Illinois State Treasurer Michael W. Frerichs crashed the gates of entrenched pension and public investment policy in winning the Sustainable Investing Act, which passed the Illinois legislature and was signed by Governor Pritzker in August, 2019. Public Act 101-473, the first state ESG bill in the U.S., provides that all state and local government entities, including pension funds, that hold and manage public funds should integrate material, relevant, and useful sustainability factors into their policies, processes, and decision-making. The Act provides a stronger focus on labor rights and human capital factors, including responsible contractor policies.
“To fulfill our fiduciary duty, effectively manage risk, and maximize returns for
our $32 billion investment portfolio, we need to focus on more than just short-term gains and traditional indicators,” said Treasurer Frerichs. “We believe additional risk and value-added factors need to be integrated into the decision-making process. These sustainability factors do not replace traditional financial and technical indicators. They serve as a complement to traditional analysis, providing an additional layer of data that our analysts and fund managers can use to better assess the risk profile and return potential of individual investments.”
The Sustainable Investing Act goes into effect January 1, 2020. What does the Act do?
Codifies sustainable investing as a best practice for public fund managers in Illinois;
Applies to all public investments by the state, local governments, and public entities, including pension funds;
Establishes a framework for public fund managers to consider ESG risks and other factors in their investment portfolios and a method for implementation.
While not an ESG disclosure bill like in Europe and nearby Ontario, the passage of the Act is an unprecedented breakthrough in the inexorable march toward mainstreaming responsible investment in the U.S. There has been a sea change underway in the institutional investment and corporate world for two decades, spurred by the Principles for Responsible Investment (PRI), which launched in 2006, and by U.S. DOL Interpretive Bulletin 2015-01, which confirmed the legality and importance of including environmental, social, and governance (ESG) considerations by pension funds governed by ERISA. These two milestones supported the realignment of the stewardship of workers’ capital with long-term responsible investing.
In 2018, responsibly invested US assets climbed to over $12 trillion, according to US SIF, one quarter of all US investment assets under professional management. Since 2010, responsibly invested US assets have grown by over 20% per annum. In addition to a growing list of pension funds, foundations and university endowments, major banks, insurance companies and private asset managers, such as Blackrock, Vanguard, Fidelity, and Federated/Hermes employ this framework or are moving in this direction. There are hundreds of rating and reporting standards that provide a path to implement and measure ESG performance.
Illinois Treasurer Michael Frerichs at The Century Foundation/Heartland event in 2018
Frerichs was first elected Illinois State Treasurer on November 4, 2014, and re-elected on November 6, 2018. The Treasurer actively manages $32 billion. He is recognized for his leadership in responsible investment, good corporate governance, and reinvesting in the people and communities of Illinois.
The Sustainable Investing Act was introduced as HB 2460 by Representative William Davis in the Illinois House on February 13, 2019. It was picked up and sponsored by Senator Iris Y. Martinez, who had introduced identical legislation earlier in the session. After considerable debate and some negotiations with representatives of local governments, the bill passed both houses on May 29. The Governor signed the Act on August 23, 2019.
“Integrating sustainability factors helps investors obtain a more complete view of a company or fund’s long-term risk and return prospects,” said Treasurer Frerichs. “That’s why we spearheaded passage of the Sustainable Investing Act, which positions all state and local government entities that manage public funds to integrate sustainability factors into their investment processes.”
The Illinois bill will require that sustainability factors include, but are not limited to:
Corporate governance and leadership factors
Social capital factors
Human capital factors
Business model and innovation factors
Thus, the Act uniquely utilizes some of the sustainability framework pioneered by SASB, the Sustainability Accounting Standards Board. SASB is an independent body started in 2011 to foster “high-quality disclosure of material sustainability information to meet investor needs and make capital markets more efficient,” according to the group.
Those of us who are familiar with ESG may appreciate the drill-down that is provided by adding “human capital” and “business model and innovation factors.” While human capital factors have traditionally been included in the “S” in ESG, there have long been complaints that the “S”—especially with regards labor relations-- is given short shrift. The Act specifies that:
“Human capital factors that recognize that the workforce is an important asset to delivering long-term value, including factors such as labor practices, responsible contractor and responsible bidder policies, employee health and safety, employee engagement, diversity and inclusion, and incentives and compensation.”
The addition of business model and innovation factors is critical. As the Office notes, the impact of sustainability issues on innovation and business models including corporate strategy and other innovations in the production process are integral to a company’s financial and operating performance. The Act pushes for factors that reflect:
“….an ability to plan and forecast opportunities and risks, and whether a company can create long-term shareholder value, including factors such as supply chain management, materials sourcing and efficiency, business model resilience, product design and life cycle management, and physical impacts of climate change.”
The Act requires that affected public agencies incorporate ESG policies into their existing investment policies, and that those policies will be published and implemented. It adds that public agencies will integrate sustainability factors into their decision-making, investment analysis, portfolio construction, due diligence, and investment ownership with the goal of maximizing returns, minimizing risk, and effectively executing their fiduciary duties. Compliance with the Act will be determined by the regular processes of auditing and evaluation.
The Treasurer’s Office has volunteered to assist public agencies in the state, offering its own sustainable investment policies as a model and providing additional guidance. It says that the Act provides sufficient flexibility such that individual managers are able to adapt and customize how the factors are considered to their specific requirements.
While the opposition to the bill claimed that the Treasury was trying to “impose its values,” the response was that the legislation was more about being “value-oriented,” focusing on long-term value-creation and enhanced risk management.
As my co-author Annie Malhotra and I pointed out in the Responsible Investor Handbook (2016, Routledge/Greenleaf Publishing), innumerable meta-studies, conducted by prestigious universities and leading researchers, found significant evidence of the positive impact of responsible investment and good corporate governance strategies on a company performance. Today there is a growing recognition that ESG performance of companies is tied to their sustained success, affecting not only investment returns but workers, jobs and communities.
This victory represents a huge step forward in the US policy conversation around sustainable finance. The Heartland Network applauds Treasurer Frerichs and his entire team, the Illinois Legislature, and the Governor for the remarkable achievement. If Illinois can pass a law that “contributes to a more just, accountable, and sustainable” state, the idea just might catch on.
PS For more information about the Illinois Sustainable Act, contact:
PARIS ERVIN|CHIEF COMMUNICATIONS & CIVIC ENGAGEMENT OFFICER
Illinois State Treasurer Michael W. Frerichs
Capitol Building – 219 Statehouse, Springfield, IL
217.524.5749 (o) | 217.685.2584 (c)