ESG funds currently investing in firms and projects responsible for “serious human rights violation and environmental destruction”.
Plans by the US Securities and Exchange Commission (SEC) to crack down on greenwashing by fund managers must be revised to cover not just environmental but human rights issues.
At present, companies complicit in abuse of local populations can not only keep high ESG ratings, but sometimes see them increase.
This is the message to the SEC from three non-profit organisations concerned with human rights and the environment: Inclusive Development International (IDI), Accountability Counsel (AC) and Friends of the Earth US (FoE US).
Citing one case, relating to Myanmar, the submission to the SEC stated: “ESG-labelled funds have funnelled billions into companies arming, funding and legitimising the Myanmar military, the perpetrator of the Rohingya genocide and a violent crackdown on the country’s pro-democracy movement.”
In March 2022, Inclusive Development International co-published a report which found that ESG-labelled funds held at least US$13.4 billion worth of shares in companies linked with the Myanmar military leadership.
Earlier this year, investors also faced challenges assessing and withdrawing from investments in Russia, in response to human rights abuses arising from the country’s military invasion of Ukraine, due partly to difficulties in sourcing information from fund managers, service providers and investee corporates. Despite due diligence processes and commitments to UN Guiding Principles on Business and Human Rights, even sustainability-minded asset owners found themselves holding Russian assets well after the initial invasion of Ukraine, which celebrated its national day yesterday.
The three organisations were responding to two proposed tough new labelling and disclosure rules for ESG funds and other financial products. First is an expansion of the scope of the rules governing the names given to funds, ensuring that, as with other labels, ESG funds must be supported by having at least 80% of its portfolio in sustainable assets.
Second is an increase in detailed disclosures of ESG strategies in prospectuses and annual reports.
Too much discretion
The joint submission commended the SEC for its proposed rule changes. “For too long, funds have taken advantage of the lack of regulation to market themselves as ‘ESG’ friendly when, in fact, the corporations within their portfolios have contributed to significant adverse impacts in relation to one or more of the three components of ESG – environmental, social and governance issues.”
It added: “Having the SEC promulgate rules that require these actors to disclose information regarding their methodology in considering ESG criteria provides vital information for investors seeking to invest in ethical funds that provide an environmental and social return in addition to a financial one.”
But it urged the regulator to tighten up the rules to take account of involvement in or exposure to human rights issues. One such change, it says, would be to set out specific criteria, or at the least a minimum standard, as to what constitutes an ESG fund. At present, the SEC is proposing simply to require investment companies to explain the factors it chooses to use.
That means, said the submission, that this allows investment companies “too much discretion” and would allow securities that meet the self-determined criteria to be included in an ESG fund “even if those portfolio companies have a dismal record on one or more ESG issues, including human rights”.
ESG ratings improved after disaster
The risk of investor exposure to human rights abuses, said the submission, is far from hypothetical and is almost commonplace among the most prominent ESG funds. “IDI has followed the money behind more than 200 large projects in Asia and Africa that are implicated in serious human rights violation and environmental destruction and has consistently found that the public companies behind these projects get high ESG marks.”
The non-profits give the example of Korean company SK Holding, described as “responsible for one of the worst development disasters in the South-East Asia region – the collapse of the Xe Pian Namnoy dam in 2018”. Seventy-one people were killed and thousands left homeless.in Laos.
“At the time of the dam burst, the company had been in many of ESG indices and funds with, in the case of MSCI, a ‘moderate’ BBB rating. However, the company’s ESG rating did not decrease following the event.
“Rather, three months after the dam collapse the company’s rating had increased to an A and, within three years, the rating had increased to AA.” When questioned, MSCI cited the company’s commitment to net zero emissions.
Flaws of disclosure-based model
The three organisations called for the SEC to provide a “clear and substantive” ESG standard against which funds can be judged. “Unfortunately, the disclosure-based model that underlies the SEC’s proposed rule only requires funds to disclose what they consider ESG to mean. As such this will not help advance the SEC’s goal of consistency and will not prevent ‘greenwashing’ or misleading claims about the real-world impacts of portfolio companies and funds.”
Elsewhere, the submission proposed greater SEC oversight of third-party data providers and suggested adoption of a ‘double materiality’ rule, with the commitment to disclose financially material information being joined by one to disclose information having a bearing on the non-financial objectives prioritised by ESG investors.
“Without setting some standards for what ESG actually means and doesn’t mean, the industry remains a cash cow for asset managers and ratings firms, while continuing to funnel capital to corporations with horribly unsustainable and irresponsible business practices,” said David Pred, Executive Director of Inclusive Development International.