Proxy advisers are at the root of misleading ESG claims
Proxy advisers are the hidden force behind the rise of the ESG movement and its morph into a large-scale grift, where American companies and investors are the victims. This little-known industry, dominated by Institutional Shareholder Services (ISS) and its smaller competitor Glass Lewis, has fundamentally changed ESG.
What began as a public relations and marketing effort for corporations to show employees and customers they are responsible actors now functions as a corporate credit score, where those who refuse to play the game are denied access to investor capital. Publicly traded companies have often been slow to fully understand the power of proxy advisers and their affiliates to materially harm shareholder value by merely issuing an ESG rating downgrade.
According to the Forum for Sustainable Investment, approximately 17.1 trillion U.S. investor dollars are invested under so-called "sustainable" investment strategies, which consider ESG ratings. Therefore, a downgrade in a company's ESG ratings from a "B" to a "C" would materially impact the stock price in the same way as a credit downgrade from Moody's.
Given the power of these ESG ratings, publicly traded companies and retail shareholders must have direct access to how these ratings are calculated. Unfortunately, proxy advisers call that information proprietary and refuse to disclose it. Where they do provide information on their metrics, their metrics leave themselves open to lots of qualitative judgments, which can be abused.
Even more troubling is that Institutional Shareholder Services currently has a significant potential conflict of interest. They provide ESG ratings and a consulting business that helps public companies improve their ESG ratings. Investors may suffer from wrongly investing in companies who have high ESG ratings because they paid for consulting rather than because they are good corporate citizens. Anglo American Plc, the parent company of the infamous De Beers Group known for "Blood Diamonds" and indentured servitude, enjoys top ESG marks and vaulted "ESG Prime" status from ISS. Did they receive their marks because of high ESG performance or because of paying ISS? This apparent conflict of interest leaves investors troubled as to whether ISS's ESG scores are based on the company's ESG performance or whether the company paid for ESG consulting.
In May, the SEC announced its intention to regulate ESG claims by asset managers, insisting that they observe some level of standardization to prevent abuse. While this is a reasonable step, it fails to address proxy advisers' significant role in the process. The SEC must regulate proxy advisors in two ways.
First, proxy advisers should be required to spin off their ESG consulting businesses that present a significant conflict of interest detrimental to investors and public companies who do not engage them. Short of that, proxy advisers should be required to disclose clearly, when releasing ESG ratings, how much money was paid to them by the public company.
Second, proxy advisers should be required to publicly disclose their quantitative and qualitative methodology in calculating ESG scores.
Given the significant amount of money run under so-called sustainable investment strategies, the SEC must take appropriate action to protect American businesses and investors from being victimized by an arbitrary and conflict of interest–ridden ESG system enforced by proxy advisers. Effective SEC action will embolden public companies making the most positive impact, not those willing to pay to play.
Terry Branstad is the national chairman of The Corporate Citizenship Project, former U.S. ambassador to China (2017–2020), and the longest serving governor in the history of the United States (1983–1999/2011–2017). In addition to his role as president of Des Moines University Medical School, his public service includes election to the office of lt. governor and three terms in the Iowa House of Representatives. For more information, visit https://corporatecitizenshipproject.com.