ESG Subcommittee Update

Report to the SEC Asset Management Advisory Committee

May 27, 2020
Agenda

• ESG Subcommittee members

• Workstream details

• Overview of in-scope practices

• Workstream report-outs

• Questions for AMAC members

• Next steps

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ESG Subcommittee Members

• Michelle Beck, TIAA Financial Solutions

• Jane Carten, Saturna Capital

• Rich Hall, Univ. of Texas/Texas A&M Investment Management Co.

• Jeffrey Ptak, Morningstar Research Services

• Aye Soe, S&P Dow Jones Indices

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Workstream details

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Workstream Key Outcomes

Is ESG About Values or Value? Recommendations regarding whether the focus 

should be on values, value, or both, and what the 

implications are for best practices and regulation

Assessing Performance of ESG Strategies Recommendations for understanding drivers behind 

risk and returns of ESG funds, as well as ways to 

measure alignment of financial outcomes with 

fund’s objectives 

Proxy Voting in ESG Strategies Recommendations for approaches to proxy voting 

for ESG strategies

Issuer Disclosure of ESG Data Actionable recommendations regarding what 

guidance or regulation should be provided to issuers 

with respect to ESG data

What Role Should ESG Rating Systems and 

Benchmarks Play?

Recommendations for how and whether to suggest 

or require the use of third party ESG ratings systems 

and/or benchmarks for those investment portfolios 

that brand themselves as ESG
There are a variety of practices described by 

fund managers as ESG

• Considering ESG Practices

• Exclusion: Screening out stocks in one or more categories

• Overweighting stocks in one or more categories

• Incorporating ESG category sentiment metrics into investment 

decisions

• Investing in line with an ESG benchmark index or rating system

• Proxy voting in alignment with ESG preferences

• Activism with management on ESG preferences

• ESG impact measurement for investments

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Examples of ESG focus areas

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• Use of carbon, Carbon emissions

• Sensitivity to flood, fire, water 

scarcity

• Need for raw materials

• Biodiversity and land use

• Sustainability practices

• use of renewable energy

• LEED certification

• recycling behavior

• energy efficiency in manufacturing

• use of disposable plastics

• Pollution/waste practices

• Deforestation practices/use of palm 

oil

• Use of nuclear energy

• Weapons

• Alcohol

• Gambling

• Support for organized labor

• Practices forbidden by the Islamic 

faith, such as debt

• Practices forbidden by the Catholic 

faith, such as birth control and 

abortion

• Human rights practices

• Supply chain labor standards

• Consumer protection

• Animal welfare

• Separation of CEO and board chair 

roles

• Companies’ management or board 

gender diversity

• Executive compensation

• Employee compensation

• Business ethics

• Tax transparency

• Corruption

• Anti-competitive practices

Environmental Social Governance
Is ESG about Values or Value—and what are 

the implications?

• How ESG should interact with the names rule; is it fundamental, or a 

strategy

• If ESG is about values, it is about consumer choice

• If ESG is about value, it is about financial metrics 

• How should either be disclosed and aligned

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What are the considerations in assessing 

performance of ESG strategies?

• There are frequent statements on ESG risk/returns in research studies & 

marketing materials, including that

• ESG funds do not underperform their respective benchmarks or ESG funds do not detract 

from financial performance

• ESG funds have lower portfolio volatility

• ESG funds limit downside risk

• Companies with higher ESG scores have stronger balance sheets and are less volatile

• Understanding Returns of ESG Funds

• Many ESG funds come to market over the past five years during which a number of structural 

changes took place – decline in energy prices, dominance of big tech and healthcare sectors. 

• Is performance coming from over/underweighting of certain industries?

• Momentum effect in ESG (flows driving performance)

• Is ESG a proxy for quality? In particular, the overlap of good corporate governance with 

typical financial quality metrics (low leverage, low earnings accrual, lower earnings volatility)

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How should ESG performance be measured?

• Measurement Time Horizon

• Near-term vs longer-term • Many ESG funds lack long-term track record.

• Mixed evidence on those over ten year of live track record as well as potential for survivorship bias

• ESG scores do not go back far in history and are often backfilled (potential for look-ahead 

bias)

• Appropriate choice of benchmark

• There are now more than 300 open-end and exchange traded ESG funds in the US. They have different investment objectives and focus.

