which you can go and say, "Hey, what is it really that is likely to matter here and why?" I think that is also an important question. Is it that regulations are changing and the environment as a result is changing? For example, you can look at it and you can say, "Okay, I'm running or I'm investing in a steel or a cement manufacturer and now there might be an EU carbon border adjustment mechanism." What are the implications for that because of that change in regulation? Or you might have actually export, for example, to the United States and now you have the inflation reduction act for battery manufacturing or for ingredients that go into batteries. Well, obviously that is actually changing the competitiveness of your product. So regulatory changes is one of them.

The other one is legal changes that might be happening. Increasing litigation, for example, in the context of climate change and carbon. That is another mechanism. Of course, changes in the competitive environment and new entrants that might be competing in the industry. So if you are actually, for example, Volkswagen or if you are General Motors and now you're competing in China with BYD and Nio and you're competing globally with Tesla and so forth, that is actually changing the competitive landscape for you and of course changes in buyer's requirements. So if you're actually a supplier in large consumer goods companies or in large retailers such as Walmart or Tesco and Sainsbury and so forth, well, actually you need to comply with your buyer's requirements. So that is actually becoming a core competitive issue. So it goes back to really trying to understand how the world around us is changing because of changes in regulatory mechanism in terms of product markets, labor markets, capital markets, and so forth. Then tighten that back and saying, "How is the organization likely to respond? And critically from that perspective how the organization can develop new processes in order to be able to innovate?" I think that is also an important point because many times we tend to view the world in a static way and we say, "Oh, I will try to do that but it's so expensive."

I like to say that the best organizations view the world in a dynamic perspective, meaning that what is costly today might not be costly tomorrow. And you're observing that, for example, in many markets around the world. So for example, we have brought the cost of batteries very, very significantly down. So everybody that 10 years ago would have said, "Look, I wish I could develop, for example, electromobility but the batteries are just so high.” Then you had different organizations that had a very different attitude to that. They saw that actually as an opportunity. Instead of saying, "The battery cost is so high, I just can't develop that," they said something very different which was, “Actually because the battery cost is high, I will bring it down and because I can bring it down, I will wait."

Algy (16:13):

There's a story which I think you have right on the front of your book “Profit and Purpose” actually, which is about-- I think it's Daimler; an executive from Daimler kind of essentially mocking Tesla. I thought that story captured so well some of the things you were touching on there. One is that static thinking which I think is the outsider, is investors. That's one of those things investors fight against because things are as they are until they're not. But also, it strapped me as kind of telling a story about the way we understand risk and idiosyncratic risk which is a lot of what you are talking about. It's just very hard to actually imagine a world where certain changes have happened.

George (17:04):

Yes. It's human nature I would call it. So it's almost like it's hard for us to imagine things before they happen, and then once they happen, we cannot imagine in the world that those didn't exist. You think about it, it's this kind of conundrum that we face as humans where actually, if I would tell you that we would have a world where we wouldn't even have basic financial information for organizations around the world, you would say, "George, this is impossible. This just cannot happen." I can tell you that before, for example, the Securities Exchange Act in 1933 and 34 and so forth, people actually pushed back against that idea that we would have accounting standards and financial reporting. They said, “This is never going to happen because every organization is very unique. You cannot do that and so forth.” So it's this weird thing that we cannot imagine the world before we experience it in most cases. But once we experience it, we cannot imagine the world without it. The same thing, a classic example of that is also the iPhone. Before the iPhone came actually, so much in the telecommunication space, so much thinking was about how you will just be putting basically a phone right next to your ear. And once they came up with this giant screen on the phone, people were confused. They were like, "Why would I want the giant screen to be next to my ear?" Obviously, the innovators at Apple said, "You're actually missing the point."

Algy (19:01):

Yeah. Then we all got the point.

George (19:03):

Exactly.

Algy (19:06):

I suppose in terms of what you are saying, I was just wondering how much-- This year, obviously there's been a lot of backlash, if that's the right words to describe it, against ESG as an idea. I was wondering how much of that is kind of to do with people not really understanding the scope of it and also just seeing things as they are at the moment where the old price has gone up a lot and a lot of those stocks have performed very well, and suddenly that's smart and ESG is dumb. Also, maybe the perception is that ESG has been marketed as having a moral high ground which perhaps is not quite how it should be thought of in terms of it's beyond risk and opportunity.

George (19:58):

It's a really good question and I think it deserves almost a decomposition to the various themes. The reason why I'm saying that is because there are different layers here that need to be analyzed. The first one is that sometimes it's because there is a misperception about what ESG is as a management concept, as a governance concept, as an investment concept in business. And ESG, at least in my mind, was never meant that it would save the world. There are several people that think that, "Oh, this is a mechanism or it has been advertised as a mechanism. That it will save the world. That it will solve basically poverty and inequality and climate change and waters, cars, and so forth." And it cannot do that. It wasn't meant to do that. It is a framework through which organizations are trying to measure, analyze, drive performance, and communicate key performance indicators that are actually relevant for them. Why? Again, because of going back to what we're saying about how the world is changing, and that's it. So I think there is sometimes a misalignment of expectations compared to the people that see it as a save the world type of tool which is not what this is.

I think the second one has to do with the fact that because ESG has become more important in how organizations are being managed and governed, it has started having more real implications. It starts to have more [meat]. A couple of years ago we published a paper where we looked at the stock market reaction to the passage of the non-financial reporting directive in the EU. One of the things that we found was this very interesting result that in the announcement of the regulation, the stock prices of companies that tended to have both good disclosure and good underlying performance or key performance indicators on ESG issues, in general, they show a small stock price increase in short term, and the organization that had poor disclosure and relatively poor expectations of bad performance on those key performance indicators, they show a negative stock price reaction on those.

The reason why I'm mentioning that is because for me, that paper is a perfect illustration of the point that not every organization will win from this as ESG is becoming more important. There are going to be some organizations that will experience an increase in their competitiveness and some organizations that will experience a decrease in their competitiveness. You would expect that naturally as these issues are becoming more important, the organizations that will see that as the threat to their identity, to their competitiveness and so forth, they will push back. So there is a natural pushback that is happening because of the underlying competitiveness that is happening there.

I think the third reason why it is normal to expect that is because basically sometimes it's misapplied as a concept what it is. And as a result, because there are bad or suboptimal applications of it, people are experiencing not the intended outcomes that they had expected either in terms of the impact that it might be generating or because it actually doesn't create value, it doesn't reduce risk, it doesn't open up new opportunities for innovation and so forth. So people are looking back and they say, "Oh, as a result, it didn't deliver on its promise." I always like to say that because there is a big difference and a big distinction between strategy development versus strategy implementation. I always say that. Every organization now that I know of has an ESG plan. But that doesn't mean that the plan is a good plan or that the plan is going to be implemented the right way. I think it's in that step of implementation where you observe many organizations actually failing. They cannot get the type of cultural transformation that is needed to really drive performance. They cannot get the incentives to be aligned. They cannot credibly communicate what they're doing.

As a result, all kinds of bad outcomes are happening which is happening also in any strategy that they're trying to implement. Not all mergers and acquisitions work. A lot of R&D that organizations is doing is failing. A lot of capital expenditures are going to zero. There are a lot of things that are successes and a lot of things that are failures. I think when you're decomposing ESG to the types of things that you are trying to drive basically; decarbonization versus human capital related issues versus product safety related issues versus supply chain related issues, you would naturally expect to see some successes but also some failures. And really, that's what I'm trying to emphasize in the book as well; that it is not all good and great. It's actually a lot, especially for organizations that are trying to do ambitious things with their products and services, there is a lot of failure and a lot of experimentation as well.

Algy (26:16):

Yeah. In your book you make that point, you really kind of drive that home that this isn't a magic wand. I'd like to come back to that actually. Also, just in terms of when you were talking about competitiveness because one of the things which I-- I love numbers. I've just got a natural affinity for anything you can quantify.

George (26:43):

Me too. Anything that makes [ ]

Algy (26:45):

I can tell from your work, obviously. It is the impact way to the accounts that I wanted to talk about because you talked about the underlying competitiveness of businesses seen through this prism of what are the real risks and real rewards. The impact way to the accounts try to put the external benefits companies have and also the kind of free ride, the external costs that they enjoy back into the accounts.

