Back to General Resources

Senate Banking Committee Hearing on ESG Principles

Senate Banking Committee

“The Application of Environmental, Social and Governance Principles in Investigating and the Role of Asset Managers, Proxy Advisors, and Other Intermediaries”

Tuesday, April 2, 2019

Key Topics & Takeaways

  • Shareholder Thresholds: Sens. Mike Rounds (R-S.D.) and Pat Toomey (R-Pa.) asked about the SEC regulation that allows any shareholder with at least $2,000 in stock for a year to place proposals on a company’s proxy ballot. Copland argued that the $2,000 threshold is too low and should instead require a “sufficiently large” investment. Streur replied that the $2,000 threshold is appropriate, adding that the SEC has a process for getting proposals onto ballots. When asked by Toomey what the threshold should be, Copland replied that “a material percentage would be good.”
  • Global Competition: Sen. Thom Tillis (R-N.C.) asked about ESG in Europe, to which Copland replied that there is interest there and Streur added that Europe is looking to strengthen their system so European companies are more competitive with American companies and attract foreign capital.
  • Recommendations for the SEC: Toomey stressed the need for the SEC to address the threshold for introducing shareholder proposals, noting that it is too low, as well as a new proxy advisor rulemaking, as there is an “obvious conflict of interest.”

Witnesses

Opening Statements

Sen. Mike Crapo (R-Idaho), Chairman

In his opening statement, Crapo stated he shares the concerns that Securities and Exchange Commission (SEC) Chairman Jay Clayton expressed last year over the underrepresentation of long-term retailers in the decision process for proxy voting, adding that retail investors require a voice to be included in the decision-making process and a clear understanding of the decisions made. Crapo said index funds have been successful for investors and if current trends continue, only a handful of investors will maintain control over most of the funds and most voting power. He said environmental, social, and governance (ESG) principles are not the biggest objective in voting today, but that the U.S. has seen institutional shareholder interest in incorporating ESG principles and that needs to be better reflected in the proxy-voting process.

Sen. Sherrod Brown (D-Ohio), Ranking Member

In his opening statement, Brown said there has been emerging growth in ESG principle investment which should be reflected in financial growth reporting priorities. He said stock buybacks are not benefiting families and investors, and corporations should spend more capital on ESG policies rather than their own long-term capital benefit. Brown said Congress should act upon the SEC’s recommendation on human capital disclosures and ensure that all shareholder votes on ESG policies, such as climate change or gun control, are reflected in relevant decisions.

Testimony

The Honorable Phil Gramm, Former United States Senator

In his testimony, Gramm stated that ESG issues are “very important” and the debate about how corporate governance is structures and who money works for will have a “profound impact on our prosperity and freedom.” Gramm said the principles borne out of the Enlightenment of the 1700s, that labor and capital were private property, not communal assets subject to share, have led to the flourishing economies that persist today. Gramm said political movements today seek to undo these principles by trying to force businesses to “swear fealty” to shareholders, pressuring corporations to adopt political, social, and environmental policies that would subvert labor and capital in ways that have been rejected by state legislatures, Congress, and the courts. Gramm said the “explosion” of index funds whose managers vote shares they do not own has dramatically increased the danger posed by political activists. Gramm noted when index funds vote their investors’ shares on broad social and political issues, the problem is that index funds have a “glaring” conflict of interest, adding that even enhanced fiduciary duty will not solve the inherent conflict of interest that index funds face in voting investor shares on high profile social and political issues that have a potential impact on the marketability of the fund. He recommended the SEC require index funds to poll investors and vote their shares only as specifically directed.

James Copland, Senior Fellow and Director of Legal Policy, Manhattan Institute

In his testimony, Copland said the Chairman’s comments only reflect main street investors and do not address the majority of stocks held by intermediaries, adding that of the remainder of stocks held by main street investors, only 29 percent follow the proxy voting process. Copland said institutional investors allow for ordinary investors to outsource their voting and holding power and that the success of capital markets is linked to these proxy voting and investment structures. He said there is currently no system to monitor the institutional investors who are monitoring the boards and asset managers, and current SEC rules and regulations have enabled special interests to pursue many social policies important to shareholders contrary to board priorities. He said the goal of index funds is to leverage capital market efficiency and minimize active management costs, which should be reflected in the process. Copland said that shareholders support modifying corporate behaviors and that change is necessary to better control board rooms to pursue policies important to investors.

John Streur, President and CEO, Calvert Research and Management

In his testimony, Streur said companies are conducting deeper analysis on furthering capital progress while incorporating ESG impacts on corporate systems, and these should be the major focus in policy discussions. Streur said a heightened interest in these issues has pushed ESG investing into the mainstream, noting that in 2018 in the U.S. alone, more than $12 trillion was invested in strategies considering ESG criteria, most of them not indexed strategies, and globally, more than $30 trillion is invested using ESG research. He said corporations are also leading the way on acting upon ESG principle implementation, increasing their focus on actively managing their focus on ESG risks, adding that 90 percent of S&P 500 Index companies voluntarily report on ESG risks. He said the U.S is lagging in transparency and standardized disclosures on ESG issues, recommending the U.S. lead the push in setting standards, noting that otherwise, foreign regulators will set the standard for us to follow in the U.S. He also recommended a feedback mechanism for direct communication between proxy advisers and shareholders to provide a knowledgeable and transparent process, as well as proxy voting guideline disclosures.

Questions & Answers

Proxy Advisors

Several Senators asked about the use of proxy advisors and whether witnesses have concerns with them. Streur replied that the U.S. has a free market system that governs itself and that there is no worry that political considerations will be placed in front of corporate profitability or track records. Gramm argued that the concern is not with proxy advisors, but rather when someone is voting someone else’s shares, especially on high-profile issues like ESG.

Shareholders

In response to a question from Brown regarding whether small and large shareholders should be able to question companies, witnesses agreed that they should, with Copland arguing that shareholders can share their ownership if they have concerns.

Sens. Mike Rounds (R-S.D.) and Pat Toomey (R-Pa.) asked about the SEC regulation that allows any shareholder with at least $2,000 in stock for a year to place proposals on a company’s proxy ballot. Copland argued that the $2,000 threshold is too low and should instead require a “sufficiently large” investment. Streur replied that the $2,000 threshold is appropriate, adding that the SEC has a process for getting proposals onto ballots. When asked by Toomey what the threshold should be, Copland replied that “a material percentage would be good.”

ESG Issues

Sen. Brian Schatz (D-Hawaii) asked about ESG issues, specifically climate. Streur replied while companies are starting to disclose information regarding material climate risk, it is “not close to being there yet” but that companies are acting to protect themselves from the risks associated with climate change. Copland argued that while ESG is a merged term, governance issues are different from environmental and social.

Sen. Thom Tillis (R-N.C.) asked about ESG in Europe, to which Copland replied that there is interest there and Streur added that Europe is looking to strengthen their system so European companies are more competitive with American companies and attract foreign capital.

In response to a question from Toomey about whether increasing the levels of social issue shareholder activism is discouraging some companies from going public, Gramm replied “no question,” adding that companies must be careful they do not allow special interests to “win in the corporate boardroom.”

Recommendations for the SEC

Toomey stressed the need for the SEC to address the threshold for introducing shareholder proposals, noting that it is too low, as well as a new proxy advisor rulemaking, as there is an “obvious conflict of interest.”

For more information on this hearing, please click here.