ETF Edge - The SEC's New Proposals on Climate Disclosure

Episode Date: March 21, 2022

CNBC's Bob Pisani spoke with Doug Peterson, President and CEO of S&P Global – along with Todd Rosenbluth, newly minted Head of Research at ETF Trends. They discussed the SEC’s new climate change proposal – breaking down the ABC’s of ESG – and a direct response from the head of S&P to those new rules. Plus, more on why active mutual fund managers continue to underperform – more proof that investors are embracing broader indexes and the ETFs tied to them. In the‘Markets 102’ portion of the podcast, Bob continues the conversation with Doug Peterson, CEO of S&P Global. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange-traded funds, you're in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll delve deep into the SEC's new climate change proposal. Breaking down the ABCs of ESG, we'll get a direct with you. from the head of S&P to those new rules. Plus, more on why active mutual fund managers continue to underperform more proof that investors are embracing broader indexes and the ETFs tied to them. Here's my conversation with Doug Peterson, the president and CEO of S&P Global,

along with Todd Rosenblum, newly minted head of research at ETF trends. Doug, you've just released a statement on what you think the essential principles of ESG should be. Everyone is worried about the environment, but nobody can agree on what these terms are ESG. What are you actually proposing here today? What we're proposing is standardization of ESG disclosure, ESG funds. What we really look at is this theme about transparency and impact,

that we should be providing a way that the market can have a set of standardized information that can be used to make decisions for investors. One of the things I could say is that the train has already left the station. People are very interested in this. There's large value of funds that are out there, of people that are interested in investing based on purpose, based on value. Yeah. So you've emphasized the essential elements of what's needed here.

Transparency is one of them. A description of the impact on society and the environment and the risk associated with things like climate change. This seems to be what they absolutely have to have here. Now, what do we do to advance this? Where do we go from here? How do we make this more real? One of the best things we can do advance this is to have a dialogue across the markets,

both with investors as well with securities regulators like we heard today from the SEC, as well as a way to have standardization around this on a global basis so that we're not seeing sort of a fragmentation. One of the risks we had before is there's a complete alphabet soup of different organizations trying to standardize ESG disclosure. And now there are a couple of different initiatives. The most important one is called the ISSB, the International Sustainability Standards Board, that is bringing together all these different groups to have one single approach. to ESG disclosure. I want to get into the ISSP and where we go from here, but I want to bring Todd in.

First, Todd, congratulations on the new job. Just started, ETF trends, joining Tom Leidens team over there. We've talked you and I many times that all these ETS employ different methodologies, and it's a problem. Spider S&P ESG is not quite the same as the I-Shares ESG. Has this confusion taken some of the luster off of ESG funds? First of all, Bob, thanks for having me, and thanks for the the kind words, excited to be part of the ETF trends and database family connecting both asset managers, index providers with end clients. They do a great job and I'm excited to be part of it.

You're right. ESGU holds companies like meta platforms and Disney that you won't find in with EFIV. That's the SPIDER S&P 500 ETF. There's different criteria that index providers use. There's different rules that go in for each of the respective ETFs and we've got narrow focused ETFs tied to governance like the she ETF, the gender diversity, and clean energy ETFs like ICLN. So it's really hard for investors to keep up with what is inside and outside.

So I applaud Doug in the broader investment community for trying to help standardize what's going on in the SG. Yeah, and those of you who don't understand what's going on, and when we put up that, the ESG ETFs, EFIV, Spider-S-NP-E-S-N-P-E-S-G, that's State Street. licensing your index. That's why it says S&P, right? I want people to understand what's going on here and how important the indexes are. State Street, which is SPDER here, is licensing your index at this point, right?

And what happened is what Todd just described is that there's so many different types of criteria being used today for ESG. Sometimes I describe it as like the healthy food movement. Healthy food movement could be somebody that's interested in organic, somebody else is interested in vegetarian, somebody is vegan, and you could go to a restaurant. and it's called vegetarian, but maybe they're serving fish. Is that the right thing? So we need to think about coming up with some standardization so that when you see that it's ESG or it's a no-carbon or low-carbon, what are those labels mean? How are we going to make sure that the data is clear to the end investors so that they know what they're investing in?