George (27:21):

We started this project about three years ago and we incubated it as a research project here at Harvard Business School in collaboration with many external partners because we were trying to understand how we can actually think about a holistic performance measurement and evaluation system inside organizations that doesn't only reflect right now, the financial performance of the organization in terms of the profit that is generated based on a transaction based system of double entry bookkeeping of resources going in and going out inside the organization and so forth. But actually reflecting and asking the question that if both the positive but also the negative impacts that organizations are having, if they were quantified and they were valued, what would that performance of the organization look like? For me, that journey of measuring impact and valuing impact that then can be reflected in pounds and in dollars and in yen and in euros and so forth, is a fascinating journey.

For me, it has revealed several key insights. The first one is how different actually your evaluation system might look like when you're measuring inputs versus when you're measuring outcomes. And because in the impact way the account system we're actually concentrating on measuring outcomes, meaning not the intentions and the targets and the efforts that you're pursuing, but what are the actual impacts and outcomes that you're achieving? We're getting at a very, very different assessment of which organizations are leading and which organizations are lagging. And because in the ESG space we have been measuring to a large extent what I would call inputs, meaning policies and principles and disclosures and targets and investments that we make and so forth, and much less the outcomes and the impacts that we're achieving, then you actually find that sometimes what we celebrate as leaders might not be actually leaders in terms of outcomes. Some other organizations that are really actually delivering much better impacts and much better outcomes wouldn't necessarily be the ones that you would find them being the most highly ranked in ESG evaluation systems. I think that is a very, very important distinction.

The second one is that I think for me, sitting here at Harvard Business School, I have always been trying to think about ways that you can actually engage with business managers and leaders in business in a way that they can associate with that and they can actually start getting their arms around some of those issues. Always a challenge has been that if you tell a leader, "Hey, you're consuming 300,000 cubic meters of water or you're having basically 0.002 carbon intensity or like a hundred times of that. Or if you say lost time injury rate of 005 and all of those things, it's just hard to grapple with." So the question is how can we actually translate things in a way that it is easier to actually embed in business planning? Because if you want people to actually make improvements in a real way, you need to actually translate and create a management system that allows for people to understand what are the consequences of action and what are the consequences of inaction? And as a result for us being able to say, "What would it mean if you had a hundred dollars or a $50 carbon tax or carbon border adjustment mechanism in your business, and how much of that would be your profit? How might your profit look like in a carbon adjusted earnings per share system or in a safety adjusted carbon per share system? Or if you're a consumer’s good company, in a shelf and wellbeing adjusted earnings per share system."

That actually translates very, very interesting insights. When you actually look at some organizations and you say, "25% of your EBITDA might be wiped out by this." But there are other organizations that are having tremendous positive impacts, actually. One of the things that also illustrated that whole analysis was how big is the difference between the strategies that different organizations are having? For example, when we analyze consumer goods companies and we said, "Okay, if we take the six basic ingredients that are affecting human life basically from a health perspective when you're consuming those products, such as, for example, fat that you might be consuming but also whole grains and so forth. There is tremendous difference actually across consumer good companies in terms of how much sugar they're selling versus how much whole grains they're selling.”

Those are having vastly different consequences on people in terms of cardiovascular disease, diabetes, obesity, and so forth. So when you're asking that question and you're saying-- Well, actually, again, going back and saying, "How is that important to me?" Well, if consumer preferences are changing, how the different organizations might be coping with this? If regulations might change, were they're actually forcing you to make those impacts more visible in your product labeling? Or if you might have a soda tax, for example, as it has been introduced in multiple jurisdictions around the world and so forth, how is that going to actually affect you? So for us, that whole journey has illustrated the value of measuring outcomes, the value of translating those outcomes into something that can be compared with existing financial measures that managers understand, and then the idea that it really actually illustrates the fact that within industries, there are very significant differences in the strategies that different organizations have adopted.

Algy (34:24):

Also, in terms of talking about consequences and the measures like the adjusted EPS and things like that. How much of that is something that an investor could use as a real basis for investing or is it more just to show actually what these companies are doing and less of a practical tool?

George (34:49):

This is my expectation that actually five to 10 years from now, this is what actually investors interested in applying some type of ESG analysis are going to be doing. They're actually going to be using a research and data infrastructure that looks into outcomes, that looks into the value of outcomes, and then is actually modeling the internalization process of those outcomes into basically growth, risk, future revenues, and costs. Because it is a more, I would say, robust and systematic process and scientific process of actually looking at what the actual outcomes are and asking what is actually really important and what is less important from the perspective of what's the value of those outcomes. So I expect that this will happen moving forward. The reason why I'm giving a timeframe is because it is a very challenging process. It is not easy. There are elements of that analysis that are easier to be done such as, for example, in our environmental impact pillar. I would say that it is easier to be done. It doesn't mean that it's easy, but it's much easier to be done relative to, for example, assessing product level of impact which is like the impacts that you're having on the actual customer and the consumer and so forth.

The reason for that is because those product impacts tend to be highly idiosyncratic. That's why in the impact way that accounts as well, we worked on a very industry specific pillar because you can ask the question. You can say, “How is a credit card, for example, affecting the consumers?” Well, it's fundamentally different than a car or a box of cereals as you can imagine. So these are very, very different dimensions that you're evaluating and you're constructing impact pathways and evaluation of those relative to something that is broadly standardizable and applicable, such as, for example, the measurement of nitrous oxide and sulfur oxide and water scarcity and carbon emissions and so forth that, of course, will differ dramatically across industries in terms of the magnitude. But the measurement of that KPI is exactly the same measurement of the KPI and then the valuation of it depends on the parameters that you might use.

Algy (37:25):

I suppose I kind of think of this and it sounds slightly like ESG 2.0 thing in a way. I was wondering if it did achieve that-- come into the consciousness of investors like that. Do you think it's possible that it could become a basis of regulation? When I was doing economics way back in school the externalities were one of those big things which people talked about but never thought to quantify really. Does it potentially have quite wide societal implications?

George (38:06):

I would think so that in the future as the state of those measurements improve over time, we might see actually more and more standardization and the development of specific guidelines and methodologies and even potentially disclosure regulations around what those might be. And again, I think different measurements have different attributes and they have different levels of difficulty. So I wouldn't be surprised if the first application of this will be something around the environmental domain where the state of the measurement is not perfect by any means, but it's certainly more advanced relative to other states of development. As a result you could actually do those types of calculations where somebody would say, "Well, if you would apply a certain price on carbon and a certain price on nitrous oxide and several other particulate matters and so forth, how would your profit looks like if you were actually doing that?” Much like many companies already do when they apply some type of shadow cost on the price of carbon in order to guide some of their capital budgeting process. I think it's a similar idea and we see that idea that is increasingly being used as a management tool, as a governance tool, and I think it can also be used as a transparency tool for everybody to have a common view of the underlying outcomes and how material those might be in different organizations.

Algy (39:58):

Yeah, I think it's absolutely fascinating. I suppose if we can kind of circle back. Another thing that I really wanted to talk to you about is your view on purpose. So your book is called,
Purpose and Profit.” One of the things you kind of set out how you can have an ESG policy rolling out through an organization which creates purpose, but purpose meaning a kind of innovative culture which kind of actually is responsive and dynamic unlike the German car maker who said, "Yeah. Well, electric cars, whatever." I thought it was a really interesting argument.

George (40:44):

It actually sounds funny right now when you actually say that sentence.

Algy (40:52):

Yeah. So if you could just explain this idea that actually this idea of purpose is very central to all these things you've been researching for so long.

George (41:10):

It's a central idea in my mind. The reason why I'm saying that is because I have been observing over the years more and more of my own students actually asking the question, "How can I actually find meaning in my work? How can I actually contribute and have impact from a personal perspective? Then how can I match that in a job role in an organization that is empowering me to do that, where I have actually the agency, the align incentives and the clarity about how I can contribute? That purpose can be very idiosyncratic. So your purpose might be very different than mine and my aspirations and so forth. I always like to say that it doesn't need to be that we all care about solving a really big problem and so forth.

