The business case for sustainable finance policy

Over the past 12 months, the COVID-19 pandemic has clearly demonstrated that even in the worst of economic crises, investors that factor environmental, social and governance (ESG) issues into their investment decisions perform better, and so does the average retirement saver and retail investor. Now, as the U.S. begins to emerge from what has been a dark year, there is a unique opportunity for the U.S. to catch up and even surpass the rest of the world by modernizing investment practices and helping American savers reap the economic gains from long-term, sustained economic growth.

That is why the Principles for Responsible Investment (PRI), which represents over 3,500 investors managing over $100 trillion in AUM — equivalent to the annual GDP of China — is calling for the U.S. to step up to the plate and take a leading role in global efforts to shift to sustainable financial practices.

As members of Congress prioritize the country’s economic recovery from the pandemic, it is vital to highlight that profitability and ESG integration are not mutually exclusive. When General Motors recently announced its plans to move to an all-electric fleet by 2035, its stock price jumped by 3.5 percent. And similarly, since activist shareholders launched a campaign to push Exxon to work towards net-zero greenhouse gas emissions by 2050, the oil giant outperformed Chevron. These tangible examples from the auto and oil industries illustrate a broader truth: investing in companies with a proven commitment to ESG issues is good for 401(k)s.

Over the course of 2020, we have seen how purposeful companies, with stronger ESG profiles, have outperformed their peers. And investors, corporations and governments alike are waking up to this fact. Larry Fink, CEO of Blackrock, the world’s largest investor, highlighted exactly this in his annual letter to shareholders. He cited a “sustainability premium” that companies considering ESG factor have been returning to shareholders.

Time and time again, sustainable investments have proven to enhance shareholder value. We now have the data to back this up. Last year, at the onset of COVID-19, 89 percent of sustainable funds outperformed their non-sustainable counterparts. More recently, a meta-analysis of over 1,000 research papers published between 2015 and 2020 confirmed that companies preparing for a low-carbon future outperform those that are not. And over the past decade, analysis shows companies that incorporate ESG factors into business decisions financially outperformed their competitors. Specifically, companies in the top 50 percent of ESG ratings outperformed the bottom half by 6.8 percent — near the average return of the stock market over the past 50 years.

Global investor signatories to the PRI are sending a clear, cohesive message. They’re calling on corporations to disclose their contributions to climate change, promote workers’ rights and build diverse, inclusive corporate cultures. These may not sound like typical priorities on Wall Street, but we’ve seen a deliberate shift among investors — including giants like BlackRock, Vanguard and State Street — toward focusing on these issues in their investment decisions. It is becoming increasingly clear that those who do not consider ESG issues will be left behind.

The PRI recently released a detailed policy paper outlining actions to support ESG integration and responsible investing practices in the U.S. With Congress’ help, these policies will help grow 401(k)s, limit systemic risks from crippling our financial markets and contribute to long-term, sustained economic growth in a rapidly changing world.

The Securities and Exchange Commission (SEC) should start by moving forward with the work started by Acting Chair Allison Lee and require companies to disclose material ESG information. PRI signatories report that the lack of consistent, comparable corporate reporting on ESG issues is a substantial barrier to their investment practices and the SEC should look to close this glaring information gap in the public domain.

However, enhanced ESG disclosures are only effective if investment managers and shareholders are empowered to act on them. That is why both the SEC and Department of Labor (DOL), which oversees the management of $7 trillion in private retirement funds under the ERISA law, need to clarify that considering ESG factors is part of fiduciary duty and work to improve investors’ ability to offer shareholder proposals through the proxy process. Fiduciary duties need to be updated for the modern era where ESG information is often decision-useful, and both agencies require clarity on fiduciary responsibilities around ESG issues. Similarly, both the SEC and DOL should clarify shareholder duties around active ownership and voting proxies when it comes to ESG issues.

Although administrative agencies can implement these policies without the legislative branch, Congress can and should codify these measures. This will avoid regulatory ping-pong and establish a long-term commitment to ESG integration to provide both companies and investors certainty about what is required of them.

The U.S.’ top economic competitors are investing in the future, outpacing it in the race to leadership in a globally emerging sustainable economy. If Congress can move forward together, creating clear regulatory guidelines that consider the full scope of ESG factors, and allow a more holistic approach to investing, we can set America’s post COVID-19 economy on the path to long-term, sustained success.

Fiona Reynolds is CEO of Principles for Responsible Investment.