Romito: ISSB Celebrates a Little Too Soon

Dan Romito is a consulting partner at Pickering Energy Partners focusing on quantitative ESG strategy and implementation.

In late June, the International Sustainability Standards Board (ISSB) officially launched its first two standards. The intent of these new standards, which will be broadened over the next 12 months, is to “establish a globally common and comprehensive language for sustainability disclosure, as well as underlining the strong connection between economics and climate.”

The formal release of the standards coincided with the ISSB ringing the opening bell at the London Stock Exchange where Emmanuel Faber, the ISSB chair, proclaimed, “today is a great day for the reconnection of global finance with the living world.” 

Given the prolific number of self-congratulatory superlatives flung loosely around social media, it may be prudent for ISSB proponents to pump the brakes on this “momentous” occasion and objectively ask what was really achieved. Unfortunately, the answer is nothing material. Yes, on a superficial level, it makes for a catchy headline, but in terms of measurable substance, the ISSB pronouncement achieves nothing except further solidifying a rhetoric-laced echo chamber and placing additional burdens upon those who can least afford it. This supposed feat adds yet another tier of reporting to the already messy ESG disclosure lasagna that currently plagues the global capital markets.

When you peel away the self-praise, ISSB’s directive is more about winning control of the ESG framework arms race rather than incentivizing the creation of functional technologies required to decarbonize. Jockeying for reporting supremacy is resulting in a variety of unintended consequences, which ultimately impede the long-term health of the global capital markets. To be fair, the ISSB is not the only group guilty of publishing immaterial announcements. Incorporating yet another layer of ESG-focused reporting mandates will not deliver an improved environmental, social or governance construct. It also will not enhance returns, expedite functional innovation, or make energy any more affordable, accessible or reliable.

The S&P 1500 is generally considered the most efficient measure of the U.S. equity market because it aggregates roughly 90% of U.S. listed equities. The top 10 holdings comprise nearly 30% of the weight within the index and the median market capitalization is approximately $4.3 billion, implying most of the liquid U.S. equity market is comprised of small and midcap companies.

Winning incremental long-term capital was already a rigid dogfight before the onslaught of ESG-related reporting directives. The collective goal should center on how to best reward the management teams whose functional technologies consistently result in excess alpha.

There exists zero correlation between excess alpha and framework completion, and the energy transition must prioritize capital discipline and returns to facilitate consistent reinvestment. By continually changing eligibility rules in the capital markets and allowing ESG-focused disclosures and biased ratings to disproportionately dictate access to capital, we are burdening smaller corporates with a laundry list of immaterial constraints that adversely impact the health of the public markets. Why are there roughly 30% fewer U.S. publicly traded companies today compared to 2000? In part, the answer centers on the degree of regulatory burden we continually embed in the capital markets.

Empirical data analyzed in the “2023 Statistical Review of World Energy,” published by the Energy Institute, notes that record increases in solar and wind installations in 2022 failed to cut into the share of fossil fuels makeup in the global energy mix. Global emissions also rose again despite the record growth of solar and wind capacity. The capital markets want to decarbonize, but they do not want to do so at the expense of reliable and affordable energy. Adding a new framework solves the symptoms but not the virus. In other words, added reporting does not facilitate enhanced efficiency or augment the number of publicly traded companies needed to foster effective competition.

The long-term innovative capabilities of the global capital markets are heavily reliant on small and mid-cap companies. While we must hold management teams and boards accountable for their long-term strategy, we should also alleviate them from the needless constraints which impede their ability to compete, grow and innovate. Groups like the ISSB should pause on the social media barrage while we collectively figure out how to reverse the trend of public company contraction, and reprioritize innovation, capital discipline and alpha over new ESG questionnaires.

Capital markets players can and should revert to the basics. The current state of the capital markets convinces corporates not to go public. Reasonable ESG disclosure can assist in establishing a valuation premium, but we must also acknowledge that capital is finite and increasingly more expensive. Companies should be afforded the right to self-appoint a set of non-fundamental disclosures which validates valuation premium and not fall prey to what a set of index funds superficially requires to win social brownie points.

Let’s reinstate a distinct level of pragmatism into both ESG and financial evaluation and stop confusing performance with framework completion and ratings.