It might mean that, “Hey, you're really passionate about building artificial intelligence mechanism that actually provides better information to consumers when they actually go to the grocery store, whatever that might be.” You're saying, "I would like to make that more broadly accessible, easier to use, less costly." Or somebody else might be super excited about going to an entertainment and media company and producing shows that really delight customers and produce happiness; the ephemeral happiness that we all live. But I think what that purpose does which is critically important is it actually allows you to drive alignment inside the organization, a shared set of beliefs about the organization that are likely to make employees more productive and potentially more innovative if that increases the level of trust inside organization. As a result, sharing information, collaborating inside organization, the reason why that is important in the context of some of the ESG related topics, and in general, some of the big challenges that the world is facing, for example, the sustainable development goal and so forth, is because many of those strategies; business models and so forth, are not easy to execute. They actually require very high levels of commitment from their organization.

As a result, it's much more likely that we will build many climate solutions organizations around the world if those organizations and those solutions are going to be led by purpose-driven organizations where employees are more committed to it. They work very hard, they really want to solve that problem, and as a result they exhibit higher levels of productivity, higher levels of innovation and so forth because it's not easy to be done. So that's where, for me, this idea of purpose connects to some of the big challenges that the world is facing, that they tend to be codified in some of the dimensions of the ESG and why those two pieces are connecting to each other. We wrote a piece for the American Economic Association several years ago around corporate purpose and climate change where we made that point that because it's actually a hard problem to solve, you need purpose-driven organizations that are more likely to take the kinds of risk, experimentation, and introduce disruptive innovations, but also to exhibit the higher levels of productivity innovation that are able to bring some of those solutions to the market and commercialize those solutions and make them broadly applicable.

Algy (45:25):

I think it's a great message actually. Also, last month we spoke to, Dan Ariely who's behavioral psychologist. Your views on purpose kind of tallied so much with what he has found from the field of psychology and he is now working on to translate into a way of understanding companies. Yeah, the human capital is-- especially in terms of the hierarchy of intangibles, really key I suppose is maybe a message we can take from it.

George (46:03):

Yes. Very, very, very important.

Algy (46:06):

But George, it's been an absolute pleasure to have you on and thanks so much for sparing the time to talk.

George (46:13):

Thank you very much for having me. It was a great pleasure to connect and have this conversation.

Algy (46:18)

Thank you.

Alex Edmans: End of ESG, or, ESG as important intangibles but not special versus other important intangibles

Alex Edmans argues: ESG is both extremely important and nothing special. It's extremely important because it's critical to long-term value, and thus any practitioner or academic should take it seriously, not just those with "ESG" in their job title or list of research interests.

It's nothing special since it's no better or worse than other intangible assets that drive long-term value and create positive externalities, such as management quality, corporate culture, and innovative capability. The following implications follow:

1. Companies shouldn't be praised more for improving their ESG performance than these other intangibles; investor engagement on ESG factors shouldn't be put on a pedestal compared to engagement on other value drivers. We want great companies, not just companies that are great at ESG.

2. Investors who greenwash are correctly being held to account. But so should other investors who fail to walk the talk, such as actively-managed funds that closet index or systematically underperform. Clients of non-ESG funds deserve the same protection as clients of ESG funds.

3. Practitioners shouldn’t rush to do something special for ESG factors that they wouldn’t for other drivers of value, such as demand that every company tie executive pay to them, force a firm to report them even if not relevant for its particular business, or reduce complex intangibles to simple quantitative metrics. 

4. Many of the controversies surrounding ESG become moot when we view it as a set of long-term value factors. It’s no surprise that ESG ratings aren’t perfectly correlated, because it’s legitimate to have different views on the quality of a company’s intangibles. We don’t need to get into angry fights between ESG believers and deniers, nor politicize the issues, because reasonable people can disagree on how relevant a characteristic is for a company’s long-term success.

Paper here (2022): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4221990

Ben Yeoh: CFA Institute Podcast, ESG, investing, progress | Matt Orsagh

Matt Orsagh talks with me. We discussESG integration, ESG education, demographics, Economist Thomas Malthus, and the future of capitalism. We also talk about current and impending regulation and policy around ESG disclosure as well as the intersection of art and ESG. One section:

You are someone in 1650, do you think we would ever not have slaves? I'm guessing 99% of people would say, "You'd be crazy. We've had slaves for 4,000 years. Our whole economy would disappear. Why would that be possible?" Yet it was. So fast forward to the 1950s. You had a lot of movements, from faith based and other investors thinking about a kind of ethical or value based judgment about how they would want to invest. They just wanted their investments to reflect their mission and values.

Then you fast forward kind of into the 1980s, 1990s where you had thinkers like Milton Friedman come along thinking about markets and capitalism in that respect. And then 1990s, you started thinking about triple bottom line, a lot of talk about people, planet, profits; all three going together. Then you had the birth of what we're calling environment social governance; ESG. So that kind of takes us to where I started where actually ESG wasn't yet a term in terms of where we started. But we started thinking about how these extra financial matters could affect long term value. I guess this is where you had the initial bifurcation between what we might call value and values. So you had a lot of people who were still thinking about it from an ethical lens, but you started to think about a lot of people who thought, "Well, actually there might be a lot of circumstances where if you do good by your customers, if you do good by your employers or employees, if you don't have environmental spillages, if you had good relationships for your regulators you would create long term value."

So a lot of people today can talk about stakeholder capitalism or enlighten shareholder value. You don't even have to produce the ESG terms. You just go, "Well, I'm looking about where long term value is." By serving my customers and by not having a good relationship with regulators you're going to get a lot of value. So a lot of the debate today now is around that. What is material to long term value creation? What might be value and what might be values? I think there's a lot of debate around that. I think I did want to pick up on two or three other things which have changed and this is in the nature of fund management itself. So again, if you go back 50 years ago, you did not have what we would call passive index funds, or rules based tilted funds, or quantitative funds. So that has changed the nature of stewardship voting and what we would call active ownership; so how to use your vote. But this idea of stewardship or active ownership actually goes back hundreds of years.

Listen to my personal podcast, Ben Yeoh Chats

Lightly edited Transcript below

The Sustainability Story: A Talk with ESG Renaissance Man Ben Yeoh; Portfolio Manager, Educator, Podcaster, Playwright

Matt (00:04):

Hey everybody. Welcome again to The Sustainability Story. I'm Matt Orsagh with CFA Institute. Our guest today is Ben Yeoh; Senior Portfolio Manager, Royal Bank of Canada Global Asset Management. Good to see you again, Ben.

Ben (00:19):

Thank you. Thank you for having me.

Matt (00:22):

I think in the title I've written-- I don't know if you've agreed yet. But I'm calling you an ESG Renaissance man, if that's okay with you.

Ben (00:30):

Fine by me. Call me whatever you like.

Matt (00:33):

But you have a very interesting background and very interesting stuff you have going on. So before we jump into the details, tell us a little bit about you, your journey on sustainability, and how you got here.

Ben (00:44):

Sure. So I was born in London, UK to a Malaysian father and a Singaporean mother. I did all of my schooling or high schooling in London. Then I went to Cambridge, Harvard and then back to London. As an undergraduate, I pretty much specialized in science; kind of neuroscience and behavioral science. Then when I was in America, I tried some of the liberal arts things and did actually a lot more in theater making, poetry, and writing. And then I started my career over 20 years ago now as an analyst in what we call the city of London in terms of doing investment analyst. I started as a healthcare analyst because that's from my science background. Then around 2002/2003, there was a lot of work being done in the pharmaceutical industry or around pharmaceuticals to do with access to drugs in Africa; particularly HIV drugs in Africa.

I was very much involved in the multi stakeholder debate and discussion there where pharmaceuticals were wanting to be seen as part of the solution rather than part of the problem. There were a lot of supposed hurdles. Well, they were real hurdles; things like parallel importing, patents, pricing. But there were also solutions which a lot of players could see in terms of trying to get that round in terms of regulation and all of that. We were involved in actually getting a lot of that work kind of done, and the end result was that HIV drugs did end up going through to Africa at cost of very little money on the back of beer trucks and soft drinks trucks going around Africa. So it was one of the kind of early success stories of collaborative engagement around back then almost 20 years ago.

That set me on the path of thinking about how you can have a lot of win-win situations. So when you're looking at extra financial type of things like access to drugs in Africa, that you can have win-win solutions which work for corporates, which work for society and actually a collaborative engagement getting you across there. So that's where I started a lot of my work and what we now would call an integrated fashion of looking at this. I picked up non-executive work working for a kind of ethical investment trust on policy issues. That kind of kick started my journey on sustainability and thinking about extra financials and investment.

