In a recently released video, Securities and Exchange Commission (SEC) chairman Gary Gensler explains his concerns about investment products that market themselves as “green” or “sustainable.” According to Gensler, hundreds of funds managing trillions of dollars claim that their investments are serving some kind of environmental, social, or governance (ESG) goals beyond delivering returns to their clients. He wants these funds to be regulated in such a way that investors can trust those claims, but his own argument demonstrates how this will likely not be possible. When it comes to claims of environmental and social virtue, the investing public will be better off living with the inescapable ambiguity.
In the video, Gensler notes the SEC’s long history of regulating the names of investment funds, going back to the passage of the Investment Company Act of 1940. Gensler says that the goal of these rules is that “when a fund company uses a name, you should be able to read that name and trust what it says.” Then he goes on to make a relatable comparison: Investment funds should be like a carton of skim milk. When you go to the supermarket and you see a carton of milk on the shelf, you can trust that it is actually fat free, because food companies are required to print the fat content on the carton.
The problem with generalizing this idea to investing, and especially to ESG criteria, is that the financial issues that people are most concerned with are not simple and quantifiable. The terms that Gensler cites early in the video – “green” and “sustainable” – are inherently subjective and hotly contested. You can send a sample of milk to a chemistry lab for analysis and confirm its fat content, but no high-tech process can adjudicate whether investing in, say, nuclear energy rather than wind power is “better for the environment.” That’s a subjective value judgment. How heavily should we weigh concerns about long-term storage of radioactive waste vs. the number of birds killed by turbine blades each year? Should we prioritize infrastructure that can be built quickly or that will last the longest? No spreadsheet formula can answer these questions.
Thus, there is no objective answer to which investment fund is the most sustainable or environmentally friendly, because different people disagree about how those things should be measured. It’s perfectly reasonable for Gensler to raise concerns about potential investor confusion, but solving that confusion with an arbitrary government definition – one that excludes multiple good-faith perspectives – does not improve the situation. Going forward, our best option is to create a bifurcated system: anti-fraud protections for specific, falsifiable claims with an open arena for inherently subjective ones.
While big concepts like sustainability don’t have a single objective definition, some environmental terminology does. A firm could easily create and market a fund that tracks corporations that are co-signers of the U.N.-sponsored Principles for Responsible Investment or that have adopted the methodology recommended by the Sustainability Accounting Standards Board. Many funds already exclude oil and gas companies or only invest in wind and solar technology. Those are fairly straightforward distinctions. If a company advertises a fund based on those objective criteria, it needs to deliver – no firm should be allowed to mislead investors with fraudulent statements. Customers who are motivated to pursue what they consider to be “sustainable” investment products should thus be encouraged to seek out the most specific – and easily falsifiable – claims when shopping for funds.
When it comes to vague terms, the SEC should follow the general attitude of the Federal Trade Commission (FTC) when it comes to product claims. The FTC polices advertising claims that are outright lies but not ones that are recommendations, general characterizations, or what are sometimes called “puffery.” As with the skim milk example, a company can’t claim that its hot dogs are 100 percent beef if they’re actually 50 percent pork, but it can claim that they are “the tastiest hot dogs in the world”—an inherently subjective claim. It’s up to each consumer to weigh conflicting product claims and determine if, in their experience and by their own judgment, such subjective assertions are valid.
Read the full article at Real Clear Policy.