And that the asset managers also complying with what they put on their label. Now, Todd, demand for ESG ETFs has slowed a bit to start 2022. Obviously, commodity ETFs, inflation ETFs are all the rage right now. But money is still coming in. It's just not as much as it was before, right? That's right. So we've seen continued interest in ESG products, but to a different degree than we saw in 2020, for example.

So ETF databases, traffic for the five largest ESG ETFs is down roughly 40% year over year to start the year. So there's less focus on ESG, but there is people who are trying to understand what is climate change and how does it affect their portfolio. And we've seen a number of products that have come to market that have Paris aligned or climate change in the name. We're finding advisors and investors want to understand what makes it into the portfolio and why. And all the more education that can be provided, the better for investors to understand what they're getting and what they're not getting. And, you know, Doug, this is a right. rather fortuitous your announcement that you made today. For example, I think it's fortuitous because SEC Chair Gary Gensler, we've got some news today,

has just released his long-awaited proposed rules on climate change, which would make disclosure mandatory, and he hopes more uniform in terms of what's being disclosed here. Is this a step in the right direction? How does this fit in with what you were talking about today? We welcome this move because it opens up the dialogue between the business community, the investment community, and the regulatory community. something that we need to have so that we can work on what Todd just described as more standardization, more common approach to this area.

One of the things Todd just also mentioned is climate change and the interest in that. And I think with the external circumstances going on right now with the war in Ukraine, that there's an increased interest in energy and energy transition, and understanding what that means, what's the role of energy, what's the difference between oil versus clean oil versus natural gas, what's a transition type of an approach to the future of energy. It's going to be a lot of interest in that. And I think the interest is going to rise,

and we're going to want to even have more standardization around what it means for investors. Now, you publish the ESG criteria you use. I mean, you have your own criteria. You have the S&P Global ESG Score methodology, right? It's on your website, in fact, right? Including the rationale and questions that you ask, the format, background information.

How do you gather this data? Give us a sense of where this is actually coming from. Are the companies providing it? How many provide information? How do you build this up from the ground up? So today we take information from companies. We have 2,200 companies provide it to us through a very detailed, rigorous approach. They go onto our website.

We have an approach with them and they provide us detailed information. It literally takes hundreds of hours for them to complete. It takes a lot of time for them to complete it. It covers all of the aspects of EES and G. For other companies that are not providing us that kind of detailed information, we take it from their own websites. Companies have sustainability scores. They have sustainability reports. Some maybe there's a little bit in their 10K or their proxy. And then in many cases, we have to model it. We have to take industry standards and model what that data is. And this is one of the reasons why disclosure will be valuable because then you're not having to model it.

You're getting in a consistent way and everybody can use it. One final point I want to make is that when you look at our scores, you're able to go not just at an aggregate score, you're also able to go down into details. If you just want to use the E part of the score or the S part of the score or the G part of the score, this has been another one of the criticisms of ESG scores. It kind of looks like an opaque score when you get one number or one letter, and what does that really mean? We think that you need that granularity as well to really make informed decisions. Now, you're describing the methodology, it sounds fairly rigorous.

You don't have complete information, so you have to model some of it. But who is ultimately going to decide what the rules are going to be? Now, you mentioned the ISSB, the International Sustainability Standards Board. This is a new organization, right? Can you very briefly tell us what this is? And why do you think they're the ones that are going to help pull everything together and bring order to this? Well, ISSB is an organization that's been put together under what's called the IFRS,

which is like the SASB at the global level, International Financial Standards Reporting Board. And they've now put in place underneath them, the ISSP, the International Sustainability Standards Board. This is also taking a convergence of other types of organizations like the Sustainability Accounting Standards Board and others in bringing them all together in a single approach to have a global standards for disclosure.

So the disclosure is a great start because it means that people like us that are going to come up with our ESG scores, will have the exact same data. So there's going to be different scores and different types of ratings, different types of opinions. But if we're all starting with the exact same data,

that's going to be really valuable. So just make it clear, plain English, the ISSP is an organization composed of people like your organization that all have a stake in this and you're all going to come to some common understanding? Are you a member of the eye? No, no. The ISSP is an organization that's run by governments.