Matt (03:17):

I've warned you about this upfront. I ask all my guests to help frame the conversation we're going to have. Is there one number, or fact, or kind of a series of those that you've come across that helps frame what we're going to talk about for our listeners? So you've warned me that you may ask me some questions back. I've never been quizzed before on this. I'm a little nervous. So what do you got?

Ben (03:40):

Yeah. I love data. I think investment analysts or portfolio managers at the end really do love data. So that's a worrying question for you. So I have some around life expectancy, literacy rates which think about social, women's votes, and actually deep poverty. Let's see how much of this you know yourself. So life expectancy in India in 1950-- kind of a generation ago-- In 1950, what was the average statistical life expectancy? Do you think I would be dead or alive?

Matt (04:20):

Well, I don't know how old you are. But I'm not going to...

Ben (04:22):

I'm in my forties.

Matt (04:23):

I was going to say mid-forties, so okay. I'm going to try. I think you'd be dead because I'm guessing today life expectancy is probably in the mid to high seventies, low eighties. I remember seeing this for the US like a hundred years ago. Life expectancy was around 50 or something in the US. I can't remember. Or like high forties or fifties. So I would be about dead because I'm a little older than you. So I'm going to say India in 1950, I'm going to say 39.

Ben (05:03):

That's super close and good line of thinking. So it's 35 in 1950 in India. In India today, it's closer to 70. But you are right, in the US or the UK you're talking about high seventies. In some places low eighties; demographics and things. The point of that and the same with the other two is that we've come a long way, but actually we still have further to go. So literacy rates is thinking really about a form of, I guess, education or social progress or social capital. We're going to go to Portugal and we're going to go around about the same time. I have the data for 1960. So 1960 in Portugal, what is the percentage of the population who can read and write? The percentage who are literate in Portugal only in 1960.

Matt (05:55):

This is dangerous because I feel I'm going to be insulting the Portuguese people if I guess too low. But this is over 50 years ago.

Ben (06:04):

Yeah. Develop the European country fairly rich.

Matt (06:08):

I’m going to say two thirds. 66.67%.

Ben (06:13):

That’s pretty close. It's 60%. So six out of 10 could read and write. But the amazing thing is, most people get it wrong at first because that means four out of 10 people in Portugal in 1960 could not read and write. And of course, today you are over 90%. So I think you are pretty close to 98/ 99% actually. So again, we've come a long way and people don't expect that in a European country. 

Social progress; women's vote. Going to take you back to 1950 because that's where I have the data. What percentage of the world allowed women to vote? This is percentage countries really. So what percentage of the world countries allowed women to vote in 1950?

Matt (06:59):

Okay. It's only been about a hundred years here in the states. So I'm going to say 30%.

Ben (07:09):

It's a bit higher than that. So in 1950, 66% of the world allowed women to vote. That did mean the other side, one in three did not allow women to vote.

Matt (07:18):

I was retrospectively more negative about the world.

Ben (07:21):

Yeah. A little bit too negative about the progress we made, but you're right. So a hundred years ago, I think the data's pretty close to zeros. Those countries had just started around there. There are a few pre 1900 but not very many. Today, it's by countries. It's 98.5%. There's just one nation state holding out. It's a little bit of a trick question because actually it's the Vatican in terms of a nation state.

Matt (07:46):

Oh, that's not true. Come on.

Ben (07:48):

So the last one, which actually I think is maybe even the heart of all of those because life expectancy, literacy rate, social progress all go to that. In 1990-- So this is really quite close. This is just 30 years ago. What number, let's go absolute number of the population were in deep poverty; were below the poverty line in 1990 in the world?

Matt (08:12):

Global?

Ben (08:13):

Global.

Matt (08:13):

Okay. I'm going to go back to my number that was so wrong before for women's vote. I'll go back to my 30% because I'm going to guess it's a little above or a little below that

Ben (08:33):

I don't know as a percentage. We can do it in percentage. I'd have to convert that to the popular-- what's the population now? About 7 billion?

Matt (08:48):

It's going to hit 10 billion by the middle of the century, isn't it?

Ben (08:53):

Yeah. But I have to go back to 1990.

Matt (08:56):

I'm trying to work back. This is a fantastic podcast where you listen to people do math on a podcast.

Ben (09:01):

So it was 5 billion in 1990 world population. So 30% is 1.5 billion. You are really good. That's almost there. So 1.9 billion. So in 1990, 1.9 billion were below the poverty line. I'm just going to fast forward to today. Today, that figure is probably around 600 to 700 million. I make that point because it really expresses two things. On one hand, that's unbelievably brilliant. You have made 1 billion people in 30 years lifted out of deep poverty. That's deep poverty. So there's still a lot of sort of normally poor people, but this is kind of below the poverty line. But you still have six or 700 million which is still significant. That's still about 9% of today's population; 9 or 10% who are below poverty. So you have really decreased that.

So I think my theme here is that we've come a long way, but we have a long way to go. But we mustn't give up on the fact that we have made progress. I think that's number one, and this applies to actually what everyone thinks in terms of extra financial and environment social governance sustainability thinking. But it also means we still have a long way to go. We want that number really to be zero, and there's kind of no theoretical reason why you couldn't get very close to zero except for the fact that it's getting much harder. In fact, the forecast of that is it already has a shallow decline in the next 10 years because it's increasingly hard to get people out of deep poverty. But I think those stats to me says a lot of the story that we've come a long way, but we have to go a long way further. We've come a long way in all of the dimensions that we think are important. So you mentioned sustainable development goals. The idea here is that we value more than what might be GDP, call it GDP plus, or the wealth of the nation that's in your social capital, your human capital, your natural capital. We're doing better in terms of women's votes, social capital, life expectancy, as well as in things like GDP.

Matt (11:08):

Wow. Well, three things actually. Those are very interesting numbers and I think it is great to remind people of the point that you can despair quite a bit if you're in this world of what's going on with the climate, are we ever going to get to where we need on climate, natural capital as well has many challenges. But take a step back and look from with the hindsight of history of where we've come and that we won't get to a perfect utopian society on any of these issues. We have come a long way, but we still have a long way to go. These goals are achievable. A lot of these ESG sustainability goals are achievable. It just takes policy and will and invest. We're talking to investors and investors to push the needle on these things.

The second thing is, I think I've said a horrible precedent that now my guests are going to be expected to quiz me. I'd be fine with that but I don't know if my guests would be fine with that because I think that was fun. This could derail the whole podcast, but it made me think about... We talk about demographics and that's something that I'm interested in. I look at what are projections for demographics around the world in the next 10, 20, 30 years in our lifetime and our children's lifetime. We're likely to hit a peak of population in the world in about two decade’s time and then slowly go down in China and Russia and other large countries. Meanwhile, Nigeria will be exploding. But around the world, we're likely to have a demographic-- not crash, but slowly go down that hill.

I think we're going to top out at somewhere projected 9.5, 10 billion, somewhere in there. And then by the end of the century, it'll be like 8 billion or something like that. My numbers might be wrong but that's the trajectory we're on. My question is-- and as I said, maybe this is a whole different podcast. So maybe we keep this short and I'll either have you back or have a demographic specialist on to talk about this issue. What does that do? Does that help with sustainability or does that hinder with sustainability? We're both people that have spent too much time in finance and the dominant theory in finance for the past hundreds of years is capitalism. That's what we live under. Capitalism assumes every growing markets, every growing resources. It's fascinating to me how capitalism will be challenged and have to change and adjust over the next 20, 30, 50 years, and what we will we even be calling it during that time. I know that's a huge topic and we didn't really discuss that. But any thoughts on that before we move on?

Ben (14:07):

Sure. Let me try and keep this short because it has very interesting philosophical roots. I'll give you both views. So if you go back really to ancient philosophers, but more recently Malthus. Malthus the Malthusian challenge would talk about that. It’s what do you do about growth? The modern movement of that would actually call themselves de-growth economist and thinkers. So they would worry about how that growth happens. Even though that capitalism has lifted a lot of people out of poverty, they would point to those people still left in poverty. But I think there are two or three interesting things to put on top of that. One is you are likely to, or you seem to be able to be getting what we would call carbon light growth, or growth which is decoupling from the use of natural resources. You can argue about whether we're doing it quickly enough. That definitely seems to be a trend.

