26 Oct Reporting Standards Regrets, I’ve Had a Few
The following commentary/analysis is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers. I am sharing it here today because I thought it might be useful to some of you.
Good Times, Bad Times, ESG’s Had Its Share
For the last several years, everyone connected to the capital markets – investors, asset managers, corporate executives, regulators, auditors, etc. – has been expecting an eventual de facto change in the materiality standard to address “sustainability” issues, as well as consequent mandatory sustainability reporting requirements. The SEC is perpetually on the verge of issuing a new reporting rule; the EU has already issued its standards; and various global bodies have issued their recommendations time and again, in the expectation that all regulators will heed their advice and follow suit.
This is a given. Everyone knows that everyone knows that new mandatory sustainability reporting standards are both desirable and inevitable.
All of which, I believe, makes me the first to say that you probably shouldn’t bet on it. Indeed, if I were a betting man, I’d take the heavy, heavy odds and wager that mandatory reporting standards are NOT in our future.
In the United States, of course, there is every reason to believe that implementation of the SEC’s new rule – whenever it is issued – will be delayed for several months, at the very least. It will be challenged in the courts immediately and repeatedly. Even if it withstands those challenges, the ultimate fate of the SEC’s environmental regulatory powers lies with the Supreme Court, which will review the 40-year-old Chevron Doctrine this term, and with the voters, who go to the polls next November. It is well within the realm of possibility that come January 20, 2025, Congress and the President of the United States will together issue explicit constraints on the SEC’s ability even to consider carbon emissions in its rule-making.
But this is even bigger than that. Indeed, my sense that mandatory sustainability reporting is already dead supersedes the technicalities of the American administrative state. It is not contingent on a decision here, a choice there, or a ruling somewhere else. Rather, it is animated by the very fundamentals of business, commerce, and prosperity.
I have long considered ESG to be part “luxury belief” and part “bezzle.” By the latter, I mean that ESG is comparable to the embezzlement and corruption extant in the markets in the 1920s, as described by John Kenneth Galbraith in his fantastic little book The Great Crash, 1929. Like the explosive rise of corruption in the 1920’s, ESG’s explosive rise was enabled by cheap money and good times, by the fact that almost anyone can appear to be a shrewd and successful investor when funds are plentiful and almost every stock goes up, regardless of its inherent value or expected corporate performance.
At the same time, tough times and tighter money breed suspicion and watchfulness. This is a positive for those wishing to root out corruption, but a serious negative for those who have invested in dubious companies based on dubious schemes in the hope of achieving dubiously relevant results. In other words, tough times and tight money place a higher value on solid management, proven business plans, and a focus on profits over moral pretensions. This bad for the bezzle and bad for ESG.
We have already witnessed the impact of these conditions on American ESG – and that impact is constantly growing and becoming more vigorously negative:
Investor appetite for sustainable funds waned in the third quarter. U.S. sustainable funds endured their fourth-consecutive quarter of net withdrawals….
Investors pulled $2.7 billion from U.S. sustainable funds in 2023′s third quarter, for a total of $14.2 billion over the past year….
The overall percent of U.S. long-term open-end and exchange-traded funds, encompassing conventional funds as well as sustainable funds, also lost nearly $3.9 billion over the period. However, the relative decline in demand was more significant for sustainable funds, compared with conventional peers.
The organic growth rate of sustainable funds, which is calculated as net flows as a percentage of total assets at the start of a period, puts the magnitude of redemptions into perspective. During the third quarter, sustainable funds contracted by 0.85%. By comparison, overall U.S. funds were flat, declining 0.02% during the period.
[Also] For the first time in recent history, sustainable fund departures outpaced arrivals. In the third quarter, three new sustainable funds launched, and one existing fund was added to the sustainable funds landscape (labeled “Arrivals” in the exhibit below). During the same period, 13 sustainable funds closed and four funds moved away from ESG mandates (labeled “Departures”).
The UK and Europe have seen ESG withdrawals as well, although the reasons for this, in Europe especially, are somewhat more complicated.
Whatever the case, investors have concluded that ESG isn’t all that was promised. It is, in fact, a far less sensible and return-compatible investment strategy than it appeared in the decade-plus during which central banks kept rates artificially low.
But here’s the catch: investors aren’t the only ones who have noticed that focusing capital investment decisions on non-pecuniary criteria can harm businesses and profits. Governments too seem to have grown concerned that the virtue-signaling that has necessitated sustainability reporting just might not be worth the compliance costs, misallocation of capital, and potential economic damage it could unleash.
This past summer, to much ballyhoo, the EU passed its set of mandatory reporting regulations, insisting that the new standards served as proof that Europe was leading the way toward a better and brighter post-fossil-fuel future. And yet, today, less than 100 days later, many in the EU are having second thoughts:
Europe’s executive arm is proposing a two-year delay in implementing a key element of its sustainable finance framework, as complaints mount that businesses can’t keep up.
The European Commission said cutting red tape is critical to ensuring that the region’s companies remain competitive, according to a document laying out its agenda for 2024. That means extending the deadline for adoption of sectoral elements of the European Sustainability Reporting Standards, or ESRS, currently due to come into force in June.
“This will provide an immediate reduction in the reporting burden for in-scope companies,” small and medium-sized firms, the commission said.
The development is the latest sign of a pushback against Europe’s ambitions to swiftly respond to climate change and social inequality, and steer its economy toward a more sustainable model. An 11th-hour attempt by members of the EU’s parliament to entirely rework the ESRS failed Wednesday, in a vote of 359-261….
Other corners of Europe’s ESG framework also are likely to be reworked.
Also of note, last week Brazil became the first country in the world to adopt the International Sustainability Standards Board’s global standards for sustainability disclosure. Even more notably, Brazil made compliance with the standards voluntary starting in 2024 and not mandatory until 2026. Once again, if I were placing bets, I’d wager that the mandatory start date for Brazilian companies to make environmental disclosure gets pushed well beyond 2026 and, in the end, is abandoned altogether.
The world is a scary place right now – and not just politically. It is economically unsettled as well. Smart politicians and regulators are apt to recognize that Greta Thunberg and people who compulsively glue themselves to streets and paintings are a mere annoyance, paling in comparison to an energy crisis, or a deep recession, or a string of bank and other business failures, and the wrath of millions of people left poorer and less secure because their leaders decided to put a Gnostic ideology above their well-being.
Answer me this: if you were a Democratic Party politician or operative facing the possibility of a Republican rout next November and the reelection of Donald Trump, would want to risk hitting the nation’s publicly traded companies with trillions of dollars in new compliance costs and other economic impediments, amid an already shaky economy, and during an election year?
You don’t have to answer that question, by the way. It was rhetorical. I know the answer. And so do Joe Biden and his advisors. And so does Gary Gensler.
It’s not gonna happen, in other words. Even among true believers, this is NOT the moment to double down on luxury beliefs. It is NOT the time to wink and close one’s eyes and pretend not to see the bezzle. The stakes are too high – which, fittingly, is and always has been the point.