Yeah. Okay. So I want to make sure that, are understanding how this is going to come to an agreement. Well, ISSP is a foundation. Yeah. And it's supported by governments and individual companies. It's funded through as if it was a foundation.

And it has a board of directors, which include people from the public sector and the private sector. It has a relationship with the international organization of securities. And is the goal ultimately, here's the standards that we are going to use. Give us a sense of a timetable. When will an agreement be reached on this? Yeah. Their approach is to start actually having standards. having standards right away. There are some standards that people had already agreed on.

I'll give an example of about 21 simple standards that the World Economic Forum agreed, that there was a large group of corporations in the World Economic Forum, agreed that this should be a standard that all companies should be able to provide. It's a very small number. And they're going to start trying to come up with

a small number of disclosures and start building from there. The approach is what I call build a baseline and then build from there. Get some simple things out. there that people would start reporting and then build from there to get more consensus and more out into the market. Todd, I've had an extended discussion here with Doug. I want to bring you back in. Does this make sense to you? You're a close observer of all this. Is the

ISB the right way to approach this? And in your opinion, is this real progress towards getting some kind of agreement on ESG standards? So I do think this is a step in the right direction. that there's a neutral observer that is helping to make sure that companies are providing the right disclosure. The SEC's role is going to play an important role. But I think it's also worth highlighting that even within the same index provider, they have different versions of ESG benchmarks that are narrowly constructed, that are broadly constructed, and there are ETFs that are tracking it, that have S&P in the name or that have MSCI or other index providers,

and they're going to perform differently because they're either broad or narrow in construction. So there's not going to be consistency. There are going to be different performance records for ESGETS, despite the fact that there's going to be some standardization of the underlying data. Right. So this is very important that you can, Doug, you can have the same data and still come to different conclusions. You can also weight it differently, right? So environmental social governance, if you wait one part of environmental differently than other parts, you come up with a different index standard and different weighting, right? It's important for people to understand that, right?

What you're looking for is more standardization of data. We're looking for standardization. I understand that later this week, the SEC might also come out with a standard of kind of the naming conventions for ESG and sustainability funds, which, truth in advertising, if you want to call it that, which means that people should be able to have the information that they will understand exactly what they're investing in, and that whoever is the ETF provider or fund provider will also be following the standards that they said they're going to follow. Well, this makes sense to me. I happen to the Gensler's right about this. He's been very critical funds that say we're green or we're carbon neutral or we're whatever,

and yet it's very fuzzy the standards of what they're calling. This is that naming convention you were mentioned. So that makes a lot of sense to me. And what Todd was just saying, that there are different ETFs and there are different types of sustainability funds. As an example, over 20 years ago in S&P Dow Jones Indices, we launched the Dow Jones Sustainability Indices. They've been around for a long time. And the criteria that's used there is not the same that's used for the S&P 500 ESG index.

Yeah, it's certainly very different. So you think it's going to take how long? It's actually going to be, well, we see pick a date a year from now, the ISSP announcing international standards for ESD. Will it actually be a published saying this is what we are all agreed to? I think that within a year from now we'll have a baseline which has started to be rolled out. It's going to start in Europe. Europe is ahead of us. The Europeans already have a taxonomy that they've started discussing.

And you also have countries like Japan and the UK that have also been mandating what's called the Task Force for Climate Related Financial Disclosure, which is a report that had been put in place a few years ago. There is a group called the FSB, the Financial Stability Board in Europe, and Michael Bloomberg, worked with them on this Task Force for Climate Related Financial Disclosure. In the United States, about 50% of the S&P 500 companies. are already reporting on that. And that's now going to be commanded in some countries. So there's various approaches to climate or sustainability or ESG,

but I think that the ISSP is going to take the TCFD. They're going to take other work that's been done, and they're incorporated into this baseline that they're going to build from. And let me ask you just to get a response again. I know we asked about Gensler before. I'm going to have him on Power Lunch in one hour from now, 2.15 on Monday. So I hope everybody tunes in for that.