The second thing which you could point to which is kind of interesting from a philosophical point of view is that human beings have made a lot of these challenges. But uniquely, human beings are probably going to have to be the ones to solve a lot of these challenges. If you come to that point of view, then actually we need humans and we need new ideas to solve these challenges. You can end up in what I would call something called techno realism. Whereas techno optimist would say, "Okay, it's definitely going to be technology.” They would say this to you and you get to a kind of utopia. Techno realist are kind of one stage back where they go, "Well, we have these problems about carbon intensity. We have to decouple. And actually some of the ways that we're doing it for things that we want; food, cement, fertilizer, airplanes, and things like that have to be done by technological progress and that will be an intersection between government state and private actors.

They would generally discount de-growth because:

1. Malthus wasn't correct at his time and hasn't been so far. Or be it the future could be different.

2. They would talk about this decoupling that you have.

3. How do you get those deeply poor out without growth?

Now you could say, “Yes, if you are in Sub-Saharan Africa you should be allowed to grow. And maybe if you are in some other nations you might not.” But they would point to that problem about getting those people out of poverty. So can you triangulate all of that? I would err on the side of saying, "I think it's possible.” It's not definitely in the bag. But if you talk about the climate challenge, if you look 10, 20 years ago on the policy scenarios that we were looking at, we were probably at the median scenario looking at something like a four degree world, give or take, which would have been a huge disaster. Today, we are looking at somewhere between a two degree to three degree world on central policy scenarios. That is far from great. You're still going to lose huge waves of places which become uninhabitable and that's still not great. But it is, you have to admit, greater than where we were at four degrees. So we have come quite a long way in 10 or 20 years even within that.

I think part of this is the fact that we need to have good economic growth, but we do need to try and decouple that from natural capital use, carbon light growth. Maybe people will go, “Rather than buy for us fashion and buy a fashion brand, you'll buy that as an intangible piece of computer digital clothing that you'll wear for your avatar.” You'll still spend $5,000 on your avatar rather than on a fur coat that might have the same sort of decoupling and signaling. Seems to be happening now. I think those were the two debates about where it's happening. But I remain, I guess, cautiously optimistic. That's what portfolio managers like to say.

Matt (17:59):

Yeah. I mean, just as a student of history thank you for bringing up Malthus. He's one of my favorites just because he seems so negative about the prospects of humanity. If I remember correctly, he was right around when the industrial revolution was starting. We had all this oil and coal to supercharge capitalism. And so it will be very interesting to see how that decoupling changes things. It doesn't mean capitalism, is it real? Or does it work? It will have to change. But capitalism and high carbon intensive economies have been the norm for the past 200 or so years. So what does that look like 50 years from now when we're in something else? I don't know.

I don't want to spend all our time on that. It's just a fascinating topic. So thank you for the quiz. I may have to add that to the podcast now. But before we start diving down into more detail, you've been in this sustainability world for a while. As a portfolio manager, where have you seen us come from? We've already talked a little bit about this. Where are we now and where do you see sustainability going in the future?

Ben (19:10):

Sure. So I want to stretch back a little bit further to where I start and then take it from there. We touched on this about Malthus and the long history sale of capitalism. I want to go back to the fact that for thousands of years in all human cultures we had slaves. Then about 200, 300 years ago, human beings decided that slavery wasn't for us. And now slavery is pretty much outlawed. You can talk about modern slavery and the things like that, but slavery is legal. You go back a couple of thousand years ago, you put a price on human life and you traded human life within slavery. And you didn't. You go back to the 1700s, you had objects, you had glassware, you had pots where you had labels and the pots were said, "Not made by slaves." That's the roots of the fair trade movement today.

Fast forward to women's rights which we've talked about. Women couldn't vote a hundred years ago. They now can vote. Great social progress within that. So you have this fast forward about these social change movements which seem impossible at the time. You are someone in 1650, do you think we would ever not have slaves? I'm guessing 99% of people would say, "You'd be crazy. We've had slaves for 4,000 years. Our whole economy would disappear. Why would that be possible?" Yet it was. So fast forward to the 1950s. You had a lot of movements, I guess, from faith based and other investors thinking about a kind of ethical or value based judgment about how they would want to invest. They just wanted their investments to reflect their mission and values.

Then you fast forward kind of into the 1980s, 1990s where you had thinkers like Milton Friedman come along thinking about markets and capitalism in that respect. And then 1990s, you started thinking about triple bottom line, a lot of talk about people, planet, profits; all three going together. Then you had the birth of what we're calling environment social governance; ESG. So that kind of takes us to where I started where actually ESG wasn't yet a term in terms of where we started. But we started thinking about how these extra financial matters could affect long term value. I guess this is where you had the initial bifurcation between what we might call value and values. So you had a lot of people who were still thinking about it from an ethical lens, but you started to think about a lot of people who thought, "Well, actually there might be a lot of circumstances where if you do good by your customers, if you do good by your employers or employees, if you don't have environmental spillages, if you had good relationships for your regulators you would create long term value."

So a lot of people today can talk about stakeholder capitalism or enlighten shareholder value. You don't even have to produce the ESG terms. You just go, "Well, I'm looking about where long term value is." By serving my customers and by not having a good relationship with regulators you're going to get a lot of value. So a lot of the debate today now is around that. What is material to long term value creation? What might be value and what might be values? I think there's a lot of debate around that. I think I did want to pick up on two or three other things which have changed and this is in the nature of fund management itself. So again, if you go back 50 years ago, you did not have what we would call passive index funds, or rules based tilted funds, or quantitative funds. So that has changed the nature of stewardship voting and what we would call active ownership; so how to use your vote. But this idea of stewardship or active ownership actually goes back hundreds of years.

In the 1920s, Benjamin Graham talked about being an activist shareholder and essentially saying, "If you feel that corporates have a poor policy, you should vote against management and you should be active." He famously was an activist investor himself. But the nature of that has changed in quantitative techniques and things like that. Then the other side on the value side; the kind of ethical or philanthropy side of arms has launched what we might now call today, impact investing or impact charity. So this is the idea of trying to measure to some extent, the impact you are having on the world. I think this is a very interesting idea which has rolled into what we are now talking about in terms of ESG and mainstream investment as well, but also have its roots when you're thinking about extra financial or non-financial.

I think the philosophical movement here which is really interesting I would call long termism and also effective altruism. So in the way that this is a kind of philosophical roots in terms of John Stuart Mill, even pieces like human things like that, about how to do the most good in the world. That's a kind of another interesting arm away from pure financial returns which is really influencing how to give an impact. That impact is then influencing those who have financial return as well in what we call mainstream integrated ESG.

Matt (24:17):

That was a very succinct summary. I think that got us. In discussions I've had on the topic, I haven't heard things go back hundreds of years. But it's interesting to think about it that way when you have things labeled out as, "Not made by a slave." The conversations that I've had and listened to on this topic usually go back to apartheid. In the late eighties, early nineties as a start. Kind of the modern focusing on governance, focusing on ESG. It was SRI back then; Social Responsible Investing. When you stop and think about it, it goes back much longer than that.

Ben (24:55):

Much longer. I make that point because markets are driven by humans. They're not driven by animals and they're not driven by plants. You could call it an intersubjective construct. They have value to humans because humans believe in them. A lot of these market constructs going back even to the early days of thinking about capitalism like Adam Smith and the like, have always had this component about what humans believe is important and what they believe is important in the future. In fact, talking about the long history, the early capitalist-- So around the times of Adam Smith, if you think about what they were articulating I have an anecdote here which is actually one which is told by Amartya Sen who is a developmental economist and Noble Prize winner. In his reading of the early capitalist he said, "Well, imagine you are being chased down the street by someone who wants to mug you or kill you for whatever reason. They want your money. They don't like the look of you. They're coming down the street at you.”

But what happens is that before they get to you, money rains down in the street. You have coins which you can collect and there are notes of value there. They stop chasing you and in their own self-interest they go and collect the money. Early capitalists believe that by directing self-interest to something like money, you would direct humans away from their more violent and base urges. So to them, early capitalists was a way for actually fostering a kind of self-interest or interest in money away from what they would view as bad behaviors, and to something where you could systemically have good behaviors. I think that's very interesting in thinking about that. But it was still very much constructed around how we would use markets essentially for the values that human find important. That's why I think the modern databases around ESG and all of these have these roots much deeper in history than we would acknowledge, and you can actually find this by reading Adam Smith. You kind of think he is the godfather of capitalism. He's also the godfather of thinking around about this social value of markets.

