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U.S. Lawmakers In Move To Formalise ESG Reporting

Hedge funds making investments that meet some kind of ‘ESG-friendly’ criteria have been hindered by the lack of an accepted industry standard to help them prove to their existing and prospective investors that these investments – and therefore, their funds - tick the ESG box. Many firms sell their own proprietary datasets to hedge funds which are designed to help in the security screening process, but the lack of uniformity between the providers means that different hedge fund investors and their consultants might be judging the same hedge fund by different, or worse, conflicting, criteria.

On September 20th, U.S. lawmakers took a significant step towards creating a defined set of rules for the ESG investing playing field as the U.S. House Committee on Financial Services passed H.R. 4329, or the ESG Disclosure Simplification Act of 2019, by a vote of 31-22. The bill is sponsored by California Democrat Juan Vargas. His comments after the passing of the bill state that “The bill will allow companies’ commitment to sustainability to be easily compared and evaluated by investors. We must have a standard definition of materiality for both investors and companies that also includes environmental, social, and governance (ESG) matters.”

The passage of the bill means that U.S. regulator the S.E.C will create a rule to require public companies to disclose certain ESG metrics, which will be defined by the SEC. The bill also requires public companies to disclose annually - in their proxy statements - a description of the company’s views on the link between ESG metrics and long-term business performance, and it also creates a Sustainable Finance Advisory Committee within the S.E.C, which would make recommendations to the regulator on which ESG metrics public companies should be required to disclose.

Hedge funds need not get too excited just yet, however.

“The real impact of the bill will depend largely on how ‘ESG metrics’ are defined, which will be determined by the SEC”, says Jessie Gabriel, a Partner at U.S. Law firm BakerHostetler and Head of its Investment Funds practice. “It will also depend on how high a priority it is for the SEC to enforce this provision. It is also important to keep in mind that the bill still needs to pass the House - which is likely once put to a vote - and the Senate, which is less likely unless it is coupled with other legislation”.

If the bill does become law, Gabriel says that there won’t necessarily be a glut of hedge funds jumping on the ESG bandwagon.

“Requiring all public companies to disclose this information will certainly make it easier for hedge funds to focus on those companies if they want to, but most investors are still focused entirely, or nearly so, on returns”, says Gabriel. “if there is no correlation between ESG metrics and [stock] performance, the additional data may actually have the opposite effect as fund managers and investors abandon ESG for profit.”

If the bill passes, there could be an impact on data providers, too, according to Lauren Attard, a lawyer with BakerHostetler in Los Angeles.

“Their role may move to one of consulting for public companies that need to collect and analyze their internal data, as well as putting more of a focus on their analytics over their hard data collection”, says Attard. “For instance, there will be investors who want to focus on ESG within public companies, and on companies that are particularly mindful as to E, S, or G. Both customer groups will still be relying on ESG data providers for support. Furthermore, The Sustainable Finance Advisory Committee will continue to examine the ESG metrics, so depending on the activity of that Committee (i.e., as metrics shift), it would have an impact on ESG data providers. The question will just be how much.”

The bill has a long way to go; it must pass both the House of Representatives, the Senate and then it lands at President Trump’s desk; it might not make it any time soon. What isn’t in doubt is the ESG investing industry’s desire for more transparency and uniformity, and this bill is a step forward on that journey. Hedge funds will be watching with interest.

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