ESG

Revealing insights from SSgA report on ESG adoption – ERISA perspective

State Street Global Advisors (SSgA) recently released a research report entitled, Into the Mainstream – ESG at the Tipping Point. It begins with a salient point: “ESG may well be becoming a mainstream trend, but every institutional investor – from pension funds to endowments to sovereign wealth funds – faces a unique mix of forces pushing them towards, or pulling them away from, ESG investing.” Indeed, asset owners and their managers are in fact subject to distinct standards of care, with ERISA’s fiduciary duties being the ultimate. In reviewing this report of global institutional investors’ reasons for addressing environmental, social and/or governance (ESG) factors in their investment decisions, and their reasons for not doing so, I considered the implications for ERISA fiduciaries, as “pension funds” were one of the institutional investors surveyed (along with endowments, charities, sovereign wealth funds and others). Consider also some of my prior analysis on the interplay of fiduciary duties under ERISA and ESG issues.

Here are the key takeaways:

  1. Fiduciary Duty: A Hurdle or Affirmative Duty to Incorporate ESG? A longstanding, significant obstacle to adoption of ESG by ERISA plans was whether it could be done in a manner consistent with ERISA’s fiduciary duties. The duty of prudence (Section 404(a)(1)(B)) has been the primary area of concern under an ERISA/ESG analysis, but duty of loyalty (Section 404(a)(1)(A)) and diversification (Section 404(a)(1)(C)) issues may also arise depending on the circumstances. Interestingly, the SSgA findings indicate that 46% of those surveyed viewed fiduciary duty as a push factor – i.e., an affirmative duty. If we drill down, the % of respondents who cited fiduciary duty as a lead push factor was highest in North America. If we drill down further, we see that, 41% of pension funds view ESG as a fiduciary duty. So, while pension funds seem less likely to view ESG as an affirmative fiduciary duty relative to other institutional investors, the fact that 41% do is notable. Again, this picks up pension funds globally and appears to cover private (i.e., ERISA) and public (i.e., governmental) plans.
  2. Risk Mitigation or Opportunity? The results also show that ESG risk mitigation is, at this point, (much) more of a basis/push factor to incorporate ESG factors into an investment decision than outperformance reasons (in North America, 42% (of all respondents – not just plans) cited risk mitigation vs. 1% who cited ESG as a way to generate higher returns). Various other studies make the point that ESG can present both mitigation and return opportunities, so it is interesting that institutional investors have gravitated toward mitigation rather than return. Perhaps lack of standardized disclosures and metrics is a reason, but it would seem that would affect both downside risk and return on any given investment. Perhaps another reason is that the outperformance takes longer to materialize. The DOL has reiterated that integration is examined under the regular prudence test and not the heightened tie-breaker test.
  3. Obstacles: A continuing theme, now picked up by this new SSgA report, is that the lack of standardized and transparent ESG data remains a primary obstacle to adoption (e.g., inconsistent scoring across the various providers). SSgA, in this report and over time, has helpfully examined the correlations of the major data providers in terms of a specific company’s ESG coverage. In one example, the ratings of companies by two prominent providers had a correlation of (only) .53. The lack of expertise in ESG was also cited as a top reason for not incorporating ESG factors – a valid reason for not making a particular investment under ERISA (fiduciaries are not expected to be all-knowing, but are expected to seek outside expertise when doing so would be prudent). Perhaps this explains why more and more ESG-related questions are showing up on questionnaires sent to investment managers.
  4. Governance: Respondents reported better measurement of governance (G) factors than environmental (E) or social (S) factors. For ERISA fiduciaries using integration, an analysis/documentation of how the respective E, S and/or G factor affects performance is important under DOL guidance. It is also important for investment managers and appointing fiduciaries to be clear on whether one or more E,S or G factors will be incorporated for any particular mandate, and to confirm that doing so would be in accordance with plan documents.

SEC schedules Nov 5 open meeting on shareholder engagement

The SEC has announced an upcoming Open Meeting, the subject matter of which will be the SEC’s continued efforts to facilitate constructive shareholder engagement and enhance transparency, improve disclosures, and increase confidence in the proxy process. The specific matters to be considered are:

  1. Whether to propose amendments to the proxy solicitation rules that would provide for disclosure of material conflicts of interest and set forth procedures to facilitate issuer and shareholder engagement, to provide clarity to market participants, and to improve the information provided to investors.
  2. Whether to propose amendments to the shareholder proposal rules to modernize the submission and resubmission requirements and to update procedural requirements.