Matt (27:14):

All right. Well, now we're going to get into the Renaissance Man part of the conversation. Let's talk about first of all, something that started a couple years ago by the UK society; The UK CFA society. It is this certificate in ESG investing that you've been participating in. Now it’s part of the CFA Institute and it's global. People are taking the exam and getting their certificate in the ESG investing. So tell us a little bit about how you came to be involved. You've written the same chapter and updated a couple times, and I think broadly kind of-- I've seen the past 10, 15 years-- I'm sure you have as well, just the need for more and better education around ESG, how the ESG certificate is fulfilling that, and how you see the state of ESG education in our financial world.

Ben (28:01):

Sure. So we built on the work for instance, that the PRI; Principles of Responsible Investment did with you guys at the CFA doing ESG case studies and the like. We realized here in the UK driven by the society that we needed more ESG education. There was a cluster of, we would call it consensus techniques that a lot of practitioners were using in an integrated ESG fashion without any value assignment for saying, "Are these good techniques? Will they definitely produce better risk return or not? What are these techniques that investor practitioners are using?" In much the same way that in the early days of value investing you would say, "Well, these are techniques that value investors use." There was still a huge debate as to, “Are you going to get better risk return by a values process or cheap price to earnings or something like that?”

So we formed a consensus as to what the techniques are. We went out to a lot of investment practitioners around as to, "Well, what is the consensus of these type of techniques?" The first half of the book was a lot of more of the basic terminology. “How does governance work? Stewardship work? What might you mean by an environmental factor or a social factor?” Then my chapter and Jason Mitchell's chapter on portfolio management about what were the techniques that people use. We were very interested in trying to get to specific questions. So there's a lot of talk about this blob called ESG. "Does it work? Does it not?" It's a very unhelpful question because the blob of ESG-- I think you said it yourself. In some way there is no such thing as ESG investing. It's kind of a meaningless term.

You're just using it as a catchall to say this is something you're interested in. It's almost the same as saying, "Are you a value investor?" Wow. The next question is, "What sort of value investor?" Because actually a value investor today is almost meaningless as well. So we looked at that and specific questions. For instance, looking at Alex Edmond's work on the fact that if you have happy and engaged employees, you seem to get better company return metrics and stock return metrics. We looked at how to look at extra financial factors, how people are embedding it in their valuations, looking in terms of intangibles and competitive dynamics. We looked at it in terms of portfolio management, different scores, how quantitative managers were all looking about this. We gave people the kind of techniques that investment practitioners were doing in order to try and help their investment process.

You can go back to the roots that investors disagree at the moment whether you can get value from active managers over passive managers. People disagree about what sort of passive management you would do. There was a lot of investment debate around how to invest generally. ESG is part of that debate and we wanted to say, "Well, these are the set of consensus techniques that people are using." Then you can decide for yourself which techniques you think are useful, which are maybe less useful, which would be useful for your own investment belief, and processes. And that's how it came about.

Matt (31:02):

I've seen just talking to people and looking on LinkedIn and hearing from people just in our world and here internally at CFA Institute, it seems to be quite successful. I'm heartened that the education we see and you mentioned about five or six years ago, CFA Institute partnered with PRI on a number of papers around ESG integration. We asked you to do one of our case studies and that's how we first met. We went around the world and talked to people about what they did and didn't understand around ESG. What was the current state of ESG where they were from? From Toronto to Sydney, to Sao Paulo, to London and everywhere in between. One of the big things I saw was the huge gap in ESG education and demand from clients to get up to speed.

And then in supply of folks like yourself at firms like RBC and other places, that really had a good grounding in sustainability in ESG. I think this curriculum and others as well is doing a lot of great work in getting folks up to speed on that. I've looked through and I've read it myself. It's very rigorous. I'm fortunate enough to have taken the CFA exams and the amount of rigor and amount of time you have to spend on it is about the same for what it is. People have joked that it's CFA level 4 because it's kind of the same amount of study. And now the CFA UK society is coming out with a climate. They just came out with something similar on climate. I've read that as well. I would argue it's actually too rigorous. There were things in it I was like, "This chapter is 150 pages long. You have to cut out some stuff.” But for anyone interested in really diving into this stuff, I think they're a great resource.

Ben (32:48):

I would say you can buy the textbook from your favorite online retailer to have a look. I do think we aimed quite a lot of the material at below CFA level 1 to some extent. So an introductory part. But you are right. The portfolio management techniques that Jason Mitchell and I talk about are in some ways very advanced. Not all portfolio managers would use them. So it's a very interesting blend. I would say though that you can look at this work even before you've done CFA level 1, 2, and 3 because it takes you all the way through it. I think the other thing to highlight is we were quite good at involving other asset classes because a lot of people just think of equities. We talked about debt, bonds, government bonds, and we don't talk about that much, but we allude to property, real estate, VC, private markets which are now all deeply ensconced in their own expressions of how to integrate a lot of these extra financial factors. I think that's really positive. If you are a believer in markets, which I am, then actually new techniques, new competition, and new debate is all very healthy for this.

Matt (33:58):

Yeah. Agreed. Now, let's get into your day job. As a portfolio manager, how do you see the ESG sustainability landscape and how do you integrate it into what you do?

Ben (34:09):

So I'm a deep fundamental portfolio manager. So we always deal with the fundamentals of a company. It happens that when you are thinking about the fundamentals of a company, many of those drivers are extra financial. How you are dealing with your customers. Your relationship with your regulators, and with your suppliers. How we look at it is if you over borrow from one of those sources of extra financial capital, you tend to end up destroying long term value. You treat your employees badly, they leave you. You get a bad glass door reputation, you're not hiring back. So that's a destruction of long term value. But if you can see that's true on the risk side, call it an extra financial liability which is not on the balance sheet, you can see that it's probably true on the asset side as well.

So if you invest in your own people, you invest in the future, you have a good relationship with your supplies and regulators you are creating an asset and value. It's really interesting that this intersects with a lot of work or what people would so-called intangibles. So even if you don't use the phrase ESG or extra financials, you call a lot of this stuff intangibles. And economist at the same time-- There's some very interesting work for instance by Jonathan Haskel and Stian Westlake. Jonathan Haskel sits on the Bank of England committee, like the fed committee for selling interest rates, and Stian Westlake is a long time innovation economist. They've done a lot of work about how the value of a business and the value of the economy today is increasingly, if not majority intangible. A lot of that is human capital and ideas.

So that comes through to the fact that these are assets and they're not reported very well in the annual report. Partly because it's hard to quantify and partly because this is not how our frameworks have come about, which is very useful for getting around the efficient market hypothesis. Because if it's all really neatly explained, as you'll know in CFA 1 , 2 or 3-- I don't remember which part of the syllabus it comes in anymore. But the fact that this information is not that efficient allows you to get better risk and return. Coming back to me as a portfolio manager, the first thing you are really doing whether you're looking at extra financials or not, is what are the core drivers and risks for the long term prospects of that business. You really want to try and hone down on those to use our pilot's material. What are the really important drivers? You want to ignore the ones which aren't that important and look at the ones which are really important.

And actually again, even your old school fund manager would say, "Well, that's exactly what we do. We wanted to disregard the stuff which is not important.” So we're probably not important for natural resource use or water stress for a financial services company. But actually we knew if we were a drinks company in Africa using those sort of resources, then how you are managing your supply chain or your natural resources would be really important for us. So you're looking at what we call materiality for how strong or good the company is, and then we will come up with the judgment about the strength of that company. Then we will embed it in the valuation how these things affect long term cash flows. Some people actually also like to do it in discount rates than a like. We personally prefer to do it in terms of how this is affecting long term cash flows because at the end of the day, the discount for your cash flows back is how you're going to value a company.

Matt (37:27):

That's a great transition into the next thing we wanted to talk about. That is getting those standards for that data around the world is really kind of at the apex of those efforts as we're speaking now. The SEC just came out with their proposals for required climate disclosures a little over a month ago. The ISSB; International Sustainability Standards Board did something similar. I'm in the middle of writing our response to the SEC; our comment letter as we speak. After we talk I have to go up to my desk and do some more on that. ISSB is due at the end of May. We're talking in late April 2022. The ISSB deadline I think is mid-July. Add to that, the folks at the TNFD; Taskforce for Nature-related Financial Disclosures, have put out kind of their first guidebook for their natural capital disclosures they want to do. That is similar in structure to this TCFD for climate. I know I'm throwing out way too many acronyms here. There's no deadline for that, but it's kind of a rolling comments if you want to get to them.

