A major stock index that tracks sustainable investments dropped electric vehicle-maker Tesla from its list in May 2022 – but it kept oil giant ExxonMobil. That move by the S&P 500 ESG Index has set off a roiling debate over the value of environmental, social and governance (“ESG”) ratings. Such ratings are meant to gauge companies’ (including fashion industry entities’) performance in those areas. About one-third of all investments under management use ESG criteria, yet many environmental problems continue to worsen. Tesla CEO Elon Musk called the ratings “a scam,” and the U.S. Securities and Exchange Commission proposed new disclosure rules for funds that market themselves as ESG-focused.

Against this background, we asked Tom Lyon, an economics professor at the University of Michigan who studies sustainable investing, to explain what happened and how ESG ratings could be improved to better reflect investors’ expectations.

How does a company like Tesla get dropped from the S&P 500 ESG index while Exxon is still there?

ESG ratings agencies typically rate companies against others within their industry, so oil and gas companies are rated separately from automotive companies or technology companies. Exxon stacks up fairly well relative to others in the oil and gas category on many measures. But if you compared Exxon to, say, Apple, Exxon would look terrible on its total greenhouse gas emissions. Tesla may rate well on many environmental factors, but social and governance factors have been dragging the company down. S&P listed allegations of racial discrimination, poor working conditions at a Tesla factory, and the company’s response to a federal safety investigation as reasons for dropping the company.

The way ESG criteria are measured also carries some biases. For example, the ratings consider a company’s direct greenhouse gas emissions but not its Scope 3 emissions – or emissions from the use of its products. So, companies like Tesla do not get as much credit as they might, and those like Exxon do not get penalized as much as they might.

What can be done to make ESG investments better reflect investors’ expectations?

One strategy is for investment firms to invest in a small number of carefully vetted companies and then use their influence within those companies to monitor behavior and drive change. Another is for raters to stop trying to aggregate all of the different measures into a single rating. Investors concerned about ESG often value different objectives – one investor may really care about human rights in South America while another is focused on climate change. When ESG ratings try to force all of those objectives into a single number, they obscure the fact that there are trade-offs. ESG could be broken up so ratings instead focused on each piece individually. 

Environmental issues tend to have a lot of available data, which make “E” the easiest category to rate in a consistent way. For example, scientific data is available on the increased health risks a person faces when exposed to benzene. The EPA’s Toxic Release Inventory shows how much benzene various manufacturing facilities release. It is then possible to create a toxicity-weighted exposure measure for benzene and other toxic chemicals. A similar measure can be created for air pollution.

Social issues and governance issues are much harder to aggregate up into single ratings. Within the “G” category, for example, how do you aggregate diversity in the board room with whether the CEO personally appointed all the board members? They are capturing fundamentally different things.

The SEC is considering a third strategy: enhancing disclosure requirements so investors have access to better information about what is in their ESG portfolios. The SEC proposed new reporting rules for ESG funds and advisors on May 25, 2022, including proposing that some environment-focused funds be required to disclose the greenhouse gas emissions associated with the portfolio. 

What else do ESG ratings overlook?

ESG ratings often omit important behaviors and choices. One that is particularly important is corporate political activity. A lot of companies like to talk a green game, but investors rarely know what these companies are doing behind the scenes politically. Anecdotally, there is evidence that many are actually playing a fairly dirty game politically. For example, a company might say it supports a carbon tax while donating to members of Congress and lobbying groups that oppose climate policies, which is one of the most egregious failures in the ESG domain. But we do not have the data to track this behavior adequately, since Congress has not required disclosure of all types of political spending, especially so-called “dark money” from super PACs

A few organizations are gathering more detailed information on specific issues. InfluenceMap, for example, invests an enormous amount of time looking at companies’ annual reports, tax filings, press releases, advertisements and any information about lobbying and campaign spending to rate them. It gave ExxonMobil a grade of D- for its political action on climate.

What can investors looking for positive impact do if ESG ratings are not the answer?

Investors can always take a more targeted approach and invest in specific categories that they believe will provide essential solutions for the future. For example, if climate change is their leading concern, that may mean investing in wind and solar power or electric vehicles. ESG funds often claim that they outperform the market because companies with strong management in environment, social and governance areas tend to be better managed overall. And on average, firms with higher social performance do have a somewhat higher financial performance. However, some insiders, like former Blackrock sustainable investment head Tariq Fancy, argue that ESG portfolios today are not terribly different from non-ESG portfolios, and often hold almost all the same stocks.