In addition, the subject matter of the Open Meeting will also include the SEC’s continued efforts to modernize the regulatory framework for investment advisers and enhance information to investors. The specific matter to be considered is:

  1. Whether to propose amendments under the Investment Advisers Act of 1940 to rules 206(4)-1 and 206(4)-3, the rules that prohibit certain investment adviser advertisements and payments to solicitors, respectively.

The Open Meeting is scheduled for November 5 at 10 am.

SEC expected to propose new proxy voting rules next month

The Financial Times is reporting that the SEC expects to propose new rules related to proxy voting next month. The proposals will likely raise the threshold for shareholder proposal resubmissions, as well as to “propose rules that would require proxy adviser firms to give companies two chances to review proxy voting materials before they are sent to shareholders….” If adopted, these rules could have significant implications for proxy adviser firms, as well as for proxy voting used to address ESG risk factors.

What the new Callan survey reveals about ESG adoption in US

Callan recently released its 2019 ESG Survey. I have previously written about their prior surveys. Here are the key takeaways (the findings are from the survey, the analysis and commentary are mine):

  • Respondents (89) were U.S.-based institutional investors, including governmental plans, ERISA plans, endowments and foundations. In other words, this is not an ERISA-specific survey, but nevertheless picks up trends in the DC plan space.
  • Rather strikingly, 62% of respondents that utilized ESG have been doing so for just the past 5 years. This translates to a 91% increase in respondents that have incorporated ESG factors into investment decisions since 2013.
  • Implementation is the most popular ESG approach. Here is my definition of this technique. I expect this trend to continue as the data linking ESG factors to investment performance continues to evolve.
  • Significant uptick in adoption by DB and DC plans (both governmental and ERISA), though their overall numbers continue to lag other investor types. 36% of DC plans offer an ESG option. Only 18% have added a themed fund into the lineup (meaning, DOL Field Assistance Bulletin 2018-01’s discussion around themed funds, particularly the questions raised over whether such funds could serve as QDIAs, may be muted).
  • Noticeable differences between early adopters (before 2015) and recent adopters (2015-2019) in how they have implemented ESG:
    • 64% of the earlies added language to an IPS vs. 39% for the recents (perhaps some of this reflects 2018 DOL guidance that ESG-specific language in an IPS is not necessary?)
    • 57% of the earlies communicated to investment managers that ESG is important vs. 35% of the recents
    • 21% of the earlies utilized shareholder engagement/proxy voting as a method to address ESG vs 13% for the recents (regulatory headwinds could have dented this number a bit, as well)
    • 14% of the earlies added an ESG option to the DC plan lineup vs. 9% of the recents
  • 68% of respondents do not have a distinct ESG allocation apart from its traditional portfolio (this make sense considering integration, which us “under the hood,” is gaining traction).
  • Of recent adopters, 22% use a screening process and 17% have divested.
  • Reasons for incorporating ESG include:
    • Fiduciary responsibility (50% earlies, 57% recents)
    • Improved risk profile (29% earlies vs. 43% recents)
    • To make an impact (29% earlies vs. 17% recents)
    • Higher long-term returns (29% earlies vs. 17% recents)
  • Reasons against ESG incorporation include:
    • Not considering factors that are “not purely financial” in investment decision-making
    • Limited participant interest
    • Perceived political activism
    • Fiduciary duty concerns
    • Perceived as pursuing a moral agenda
    • Not legally required
  • Respondents have interest in seeing greater ESG products for both private equity and real estate, among others.

Ticktock on potential new DOL guidance re. proxy voting

In just a few days, the Department of Labor will be set to satisfy its obligations under the President’s April Executive Order by “complet[ing] a review of existing Department of Labor guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.” In an op-ed I wrote for Pensions & Investments, I put the EO into context and highlighted some possible paths the DOL could take. As we await any guidance, I would like to highlight this point that I made several months ago:

“…it is possible the DOL could adhere to the executive order by issuing new guidance that raises the perceived costs of proxy voting and other forms of shareholder engagement and/or demands a more rigorous analysis on the part of fiduciaries that such engagement is “clearly connected to” shareholder value. Any new test could not be so onerous as to make divestment preferable to engagement, as that would seem to undermine the executive order’s very purpose.”

We will, of course, conduct a full analysis of new DOL guidance, which we will post to this blog.