CFA Society Chicago Education Advisory Group presented Standards Ethics and Regulations Road Map, a two-session presentation updating members on emerging issues on regulatory matters. The first one-hour session was a discussion of emerging regulatory issues by with Allyson Buckles, Director at Grandview analytics (performance reporting and GIPS) and Lindsey Simon, Founder and CEO of Simon Compliance, moderated by Debby Eades, Co-Chair of the Women’s Network Advisory Group of the CFA Society Chicago.
The panel started with an update on Marketing Rules including recent developments that created concerns over “Busy math,” which Simon defined as calculations that don’t mean much to investors, amid uncertainty on how rules would be interpreted. Performance on net vs. gross investment returns and the challenges of calculating these returns was a significant area of discussion.
There were questions on what to call these performance metrics as well as detailed aspects of compliance on the calculation of returns. There was a discussion of marketing materials vs. investor reporting for existing investors.
The panel discussed inconsistencies in regulatory examinations including requests for support files on all statements (substantiating adjective use i.e. “leading” what does this mean and how can you substantiate it?). In some cases, the time frames for responding to regulatory requests were short, often as few as 1-3 days.
Buckles provided a GIPS Update – global investment performance standards used in 40 countries for calculation and presentation of investment performance results. She noted that the SEC doesn’t say you need to follow GIPS, but you can rely on composite construction under GIPS for performance disclosures.
Generally the math is easy in GIPS, but the complexity lies in what to include in the calculations of the composites including whether to include or exclude pooled accounts in composites.
There was a discussion of texting for business purposes and SEC rules – use for non- substantive business communications, vs prohibiting all texting. Concerns over the use of phones, apps and other communications methods and mixing personal and business messages on phones, and informality on texting are all still evolving.
There was discussion of the recent FTC Non-compete rule which effectively eliminates the use of non-compete agreements. Non-compete clauses very common in industry but new rules basically ban non-competes with exceptions for senior executives and bona fide sale of business transactions. The panel believed the rule likely will not stand but we will see how the court challenges proceed.
There was discussion of the Private Funds Rule currently pending in Fifth Circuit but possible that it could be thrown out. Chairman Gensler believes there needs to be more transparency. The panel noted there is no grandfather provision, and all funds over $1.5 billion will need to disclose all terms that are favorable to one group of investors, including preferential pricing. Disclosure of fees, rebates, and portfolio manager compensation become much more detailed. The Institutional Limited Partnership Association will require the disclosures even if the rule is thrown out.
The panel discussed emerging trends in regulatory examinations, noting that the SEC is hiring people that know and understand performance. They also noted the importance of providing Compliant Presentations (GIPS reports) to clients and potential clients. The panel talked about disclosures of conflicts of interest, including relationships with service providers, investors, clients, and related parties. Items as benign as a private equity firm drawing on your line of credit for a transaction and later paying back the loan needs to be disclosed as related party transactions. These rules apply to similar transactions between operating partners or operating groups.
The panel concluded with a discussion of emerging rules/issues, noting that practitioners should embrace technology, particularly if you are doing very manual calculations, streamline the data and process to be more efficient. The panel also noted that many Chief Compliance Officers (CCOs) have had enough and are moving on, potentially creating an acute need for new compliance professionals. Vincent invited the panel back to update Society members on emerging compliance issues.
The second one-hour session was a discussion of ESG and regulatory compliance with Blake Pontius, Director of Sustainable Investing at William Blair; Uwe Schillhorn, Program Director at Emerging Market Investor Alliance; and Lisa Sachs, Director of the Columbia Center for Sustainable Investment, moderated by Debby Eades, Co-Chair of the Women’s Network Advisory Group of the CFA Society Chicago.
ESG Disclosure and Benchmarking
Pontius offered his initial thoughts on the importance of ESG investment being defined in a transparent policy. There are differences on how funds are classified in Europe and other geographies. He is hopeful that work can be leveraged across jurisdictions, but there are some similarities and significant differences. Most firms are working to be well aligned and looking to the CFA Institute ESG disclosure guidelines. He emphasized that it is important to do what you say and not embellish disclosures.
Schillhorn noted there is not one source of truth but that you have your method that is applied consistently across the firm.
Sachs asked are whether firms doing what they say they are doing (accountability), and second, are they achieving some aim? Those are not resolved by regulations, but can create confusion and discordance.
Pontius noted the difficulty in measuring impacts. To demonstrate impact in a public equities portfolio is even more challenging given inconsistency in corporate issuer reporting. This is even more challenging for small caps, particularly in Emerging Markets, on ESG disclosure.
How are people reacting to the negative political pushback against ESG?
Schillhorn noted at the state level, some states barred certain firms from state investment management. Schillhorn gave examples where some state pension funds wanted to divest from certain ESG managers, but those managers were the best performers so that would violate fiduciary responsibilities of retirement fund managers. In Europe was a legal opinion by Financial Markets Law Committee ESG and Sustainability and fiduciary responsibilities of pension boards noting they can forego financial gains for the benefit of other priorities.
Sachs opined that there is no legal merit to allegations of anti-trust activities, but it had a chilling effect on what the financial sector should be doing on climate actions. In terms of antitrust and sustainability concerns, there is no “there there” as it’s a far cry from a cartel. Lisa believes it is unlikely any antitrust agencies will issue any opinions as climate is such a hot potato.
Schillhorn noted the chilling effect seen, as previously ESG investments were growing much faster but now expected to grow in line with the market.
Pontius expects increasing scrutiny whether justified or not. He expressed the need to be clear on why we are committed to various goals and have that disclosure available for future regulatory inquiries. He doesn’t expect the political impact to dissipate any time soon.
Energy transition topic
Sachs was concerned over the multi-trillion-dollar funding gap for the energy transition and other broader sustainable development objectives. What is needed to drive the financing of these goals. On a national level, we lack clear roadmaps of what is needed, what is better to be a public vs. private investment, regulatory standards, etc. All of these factors impact the investability of these solutions. She expressed concern over the differentials in developing vs. developed countries for financing, and the need to have financing at affordable terms for less developed countries. She noted a need for different modalities for de-risking energy products and methods for how we measure and assess corporate transition plans.
What trends are you seeing going forward for the next 18 months?
Pontius highlighted that ESG integration is just becoming table stakes for good investing practice. There will likely be greater differentiation between ESG integration and sustainability focused funds as well as increasing disclosure and transparency for US focused funds. There will be a re-emphasis on financial materiality.
Schillhorn noted that efforts will continue and, given more climate instability, that will drive greater investment in ESG initiatives. Investors need to be patient as this is still a relatively new area. We can’t expect to go from disclosure to results right away. He also expects more harmonization of taxonomy and rules.
Sachs noted that she does not have patience, since the climate crisis is here now. Climate risk is a real risk and we need to differentiate between climate risk and materiality. She would like more clarity between maximizing risk adjusted returns and solving the climate crisis.
Eades thanked the panelists for their insights and time. Vincent wrapped the call by expressing his appreciation to Eades for moderating two panels over two hours.