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November 22, 2016

What Does Trump Mean for ESG Data and Investment Strategies?

by Hendrik Bartel, CEO, TruValue Labs.

It has been one week since a historic election took place, jolting markets and transforming the outlook for the U.S. and its economy.  President-elect Trump is working on putting a transition team together and trying to lay the groundwork for new ways of thinking that could drive U.S. policy for the next few years.

What will the new administration mean for environmental, social, and corporate governance (ESG) investors, from a data and investment strategy perspective?

There are plenty of goals that most ESG investors share, which Donald Trump has said are not his values: reducing carbon emissions, oil and gas production rules come to mind, among other environmental regulations.

Are these goals dependent on a President alone? No, I don’t think so, but more on this later.

Donald Trump does not have the final say on investment strategies, due diligence processes or other investment matters, nor is it clear what his influence may be.

ESG is not about a “movement”—it’s about a new set of tools no investor can ignore. Even if the president-elect and his appointees and many in the Republican Congress may ignore it, it is up to investors to actively integrate new datasets into their decision-making process.

The ESG investing transition is about transparency into company business and operational practices, and risks, beyond traditional financial metrics.  It examines risks and opportunities. ESG isn’t a homogenous set of values: it’s a shared understanding that company behaviors concerning consumers, workers, and the planet are fundamentally important to every company’s future success.

ESG is the foundation of what I call Financial Fundamentals 2.0.   If you don’t use these emerging tools, your financial analysis is incomplete.

What do I mean by that?

Half a century ago, black and white TV’s outnumbered color, and about 85% of company value was based on tangible assets like buildings, machinery, and inventory. Today, it’s the reverse:  about 85% of a company’s value comes from intangibles including reputation and intellectual property, and you have to look hard to find a black and white TV these days.

Exhibit 1. There’s no going back to black and white


Image by Evert F. Baumgardner

We all know investment professionals love the latest, biggest, highest-resolution screens.  So why would investors choose a black and white TV today?  Why would they choose to ignore ESG? The majority of investors, especially institutional investors which dominant markets are “rational investors.” Yes, there are expectations, but for the most part the investment profession is grounded in facts, causality and the understanding of systems in a macro environment.

It’s helpful for investors to know whether a company treats its employees right, or if it tries to scam automotive regulators, but activist investors aren’t the only ones who must consider these facts.

All investors, from retail to institutional, need to incorporate ESG criteria or they’ll be blind to a universe of risks and opportunities – yes, this does assume that most investor are rational.

Now, on to specifics.

Trump’s SEC and challenges for ESG standardization

One of the major challenges for ESG investors has been a lack of consistent and verified data.

The charge to standardize reporting has been led by the Sustainability Accounting Standards Board (SASB), which has support from PricewaterhouseCoopers, McKinsey & Co., BlackRock, Goldman Sachs, UBS, and others.

The Securities and Exchange Commission has been hearing evidence from SASB and others for years.

That work may face a lengthy pause as Trump seems to be filling his administration with traditional conservative policymakers, according to Howard Berkenblit, a partner in Boston-based law firm Sullivan & Worcester LLP, who earlier this year wrote about the likely Trump SEC outlook.

“The signs so far are that he’s moving toward the traditional Republican standpoints on things,” Berkenblit said by phone this week. “ESG-type disclosures are deemed by conservatives to be beyond the scope of what the SEC’s mission is, of protecting investors.”

Nevertheless, the SEC is “just” a regulator: they will act based on investor and company demand. It is never certain when any individual regulators, such as the SEC, may act.

Yet, investors are demanding this kind of data, case in point the $8.7 trillion in ESG assets under management in the U.S. alone. That number speaks worlds and will behoove the SEC to make a move.

In principle, market regulators should listen to what investors need, as a simple function of supply and demand. If it’s not U.S. regulators who listen, others will.

That’s why my prediction for the next four years is that at least one sizeable regulator will standardize ESG. If the SEC won’t give investors what they want, then a foreign market regulator like ESMA or China’s CSRC will.

The other driving force here are stock exchanges. There have been more than 60 stock exchanges that have signed on to the Sustainable Stock Exchanges Initiative (SSE) driven by the UN.  That initiative requires members “to make a good-faith effort to integrate sustainability into the exchange’s business strategy.”

Climate concerns and hopes

Global markets already live the reality of climate change.  While I am concerned about the possibility of the U.S. leaving its COP21 commitments behind, I believe that for the U.S. to stay competitive on a global level, companies will automatically invest in “sustainable” products.

Nobody will buy a big-block engine anymore once an electric car is competitively priced, has generous range and a refueling network, and looks just the same and can accelerate far faster, if that matters. For the larger fleet of cars, federal auto regulations may not advance under Trump, but California will likely continue pushing efficiency as it has for decades.

Coal will not remain a dominant fuel in this world when wind, solar, and other renewables continue to decline in price in the medium and long term, while in the near and likely longer term as well natural gas is an easy substitute. Additionally, clean fuels appeal to emerging market economies that recognize the downside of air pollution in their growing metropolises. That only brings additional pressures for oil and coal.

Don’t take my word for it—there’s evidence of these shifts because politicians are already acting, and investors are already pricing in these behaviors.  It’s evident in the vote by Germany’s Bundesrat to ban internal combustion engines starting in 2030. It can be seen in the drop in market cap for the biggest U.S. coal producers, which fell 92% between 2011 and earlier this year.

Saudi Arabia is on the record stating that fossil fuels may phase out as soon as 2050, and Dubai aims to get 75% of its energy from clean sources by that time. Also consider what is being talked about in Europe—a border adjustment tax if the US backs off Paris climate: an offset tax for the implicit subsidization of U.S. exports if they don’t already incorporate carbon curbs or taxes.

Even if the U.S. should do something as dramatic as withdrawing from the COP 21 climate pact, how do you think the rest of the world will react?  Don’t you think they’ll impose a carbon tax on U.S. goods and services exports, or consider similar measures?  Under WTO agreements, arguably this can be done and sustained.

Nicolas Sarkozy, who is again campaigning to lead France, suggests that a carbon tax on U.S. imports should be considered if a Trump-led U.S. turns its back on climate deals.

There are all sorts of ways for the global economy to reign in lone wolves, or dinosaurs, as the case may be.

There’s a lot of change in the air, and people are apprehensive, rightly so, as we’ve seen in the last week.  But as global citizens we know that the future won’t be halted in its tracks.

Citizens of the U.S., Great Britain, and the world vote once in a generation to turn the political world on its head, but they vote every day with their investments for the newly developing market standards that are slowly and surely reshaping our world.

At my core, as an entrepreneur, I’m an optimist—but in the case of ESG investing, there’s no optimism needed.  There’s no turning back from ESG as an investment fundamental, and a force for change in our world.

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