But my point is that we are at the height of trying to put some numbers and some structure to these standards on what is material; whether it's climate or natural capital. Europe has been at the forefront of this more so than other parts of the world. So as someone who's involved in this and closer to what's going on in Europe, what are your thoughts on where we are, all these efforts, and are we getting to where we need to be?

Ben (39:04):

So let's start with SEC and climate and use that as a lens. I will start with the opposing arguments which I think are probably best expressed by Hester Peirce; one of the SEC commissioners who dissents from this idea. You have to go back to her original source material, but from what I'm seeing she sort of claims two matters.

1. Where climate is material, companies should be disclosing this anyway, therefore these regulations are unnecessary. That's her sort of first line of argument.

2. The SEC is not an environmental regulator. So it's overstepping its regulatory mark. 

Those are broadly I think the strongest arguments on the other side. Now on her first argument saying that, “If they are material they should be disclosed,” I have a little bit of sympathy for that because I think that is true. If this is material, then you should be disclosing this kind of information. But there are two problems with it. One is the fact that some companies are not. So to the extent that we have better regulation that would force that from the point of view of investors, that is going to be helpful. So on the one hand, I agree that if it's material it should be disclosed. But actually you can see from market practice that there is a lacuna there. There is a little bit of a hole.

The second part of the argument though is kind of interesting that it's a little bit different. That is that even if for one small company, you could maybe make an argument that some sort of climate disclosure is not super material for that company-- which we can debate whether that's going to be true of any company. But say you had that argument and you bought that, you would fail if you say adding up all of the largest 2000 companies in America, you would definitely say that was systematically important. This is an interesting second leg of where you see it from, for instance, Commissioner Gensler in the arguments that he makes. That is then going to be interesting to investors. Particularly for instance, investors who hold all 2000 companies in the US; largest 2000 companies. They will need to have this information in order to make a materiality judgment on that systems basis.

I think that's a slightly newer argument that we've heard and that also kind of goes back to what we're talking about. The fact that in my work, and I think the work of a lot of asset managers, they're very interested in this revolves around active stewardship. How you use your vote and how you use your engagement, because particularly in what we would call secondary equities-- So when I'm buying and selling shares with another counterparty but not raising any new equity or debt, engagement in stewardship is one of the main ways that we make a difference in the real world. 

If we don't have the information to base our engagements on, then we are not going to be able to do that as effectively; whether you are deep fundamental active manager like myself, or a large tilted quantitative or passive manager. So I think it is really important and I think it's going to be increasingly important to have that baseline level of disclosure. Then actually, this is where whether you're a market leaning person or a policy regulation leaning person, the markets can do their job when they have their information of which there is a consensus agreement on that. Now, some would say, "Yes, material you're meant to have this information." But you can tell for market practitioners, we don't have this information.

So therefore I think it would be an important disclosure to do. This is where it's closing a loop on the fact that I think in the future-- already today but definitely in the future, this active ownership stewardship piece is going to be increasingly important. And to the type of asset owners that I speak to in the institutional land, that's already important now and growing. But I think the person in the street, the woman in the street is increasingly interested in how their money is being managed in this fashion as well. So I think this is likely to be a long term trend.

Matt (43:17):

I would agree. I think we're also in a very interesting kind of nascent stage of, "Well, what does that mean when you say ESG, versus an ESG fund, or sustainable fund, or sustainable investing?" I think the moment we're in now there's a lot of greenwashing out there; whether it's for products or whether it's for companies reporting. I think a lot of it gets back to just education-- not just for us in our world, but for the consumer, or for the regulator, or for the company. What does it mean to be 'green or sustainable?' We're still working around that language of what that means from the woman on the street who wants to buy a fund that does well by doing good. “Okay. But how do you do that? You can't just buy something that is labeled green.” The CFA Institute put out standards on sustainable or ESG labeling for funds that came out last year. The SFDR in Europe is doing the same. 

So I think if we're having this conversation five years from now, there'll be a much better understanding-- not just in our industry, but from the person on the street, from the policymaker, from issuers, corporates. There's more agreement about when we say sustainability or we say ESG and what that means because there will be the standards from the EU, or the SEC, or the ISSB, or it will have been baked into policy for X number of years. So I think ESG and sustainability is a cultural change in our industry, but also beyond that in society. That's going to be a messy proposition in some cases.

Ben (45:00):

Yeah. So I would make an analogy with actually typical financial rhetoric. So you've always had a problem with corporate puff. Everyone wants to put their best foot forward, and sometimes you overstate that and that's why you have advertising standards because sometimes it's such an overstatement that you need to retract it. I do think that institutional owners in some ways should know better. They should be able to know whether something's going dark brown to light brown, whether that's good, whether they could go dark brown to light green, and not necessarily need a taxonomy for them to sophisticatedly figure that out. I think on the retail or the person in the street, there is a lot more need for that. But if you think about it, what does it mean to say if you are a value investor? Is Warren Buffett a value investor?

Does that mean if you're a value investor you never buy anything which is overvalued? Does that mean you never buy anything which is below a PE of a certain type or a certain thing? If you are a sustainability investor, does that mean does anyone ever want to buy anything which is unsustainable? Does anyone ever want to buy anything which is overvalued, if you take the counterfactuals of those terms? So I do think we need a lot more. But I think there needs to be a sophisticated in the judgment. That actually goes back to your earlier question on the data. So I think we need a lot more disclosure and I think standardization will help. But actually, data in itself is also not going to solve the problem. I sometimes worry a little bit that you have some people saying, "We'll have all of this data and our problem will be solved."

Well actually, there's a twofold thing to that because you still need analysis of the data. Actually, sometimes the lack of data doesn't stop you from knowing what the correct thing of what you should do is. So on the one hand, you also don't want to let a lack of data stop having good strategies and creating value; so you don't want to wait sometimes for that data to come through. And on the other hand, a lot of the data might be contested. Particularly if you look at the scenario analysis or the things like that. We'll still need analysis, right? So you don't want to sort of say, "We have all of this data. ISSB has done its job. The regulators have done its job and we have it." That's a little bit like saying, "Well, now I know the return on equity is 8.4%. Great. Job done." Well, what has that told you? Even if I tell you my carbon scopes and even if that's audited to some degree, the fact that I've got 30 tons per million carbon intensity, what does that tell you? Where am I going? What does that mean? What's your scope three? How does that work in your strategy? Where are you in the world? Data is only a piece of the problem. It's a really important piece and I think we do need to work on that. So I don't want to take away from any of that. But if you think that is definitively the end of the journey, then we're also going to be in trouble.

Matt (48:05):

Yeah. It's what we've been talking about so far. That data that we will be getting in some better way over the next three to five years has to be coupled with the education we're talking about, with solid analysis. Data with no analysis is useless and analysis with no data is useless. They go together.

Ben (48:29):

Exactly. And actually the analogy might be that we're going to need private actors and we are going to need government policy. You can't have one without the other. I think you can be working on them separately, but you want both tools. And actually you'll also want non-government actors as well; NGOs and the like. Traditionally, the classical model has been governments, NGOs, private actors, and they each have domain expertise and they also coin sect. They're all looking about creating long-term value or long-term wealth; however you want to define it. I think that still holds. Each is going to have to play its part in being part of the solution and not part of the problem. Companies will not be able to act without supportive government policy and NGO and the like. Government policy itself is also not going to get you there without corporate actors also playing their part.

Matt (49:20):

Agreed. All right. Well, we've gone through everything in the Ben Yeoh Renaissance ESG Renaissance Man Portfolio except Ben Yeoh Playwright. Can you tell us a little bit about how being a playwright intersects with the ESG world and a little bit about your journey there?

Ben (49:40):

Sure. So I was really interested in theater all the way from school as a teenager, high school, and then did more theater work at Cambridge; although that wasn't part of my degree. And then at Harvard as part of the liberal arts training, did a lot more training in terms of dramaturgy, writing poetry and the like. I guess part of my own personal theory of change is that stories and arts and culture really matter. They matter because for instance, the stories we told ourselves around slavery, the stories we told ourselves around women's rights were absolutely key for those social change movements. If you think about the things that humans value, yes, there are a lot of tangible things like having enough to eat and things like that. But there are also things that we do for instance, in our leisure, in arts, and in culture.