But what do you think corporate America is going to say about this? You know, there's this big thing about materiality. Gensors insisting, this is material information. And our job, one of the jobs of the SEC is to protect investors. To protect investors, we need to have disclosure about this because it's materially important. And yet I see pushback already for people who are saying this is beyond the SEC's mandate at all. we had Hester Perce, one of the commissioners or Republicans, say, Congress did not give the SEC authority over the economy.

She had a rather scathing dissent this morning and vote on this. What do you think corporate America is going to say about this? You taught to corporate America. What are they saying? Corporate America is going to be split on this. There's going to be a wide array of opinions. There are people that are already reporting this. As I mentioned, 50% of the companies are already doing a TCFD report.

90% of the S&P 500 companies already disclose some sort of an impact report or a sustainability report or a CR report. And they're already putting a lot of this information out there, maybe not in the same format that would be required here. But there's a couple of big reactions. One of them's going to be about the potential litigation, and they're going to have a safe harbor. Companies don't want to go out and disclose in particular scope three emissions without having the ability to be, protected from litigation against either making mistakes or not being a clear standard or people saying, well, I never knew that this was the total impact of your carbon footprint and potentially having litigation. So there's going to be a whole discussion about safe harbor and litigation.

And there's going to be another discussion about how expensive this is to comply with. And then there's going to be a set of companies that are going to say, well, I may be in a disfavored industry and this could be difficult for me to comply with. There's going to be a wide array of opinions. But from my point of view, we welcome this debate. We think it's time to do it. As I said, the train has left the station. This is what investors want. I want to just, Todd, move to a separate subject that is near and dear to both of our hearts. Last week, S&P Dow Jones Indices, which Doug Peterson runs, by the way, released its annual Spivabre report. This is an annual report on how active mutual fund managers are doing against

their benchmarks. And the results were pretty pretty. predictably dismal. Seventy-nine percent of fund managers underperform their benchmarks. Over 10 years, 86 percent underperformed. Don't get much worse than that. Todd, is this more proof of why investors have rightly turned to broad indexes and ETFs tied to them? This is a theme we go over all the time, but every year this report comes out, it's amazing. That's right. So it's actually been 12 consecutive years that the average actively managed large-cap fund underperformed the S&P 500 index. That's the benchmark large-cap managers are shooting for and they're failing to deliver. It's no surprise that in the last two calendar years, a combined $400 billion flowed out of

equity mutual funds or U.S. equity mutual funds. The vast majority of that has gone into ETFs that are tied to the S&P 500, IVV-V-O-O-O, it just shows you that it's hard to outperform And it's hard to outperform because it costs more for active managers when they're trying to compete with the S&P 500 that is essentially free through the ETF wrapper. You know, Todd, I always point out, people say, how can that be? How could they, why are they so bad at this? And it's not really, they're not dumb, that's for sure. And I think it's important to note, you know, the academic literature has been for decades studying this. This is one of the most common things about studying finance, financial markets.

So it's important to note why these fund managers are underperforming. And what I see year after year in the research is number one, they charge too much, the active managers. So their fees eating into whatever outperformance they have, even if their stockpills are still strong. They're overconfident in their ability to pick winners. So there's some behavioral economics effects there. And market timing is impossible to get right consistently because you have to be right going into the trade and then right going out. chances of doing that are very small. And finally, the opposite of they're dumb. There is really tough competition. The competition is professional. It's smart, and it's getting smarter all of the time.

So I think, you know, we've known this for decades, Todd, you and I, but it's important why I think Spivis report is important every year to just keep emphasizing what the research indicates so far. That's right. So let me hit a couple of quick points that you touched on. The average, actively managed Mutual Fund charges 100 basis points. That's already a high bar to overcome. You can get exposure to IVV and VO and SPLG. Those are three S&P 500 index-based ETFs for three basis points. And if you wanted something more targeted, value, for example, did very well.

