Adam O. Emmerich of the corporate and securities law firm Wachtell Lipton in a recent memo cautioned the firm’s corporate clients that the expectations on them with regard to transparency on environmental, social, and governance matters will increase in the months ahead. His emphasis is on the social part of ESG and, especially, on one aspect, namely the employment/human resources question. Indeed, he observes that the now-standard phrase and list may need expansion, to “environmental, employment, social, and governance” (EESG). Emmerich doesn’t discuss implications for strategic traders/investors of this change in climate. That is not his function. But it would surely seem likely there are implications. The Increase of Expectations The EESG and transparency/measurement expectations will increase because stakeholders of various types—including both equity and debt investors—want to “view these issues across companies and industries,” a viewing that requires comparable data by all relevant public companies. Expectations will also increase, Emmerich suggests, because the Covid pandemic has acted as a reset button. As a range of economic and financial activities revive from the near-frozen condition of recent months, investors—asset managers among them—can expect that some things will be done differently, that the reset will not be a rewind. ESG metrics, the memo says, can provide “valuable tools and models to help both public and private companies and their investors and other stakeholders (including employees, customers, business partners and communities) understand their progress on these issues,” such as the issue of racial inclusiveness that has acquired an extra salience since the killing of George Floyd in Minneapolis on May 25. The Sustainability Accounting Standards Board, the Global Reporting Initiative, and a draft document from the International Business Council of the World Economic Forum all address dignity, equality, diversity, inclusion, discrimination, and so forth. Each of those organization’s frameworks proposes, for at least some of the covered entities, the annual disclosure of percentages of management and non-management employees by sex and (where relevant) race, ethnicity, and other minority status. Objective, Quantitative, Operational Emmerich references a recent report from Willis Towers Watson to the effect that a little more than one half of the S&P 500 now uses ESG metrics in incentive plans. But he also observes the “bad news,” for people who care about advancing sustainable investing, to be found in the same WTW report. The companies that use such metrics largely regard ESG as “a subjective matter” where the criteria used are qualitative rather than quantitative. Emmerich suggests, rather, that the coming higher expectations involve treating these matters, especially diversity and inclusion, as objective, quantitative, and operational. This means that they and their shareholders (and other stakeholders) can “better understand whether [incentive] payouts on this criteria match company performance.” The Tangible and the Intangible Neuberger Berman, as Emmerich notes in this memo, recently created a sustainability-linked revolving credit facility. It is the first US asset manager to do this. To whom is NB going to be lending money? To firms that have been increasing their diversity at management levels—that is one of its key metrics. Lending money is a rather tangible way of advancing a cause. A perhaps less tangible approach is changing a familiar set of initials. But as Emmerich tells us, ESG in some corners has already morphed into EESG. As Emmerich writes, “the heightened focus and appreciation for ‘EESG’ imperatives generally … in the context of the COVID-19 pandemic also holds promise with respect to these areas.” Market Inefficiencies and the L/S Play As a communication with clients (corporate managers for the most part) the memo naturally does not delve into the question of what market inefficiencies might be created by the higher expectations it posits. But it is reasonable to suspect that inefficiencies will come about as some firms and even industries will meet the invigorated new metrics in ways that may sacrifice operational productivity. For others, post-pandemic restart and shake-up may itself enhance productivity. Shorting the former and going long the latter will be a big ask for Big Data and a human (not merely an algorithmic) insight.
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