Third-Party ESG Ratings Too Simplistic, Backwards Looking For Investors, SEC Told

Starling Team

Third-party ratings of companies on ESG (Environmental Social and Governance) standards are too simplistic to be useful for investors, the US Securities and Exchange Commission (SEC) was recently told by officials from AllianceBernstein and Neuberger Berman, at a meeting of the SEC’s Investor Advisory Committee.

Joined also by representatives from State Street Global Advisors and Calvert Research & Management, the group argued that current corporate ESG disclosures lack consistency and standardization, and that the desired standards must work to support investors’ interest in long-term value creation.

Michelle Dunstan, Global ESG Manager at AllianceBernstein, argued that the SEC can take the lead to solve this problem. Whether the SEC will seek to play a role in driving the creation of reliable and consistent ESG standards remains to be seen. It is common for regulators to look to the industry to stand up such solutions. However, regulatory bodies and other public agencies can play an often critical role in helping to overcome “collective action problems.”

SEC Chair Jay Clayton has been vocal recently about a need for greater disclosure around non-financial risks at listed firms — particularly given business challenges posed by Covid — and has issued calls for an exchange of “forward looking information.”

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Supervision: Sharp Focus on Tech Capability, Customer Well-Being

Starling Team

The crisis has already supercharged existing trends in how bankers and examiners interface with each other, to emphasize off-site monitoring processes.  In-person meetings with CEOs and bank boards gave way to online meetings.  Meanwhile, with bank staffs working from home and largely outside the normal scope of “first line” oversight, risk exposures may be increasing:  we simply don’t have enough data to know for sure.  

Aware of this gap, regulators are increasingly looking to new regulatory technologies. (“regtech”). Some argue that the Covid-crisis will accelerate a drive toward a more sophisticated supervision process driven by data and digital know-how. “If we can do that in an emergency and build on it, we can look back on this as the moment when we started to put the whole system on a smarter path that serves everyone,” on regtech commentator recently observed.

In addition to a drive towards more data-driven supervisory capabilities, we also see an increased focus on how banks work to protect the interests of their customers.  “Examiners are already thinking a lot about the safety and soundness of the institution, and how a bank’s safety and soundness will affect customers,” said Kelly Thompson Cochran, deputy director of FinRegLab and a former official at the Consumer Financial Protection Bureau. (CFPB)  But the Covid crisis is prompting fundamental rethinking.  Rather than financial stability, policymakers may introduce a new focus on “individual stability,” Cochran added.

This shift too may compel regulators to focus more on banks’ technological capability. “While regulators in the past would have been hesitant to approve new tech that didn’t come from banks, remarked Julie A. Hill, a University of Alabama law professor, “they may now realize the weakness of doing things the same old way.” 

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Financial Conduct Authority’s Crackdown on Fund Managers

Starling Team

Across the globe, institutional investors are placing greater emphasis on ESG themes — environmental, social, and governance concerns — and scrutinizing their portfolio companies in this regard. While news headlines tend to prioritize environmental and social matters, investors are often more concerned with governance questions.

But the governance of asset managers is also a matter for scrutiny, from regulators of the industry. Now, the FCA is working on a framework to improve the governance of fund managers. With this new framework, firms may have to publish information on risk management, governance and investment policy.

“A new UK regime would represent a significant improvement in the prudential regulation of investment firms. For the first time, it would deliver a regime that has been designed with investment firms in mind.” Christopher Woolard, interim chief executive of the authority, said.

Remuneration policies will be an initial primary focus. But recent history suggests that the FCA will also turn its attention to culture and misconduct risk concerns, as well as to gender parity and diversity & inclusion questions. The asset management industry will thus confront some of the same questioning that we have seen in the banking and insurance sectors in recent years. Even as they scrutinize their portfolio, asset management firms will need to look inwards as well.

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What’s Next: Post-Covid Pitchforks

Starling Team

There is increasing attention to bank fraud risk amidst Covid-19. “A crisis is like the fog of war,” said Starling Advisor Thomas Curry. “Banks redirect resources to critical areas and neglect other risks that bite you down the road.” Curry served as Obama’s Comptroller of the Currency and sat on the board of the Federal Deposit Insurance Corporation. From such perches, he watched the Financial Crisis unfold and was one of those tasked with trying to keep the U.S. financial system afloat.

Curry observes that, following the Crisis, misconduct scandals that had previously gone unnoticed caught the attention of aggrieved taxpayers who had just “bailed out” the banks. Firms faced large punitive fines and a continuing resentment from both sides of the political aisle.

Now, in the middle of the Covid-triggered economic crisis, fraud risk seems once again to be flying largely under the radar. As in 2008, regulators are focused on making sure that banks have the ability to lend, and many have suspended conduct risk supervisory activities. “The Fed has been trying to say to the banking community that in this crisis environment we don’t want the constraints we normally put on you. We don’t want to hamper your ability to lend to clients,” said Gary Cohn, Starling Advisor and former Goldman Sachs COO who served as Trump’s first chief economic adviser.

“Banks need people to be working together in a cooperative fashion and watching and listening to each other,” Cohn added. “That is what the Fed would call a first line of defense: Overhearing conversations, looking at presentations, or looking at the way you talk to a client. Or calling a compliance officer – ‘Can you guys look at this?’ When people are sitting in their bedrooms. There is no one there to look over their shoulder.”

When emergency efforts wind down, and financial system overseers conduct the inevitable look-back, should they discover bank misconduct while billions of dollars were rushed to support struggling business and households, we can expect a backlash against the industry that will be perhaps far more prominent than that which followed the 2008/09 crisis. “There will be pitchforks,” said Starling founder and CEO Stephen Scott.

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Starling advisors Gary Cohn, Mark Cooke, and CEO Stephen Scott feature in Fortune

Starling Team

Over the last decade, the financial industry was subject to increased regulatory scrutiny and public scorn triggered by misconduct scandals. During the coronavirus shutdown, however, banks have been critical partners to policymakers struggling to prevent a full-blown depression. Amidst such efforts, regulatory supervision has been partly suspended, to allow the industry to focus on the provision of economic relief.

However, lighter supervision might result in a heightened conduct risk. It is highly likely that increases in opportunistic crime will be spurred by economic anxiety. With many working remotely, outside the scope of standard internal risk controls and systems, things could turn sour quickly. Banks must therefore exercise added vigilance if they are to avoid future scandal and regulator wrath.

A rules-based approach to risk and compliance governance has failed to prevent misconduct in the past, and such an approach is to be avoided now. Firms have not done well in anticipating misbehavior, in part because their leaders overweighted the impact of setting the right “tone at the top,” when it is actually the “echo from the bottom” that matters more. Now, what is called for are principles-based policies aimed at encouraging responsible corporate cultures.

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