There are ETFs like RPV or VLUE, which is the I-Shares Value Factor ETF that charge considerably less than the active manager. You get the same exposure that you might from an active manager with that targeted favoring of value-oriented stocks. But you don't have to worry about that manager letting winners run too much. It gets rebalanced out as it should be. And I know you didn't write this report, Doug, but you're in charge of the company that does it. And to me, it just goes to the value of indexing. Again, it just keeps this is why people figured out a long time ago that generally they don't outperform, particularly when you include the fees.

mentioned 100 basis points here. And as a result, what we have seen in 20 years is indexing grows, value your company grows, and ETFs grow because most of them are tied to indexes. And you license those indexes. Well, when you go back to the history in 1896, Charles Dow formed the very first index, the Dow Jones Industrial Average,

which gave the markets a benchmark to start averaging and seeing what the performance was. And over the years, there's been this approach approach to finding indices and the S&P 500 is now over 60 years old and you have that level of performance for many many years you have the independence of an index committee there's a governance process they're over a firewall I cannot get near them they're able to look at the economy in a whole or look at different aspects of what they want to have that index perform against and so

it's it's it's it's it's been defined you know exactly what you're buying or trading every single day it's liquid it has It has tax benefits and it has very low fees. And we'll go 30 seconds on this because I get asked every time an S&P person's on. S&P Dow Jones indices, which is a part of S&P Global, has thousands of indexes. Each of these indexes has a committee that goes on it. The Dow Jones Industrial Average has a committee that meets regularly. You are not on the committee.

I am not on the committee. So don't ask Doug what's going to go into the Dow Jones Industrial Average because he'll look at you like, am I on the committee? Explain that quickly. Yeah, we have a governance process where the committee that provides the information that determines the formation of an index is behind a firewall. Their information is material, non-public information. The only people have access to it, have very strict rules about their own standards of performance and behavior. And once they make a decision, then it becomes public. That's when I hear about it.

And they meet privately. You are not in the meeting. I'm not in the meeting. And they meet it in the dead of night with candles, some cloaks on their head, like the Illuminati, I gather. This is true of the S&P 500 committee as well, right? All of the index committees are managed in the same way, with a committee on the other side of a firewall, with very strict governance and compliance processes that we... I just want to get that in, because we hounded David Blitzer for years.

He ran the index S&P Dow Jones for a long time, and always the answer was the same. I can't tell you, so don't ask me what's going in the S&P or the Dow Jones. Jones and Dustrovich, Doug Peterson, thanks very much for joining it. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Doug Peterson, the CEO of S&P Global. Doug, thanks for sticking around with us. I noted at the end, you just completed a major merger. Merger, I should qualify that. Merger with another financial information provider, IHS Market. I've always said indexed

and data providers are controlling the investing world. What was behind this deal? What was the rationale? Why did you want to complete that merger? Yeah, the rationale for the deal was we wanted to build broader scale in some of the core areas of the business, like reference data, fixed income data in the business, but also much more importantly, attack the growth areas of the markets,

like ESG, which we've been talking about, climate change, energy transition. That was one broad area. Another broad area relates to private markets. As you know, companies stay private much long. than they were had. And the size of untapped capital in the private equity world that's going to go to work, there's investors that want to know more about that. And then a third area is just broadly speaking, credit and risk. And there is like cyber and basic credit risk

being something that the demand is growing. So we looked at all of that and said, we need a partner, and we decided to talk with IHS market. We decided to merge. Yeah. You know, I always say the indexes are going to rule the world, and you're one of the biggest ones that are out there. I mean, you own S&P Dow Jones indices. People don't understand it. When I tell them people, you literally license thousands and thousands of indexes. You know, people think it's just the Dow Jones and the S&P 500, but there's literally thousands of index. It's a major source of revenue for you, isn't it? Yeah, there's, the indices themselves are, as an example, the S&P 500, but you know that there's sectors of the S&P 500 itself. So you have

financial institutions, you have the industrial sector, you have technology sector. So that in itself is a whole set of indices. We also have organizations that want a custom index to be able to benchmark their performance against a customized index. We then have all sorts of ESG indices that have started cropping up. We have international, we have domestic, we have blended indices. And one of the reasons that we were very interested in addition to what I already mentioned about IHS market is they have fixed income indices. And so when we bring the fixed income index family into SMP Global, we'll be able to now have what we call custom indices, multi-asset-class indices, age-based indices for insurance companies.

