As Environmental, Social and Corporate Governance (ESG) based investing continues to grow in importance, it faces a problem.  The problem is how to get issuers to disclose the information these investors need.

Or as an article on a Natixis survey on ESG investment issues summarized it:  data is the missing link.

Investors are more interested than ever in how publicly traded companies handle environmental, social and governance issues, but many say they lack the information to make ESG investment decisions and their advisors often offer little help.

Those are some of the major findings of a recent Natixis survey on ESG investment issues, which essentially combines the results of four previous global surveys of close to 12,500 individual investors, financial professionals, institutional investors and professional fund buyers.

The lack of data includes minimal disclosure by companies which impairs investors ability to drive ESG outcomes.  For example, the Net-Zero Asset Owner Alliance is

an international group of institutional investors delivering on a bold commitment to transition our investment portfolios to net-zero GHG emissions by 2050. Representing more than USD 2 trillion in assets under management, the United Nations-convened Net-Zero Asset Owner Alliance shows united investor action to align portfolios with a 1.5°C scenario, addressing Article 2.1c of the Paris Agreement.

This Alliance was initiated by Allianz, Caisse des Dépôts, La Caisse de dépôt et placement du Québec (CDPQ), Folksam Group, PensionDanmark, and SwissRe. Since then, Alecta, AMF, CalPERS, Nordea Life and Pension, Storebrand, and Zurich have joined as founding members.

So how does the Alliance or any ESG investor get companies to provide the necessary disclosure to measure their compliance with the Alliance’s or the ESG investor’s objectives?

They could try to get disclosure mandated.  But turning to the SEC isn’t likely to produce the required additional disclosure.

Why?

Despite the existence of minimal ESG reporting standards, the SEC is sitting on its hands.

SEC Director Bill Hinman spoke about the benefits of the SEC’s current, flexible approach to environmental, social and governance (ESG) disclosure for public companies. He noted that current disclosure requirements are largely principles-based and “apply in areas where the disclosure topics may be complex, associated with uncertain risks and rapidly evolving.” Such an adaptable principles-based disclosure regime, Director Hinman posited, is well suited for addressing often complex, risk-laden and rapidly evolving ESG topics, including how companies consider climate change risks, labor practices or board diversity in their decision-making.

Despite pressure from various investors for the SEC to require specific ESG disclosure requirements, Director Hinman argued that doing so at this juncture may be unwise. The market, according to Director Hinman, is still evaluating what, if any, additional ESG disclosure is needed. During this wait-and-see period, Director Hinman noted that the SEC is keenly monitoring and analyzing corporate ESG disclosure, actively comparing information that companies voluntarily provide–often outside of SEC filings–with their SEC disclosure.

The SEC is leaving it up to the companies and we all know companies are only going to disclose information in a way that makes them look good.  There is no reason to think this disclosure necessarily reflects the underlying reality.

So ESG investors need another method for getting the company specific disclosure they need.  Disclosure that is likely to exceed any disclosure standard set by the SEC.

The Transparency Label Initiative offers the ESG investors a lever to overcome the reluctance of companies to provide the necessary disclosure.

The Initiative awards a label to companies that provide the information needed so investors can know what they own.  So it would be easy to add the disclosure needed by  ESG investors into the criteria for awarding a label.

The label’s leverage comes from dividing companies into those whose securities are transparent and those whose securities are opaque.  This allows investors to choose how much, if any, exposure they want to opaque companies.

Investors understand when they buy an opaque security they should also sign a Certificate of Dumb Investment saying

I want to buy this opaque investment.  I understand that the person selling it will almost certainly steal all my money, and that I would almost certainly be better off buying a transparent investment where I can know what I own, but I want to blindly bet anyway.  I agree that I will never, under any circumstances, complain to anyone when this blind bet inevitably goes wrong.

Buying opaque investments is like buying lottery tickets knowing that a lot of them will go bad, but hoping some might pay off.  As a result, investors demand a higher return for buying opaque securities (this is reflected in a lower stock price and higher cost for debt).

It is management’s decision whether or not it wants to pay this higher financing cost.  Management knows if it discloses the information investors need to know what they own it will lower the company’s cost of debt and equity.