In some ways, those are the very things that we try and defend when we're looking about growing the wealth of a nation. In some ways, those are the things which are very hard and are often not put into GDP but are really important to us. So I've been intersectional in having that, that I feel driving that type of change is important. It's also important in terms of equity. We have a feeling of the voices that are not heard. Yes, that's true in terms of diversity inclusion amongst our sector generally. But it's also true that the stories that we tell ourselves. For instance, today, depending on how you define it, anywhere between 10 to 20% of the world has some form of disability. They are not how you'd view a typical person.

We need to hear about the equity there, their stories, what makes them human. I think that's a really important part of what makes investors real in the real world. In terms of my latest work in terms of this, I host my own personal podcast around some of these type of things; around arts and culture as well as in investing. I recently done a line of work which we call performance lectures, which you kind of cross a little bit of lecture and data with story and art and things like that. So I've done one around the topic of death; how we die today versus two or 300 years ago? What are our actual major causes of death? Then some of the causal things we might think of that we do or don't die from like, "Do we really die from grief?" 

300 years ago people said that you did die from grief. Do we die from grief today? And things like that. I've also actually done one thinking around sustainability and climate. Again, trying to put all of these things together about what we might do both on systems and a personal level for all of the intersectional entity on that. That's part of the wider work I feel in terms of being impactful. Talking about what we do, how we can have better ideas, and being pluralist about getting people in the room who want to point in the same direction. We want human beings to be wealthier and better, living longer and having all of these things. But what are the actual changes that we can happen to do that? I think arts and culture is a really important part of that.

Matt (52:54):

I couldn't agree more. I called this podcast The Sustainability Story for a reason. Because I think of myself as a storyteller. I love stories. I've always loved stories my whole life. And I think it's an underappreciated part of really any endeavor you're involved in. We are the stories that we tell ourselves. We tell ourselves the stories of our tribe, whatever that is; our nation, whatever that is; our sports teams we follow, whatever that is. You think about if you're a Yankees fan or a Chelsea fan. All the stories you talk about of what that means going back all those years. And really anything in your life, and the personal relationship you have, all the stories you have, when you get together with friends you haven't seen for five years, you come and you recount the stories that give that friendship meaning. It's not different whether you're talking about a market or investing. There are stories behind all these companies. They're not just numbers on a spreadsheet.

Ben (54:01):

Exactly agree. Had we told ourselves different stories, we would not be at war today. The stories that have gone into some of these things are being uniquely influential-- and that's been throughout the whole of human history, not just now. That's why I think it's critically important. If you look at these, talking about some of the major causes of death in our lifetime, we call them the full horseman of apocalypse for a reason. So once you've got around death, we've had pandemics, we've had famine and we've had war. These are not human inevitabilities. Depending on the stories we tell ourselves, how we work together, and what we're going to do in the future will really depend on the course of human trajectory about what we do. I think stories and ideas will be extremely important in the future to come.

Matt (54:53):

I think that's a great way to end things. But before we let you go and before we let our listeners go, what are you reading? What are you listening to? What are you watching that you think our listeners might be interested in to kind of help them dig deeper on some of these topics, or something unrelated to what we've talked about that you think you want to share with them?

Ben (55:13):

Sure. So I read an awful lot. I read a lot of books at the same time. I also don't always finish books nowadays. That's one of the changes for me versus 20 years ago. Sometimes you get the key idea or it's flabby. I don't think you have to finish all books. Having said all of that, I am currently reading Lydia Davis. She is an exceptional American short fiction writer and also essayist. Some of her short stories are only a paragraph long, and she has really put the whole form of stories and storytelling on another level in terms of what she's done. So interesting form as well as interesting stories. 

In terms of theater, I'm actually rereading. I actually have hundreds of plays sitting in my home library, but I'm rereading Ionesco's “Rhinoceros.” This is an absurdist story where essentially everyone turns into rhinos. This is really interesting because it's a sort of commentary on mass delusions or delusions, but depending on which side of the fence you are on, you can actually often apply it to either side of the fence. It's a really beautiful universal story because often you think the person who disagrees with you is having the mass delusion. So I think it's even greater than where it is. So people talk about Ionesco's “Rhinoceros” and they use it in their favor. Then I can think, "Well, people would've thought that earlier--" Like our earlier conversation on slavery. I think before it happened, people would've thought you are really deluded to ever think that we wouldn't have slaves. And now today, we would think you're deluded the other way around. So it's got great resonance in an absurdist manner.

Then in terms of economics, I'm also rereading Albert Hirschman's “Voice Exit and Loyalty.” He was an amazing economic and political economic thinker. I reread this quite a lot because Voice Exit Loyalty talks about the difficulties of essentially whether you engage or whether you divest; not just in terms of investments, but every decision you might have in your life. Where you work, how you might view your relationships, and all of those things. You've always got this choice. Let's say in the relationship-- Say it's a friendship and for whatever reason you haven't spoken or you've had a disagreement. Do you put the work in it and try and change it for the better? Or do you walk away and say, "This is no longer for me." Those are always your two choices. Do you use your voice or do you exit? It's actually a thin book and it's been very influential in people's thinking. He writes really well about it.

Then my last one that I've almost finished reading-- so I'm going to finish the whole book and I really recommend. It's called “Letters To My Weird Sisters” by Joanne Limburg. She is autistic and she talks about historical female figures who have some of the traits that you might think about in terms of autism. But it's really intersectional about thinking about female figures, thinking about otherness, different ways of thinking, inclusiveness, and what it really means to be human today. It is extremely erudite and has really changed my thinking at least, opened my eyes to thinking about through both the gender lens, but through an otherness lens and then through history about what it means to be human. So that's another book I would recommend to change your mind about something.

Matt (58:39):

Great. Ben, as always, it's great to talk to you. Thanks for the conversation. I hope to see soon.

The US SEC has proposed two ESG rules for asset managers.

The US SEC has proposed two ESG rules for asset managers. (1) Names Rule would require funds that use ESG terms in their names to follow ESG strategies. (2) ESG Strategy Disclosures would require funds that follow ESG strategies to make certain disclosures.

Names Rule
■ This would require a fund to invest 80% of its assets in ESG if it uses ESG terms in its name. The proposal would bar the use of ESG terminology in a funds name if the fund only considers ESG as "one of many factors" in investment decisions.

ESG Strategy Disclosures
■ This would require funds that have an ESG strategy to provide details in their prospectus of how they consider ESG factors when selecting investments. There are 3 “tiers/layers”. (1) “Integration” (2) “ESG-focused” (3) Impact.

There would be lesser requirements for “integration” funds than for “ESG-focused” funds. There also would be greenhouse gas emission disclosures for funds that have a climate change focus.

An “ESG-Focused Fund” would mean a fund that focuses on one or more ESG factors by using them as a significant or main consideration (1) in selecting investments or (2) in its engagement strategy with the companies in which it invests.

On Impact, the main disclosure will be “an overview of the impact(s) the fund is seeking to achieve, and how the fund is seeking to achieve the impact(s). The overview must include (i) how the fund measures progress toward the specific impact, including the key performance indicators the fund analyzes, (ii) the time horizon the fund uses to analyze progress, and (iii) the relationship between the impact the fund is seeking to achieve and financial return(s)” But also the “impact objectives” will need to be disclosed upfront along with return objectives.


Of note, there is one dissenting commissioner. SEC Commissioner Hester Pierce objected to the Names Rule proposal because she said the 80% investment requirement is too subjective given ambiguity about what constitutes an ESG investment. The better approach is to focus less on the name and more on the disclosures describing the investment strategies. She also objected to the ESG proposal as the SEC already has the power to police asset managers who mislead investors about their ESG efforts. She also complained that the SEC fails to define ESG, which means the proposal will not work because the terms are too broad and it will be nearly impossible to have consistent disclosures among funds.

Comments open for 60 days. Link to proposals below:

List page for SEC rules: https://www.sec.gov/rules/proposed.shtml

Direct links to pdfs of proposals:
Proposing Release: Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices (sec.gov)
https://www.sec.gov/rules/proposed/2022/33-11068.pdf
https://www.sec.gov/rules/proposed/2022/33-11067.pdf

Links to statements, including Hester Peirce's objections:
https://www.sec.gov/news/speeches-statements
https://www.sec.gov/news/statement/peirce-statement-esg-052522