And we have all of these. And then today we're seeing increasingly interest in all of our standard indices to start applying ESG screens to them. Yeah. Now, where does this go from here? I guess you already hear the complaints about people that the indexers like you were getting too powerful. So a couple of years ago there was a big stink about voting rights. So BlackRock and Vanguard, for example, they own massive amounts of shares of these companies through ETFs that hold them.

And there's complaints, well, you're giving away voting rights to these companies. Is there any validity to that kind of claim? I mean, how do you feel when people say indexes like you are getting too powerful? Well, first of all, we provide a service which is to give a transparent set of assets or assets, in this case, stocks which provide a fund. We're providing that information. We're providing a consistency and transparency what's in it. And then it's the ETF provider that is actually doing the marketing and the packaging and the financing for that. We've heard people say that what they're providing is passive investing but active management. I think through this dialogue, what we're seeing

is that the asset managers are starting to vote shares individually instead of just vote across an index all on its own. And as you know, many of the asset managers, that have the index funds also have active management funds. So they can look across the aggregate of all of their ownership and start voting shares according to what they have in their total portfolio. So is it better to do it that way based on individual stocks and share votes? I mean, what's the right way to look at this? Yeah, the right way to look at this is that the asset manager

should vote the shares that are in the portfolios that they manage. And they can vote for the proxy votes according to what's in there, even if it's in an ETF, they can still vote. they can still vote those shares. Yeah. Is there such a thing as trends in indexing? I mean, you bought IHS market because they have some things that you want, some financial services, some index products.

You mentioned bond funds, for example. What is it? We always talk about trends in ETFs. Is thematic tech hot? Is pot investing, you know, hot? Is crypto investing hot? We do trends because that's what investors follow. What's important in indexing in the indexing business these days?

Yeah, the last couple of years that right when, the pandemic hit the biggest trend was fixed income ETFs because there were a lot of people that wanted to go to the safety of bonds and they wanted to go to the safety of cash and there was a big movement into fixed income and money market, different types of ETFs. And there hadn't been a large movement in fixed income before. And then over the last two years there's been a large movement into

ESG or some type of screens at either exclusionary screens or positive screens that look at value investing. and by, actually, I mean values investing, where they're looking at low carbon, no carbon, there's different types of values funds, Christian values, funds, et cetera. So we've seen a large increase in values-based investing, and those are the two biggest trends that I've seen. Yeah, it's a very interesting to watch this grow. I have been 32 years at CNBC, and when I got here in 1990, I can tell you, there was nobody talking about, I mean, And Vanguard did have the S&P 500 fund that was there.

That was one of the only ones that were out. 93, we had the spy come in. And I remember in 98-99 when Jack Bogle really started to get traction at Vanguard, that was a big thing. He had a very big book out, Common Sense on Mutual funds in 1999. That had a huge influence on me. That brought a lot of attention to indexing and its outperformance against active management, for example. So it's been wonderful to watch this industry grow and prosper.

And the opposition that it faced many, many years ago, going all the way back to the 60s, when they tried to start really doing indexes, I remember Crisp, for example, early attempt to just get a date. get a database together. Right. People don't remember how difficult it was. Before computers, how did you compute the S&P 500? I mean, imagine in 19506, they had the modern S&P came in in 2015.

Right, and that had to be, somebody had to figure out how to calculate that. Yeah. I mean, how did you even do that in 1950s? ...stringing computers together, probably on this floor, and coming up with ways to calculate, continuously calculate that. Now it's done continuous. We have a triple backup system, so it will never go down, so that we can be calculating the value of the S&P 500 and all the other indices.

So somewhere in the United States, there's a triple backup server. And outside of the United States. We have it hedged. Yeah, yeah. So in case that cyber war ever happens and they try to take down the entire history of the S&P 500, you've got it backed up in Lithuania or someplace that you cannot disclose. I'm going to say that. You can't disclose that where it is.

All right, thank you very much. Doug Peterson, of course, is the CEO of S&P Global. And a rare public discussion here. discussion here around ESG principles. Thank you very much for joining us. Thank you for having a T. And everybody, thank you for watching the ETF Edge podcast. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQQ, Invesco Distributors, Inc.