• Exclusionary Broad based (S&P 500 ex tobacco, S&P 500 ex fossil fuel reserves)

• Thematic (gender diversity, clean technology)

• Best in Class (ESG Leaders)

• Integrated (with quant factors or alpha overlay, optimized with TE budget)

• Should ESG funds be measured against broad based, market cap weighted benchmark or 

should it be beta-adjusted/style-adjusted benchmark? 

• A primary and a secondary benchmark for performance reporting

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Without a consistent framework, 

performance attribution is not comparable

• Lack of well defined, systematic steps in how 

managers integrate ESG in their investment 

process

• Makes performance attribution difficult.

• There is no industry standard as to what ESG 

integration means and expected outcomes from 

integration. 

• In order to have comparable attribution, we 

need: 

• Clear disclosure of ESG score data including history

• Use of primary and secondary benchmarks

• Disclosure on expected non-financial outcome – alignment of outcome with fund’s objective

• Disclosure and independent validation of the 

degree of ESG compliance – ingredient mapping 

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What are the considerations for proxy voting 

in ESG Funds?

• What are funds trying to accomplish in their proxy voting—help 

shareholders? Help the environment?

• What are the potential pitfalls?

• Who benefits/loses?

• What is the role of proxy advisory firms?

• Is it significant that ESG funds do not always vote the ESG positions recommended by 

proxy advisory firms in proxy votes?

• Should ESG funds be held accountable for proxy voting?

• Can the funds outsource these decisions to proxy advisors so long as they have rules 

related to this? Should anything be mandatory in this area for any fund that brands 

itself ESG?

• What should proxy voting practices look like in fund disclosure?

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What enhancements to issuer disclosure could improve 

investors’ ability to invest according their ESG 

preferences?

• Are there opportunities to improve the quality of disclosure

• Comprehensiveness

• Meaningfulness

• Materiality

• Comparability

• What gaps are there, and what role can regulation play

• There are multiple standards available (UNPRI, SASB and others), and multiple 

stakeholders

• Comparability and consistency are sometimes lacking; fewer than 30% of public 

companies disclose ESG risks, and the percent is smaller for private issuance; fixed 

income disclosure is often threadbare and focused only on the issuer, or use of proceeds.

• Disclosure is often backward looking rather than forward looking

• Metrics required by public standards could number in the hundreds, making it difficult to 

consume

• Issuers appear to cherry pick their ESG information for use in marketing materials

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What are ESG rating systems and 

benchmarks?

• ESG ratings systems are scoring tools developed by third parties that 

rate and rank investment portfolios based on their adherence to one 

or more ESG principles

• Akin to credit ratings

• ESG benchmarks adjust an existing index, or create indices from root 

principles, in order to express ESG tilts in one or more categories of 

focus

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What role should ESG rating systems play?

• While the quality of ESG data has risen in recent years, disclosure by issuers 

remains fragmented and inconsistent across most sectors. ESG data 

providers attempt to fill these gaps through estimates and other 

proprietary processes.

• A number of rating systems focus only on environmental and/or 

governance practices

• Types of data these can use include

• Controversy scores

• Direct disclosure elements

• News sentiments

• Impact metrics

• Shareholder/governance engagement data

• Screening data on activities

• Emerging categories (e.g., geospatial such as proximity to water resources, 

consuming info from sites like Glassdoor)

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How comparable are ESG rating systems?

• Ratings systems can differ in key ways philosophically

• Absolute vs relative

• How peer groups are defined

• Whether they focus on financial materiality vs. stakeholder sentiment

• Whether they focus on disclosure (company policy) vs performance (impact: 

emissions, water management)

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Questions for AMAC members

• What is missing here that you think needs to be explored?

• What are your concerns about potential regulatory responses? What 

would be helpful, what can you see as problematic?

• What are your concerns about the way the ESG investment industry 

currently works? What are positives that you think need to be 

retained, and what are negatives that you think need to be managed?

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Next steps for the ESG subcommittee

• Receive feedback from committee members on questions, and on the 

subcommittee’s scope and focus, to make any needed adjustments

• Analyze and present pros and cons of “do nothing” vs. various 

approaches to “do something” in our areas of focus at next AMAC 

meeting, including

• Guidance and suggestion

• Principles based regulation

• Rules based regulation

• Develop recommendations based on this assessment and your 

feedback, targeting end of 2020

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