There is also a larger question in the background of all of this: Is investment pressure really what is going to drive us toward a more sustainable future? 

Tom Lyon is a Professor of Sustainable Science, Technology and Commerce and Business Economics at the University of Michigan. (This article was initially published the The Conversation.)

Just over a year after the U.S. Securities and Exchange Commission (“SEC”) announced the launch of a Task Force in order to “proactively identify” environmental, social, and governance (“ESG”) related “misconduct” by publicly-listed companies, investment advisers, funds, and other market participants, the Task Force has initiated its first enforcement action in what could signify impending action for companies across industries. In the complaint that it filed late last month, the SEC alleges that Brazilian mining company Vale S.A. is on the hook for making “false and misleading claims about the safety of its dams” prior to the deadly collapse of its Brumadinho dam in 2019 “caused immeasurable environmental and social harm, and led to a loss of more than $4 billion in Vale’s market capitalization.” 

According to the SEC’s complaint, which was filed with the U.S. District Court for the Eastern District of New York on April 28, Vale engaged in securities fraud by “improperly obtaining stability declarations for the dam by knowingly using unreliable laboratory data; concealing material information from its dam safety auditors; disregarding accepted best practices and minimum safety standards; removing auditors and firms who threatened [its] ability to obtain dam stability declarations; and making false and misleading statements to investors.” 

Vale allegedly “knew that the dam did not meet internationally-recognized safety standards,” the SEC asserts, However, its public-facing sustainability reports and other public filings “fraudulently assured investors that the company adhered to the ‘strictest international practices’ in evaluating dam safety and that 100 percent of its dams were certified to be in stable condition.” 

“Rather than confront the high reputational and economic costs arising from the unacceptable safety risks posed by its Brumadinho dam, Vale engaged in a pattern of deceptive acts designed to skirt the applicable regulatory requirements related to dam safety,” the SEC asserts. Specifically, from February 2016 through October 2018, the regulator alleges that Vale “knowingly or recklessly obtained eight fraudulent and deceptive stability declarations in connection with corrupted audits of the Brumadinho dam.” While Vale’s “fraud and deception caused immeasurable human suffering, it also caused significant harm to investors,” the SEC argues, stating that investors relied on Vale’s statements on “several material issues, [namely], the stability of [its] dams; the nature of [its] safety practices in the wake of [a prior] dam disaster; and the actual risk of catastrophic financial consequences should any of its high-risk dams, like the Brumadinho dam, collapse.” 

With the foregoing in mind, the SEC contends that by “knowingly or recklessly engag[ing] in deceptive conduct and making materially false and misleading [ESG] statements to investors,” Vale engaged in violations of Section 10(b) of the Exchange Act, Section 17(a) of the Securities Act, and Section 13(a) of the Exchange Act. As such, the regulator is seeking a permanent injunction to bar Vale – and “all persons in active concert or participation with it” – from violating the federal securities laws alleged in the complaint, and is also seeking monetary penalties, as well as a disgorgement of all “ill-gotten gains” in connection such alleged securities fraud. 

Certainly not a retail industry case, the newly-initiated ESG enforcement action by the SEC is worthy of attention for companies across industries, including fashion/luxury, which has long been plagued by allegations of unreliable reporting and deceptive audits in connection with brands’ globally-stretching supply chains. In addition to the risks that come with brands making sustainability and climate claims that they potentially cannot backup, the SEC’s case “demonstrates that statements made in ESG reports should now be considered ripe for litigation – whether public enforcement actions or private securities litigation – as classic sources of disclosures,” according to Mintz’s Jacob H. Hupart. “Notably, the SEC’s complaint also features allegations concerning corporate governance failures and problems with the auditing process related to the ESG reports and other disclosures,” he states, asserting that “the presence of these allegations may act to reinforce the SEC’s focus on corporate governance and attestation in its proposed mandatory climate disclosures.” 

Jones Day attorneys Marjorie Duffy, Linda Hesse, Henry Klehm III, Samir Kaushik, Sarah Levine, and Joan McKown say that they “expect the SEC to use this approach more regularly in the future,” meaning that companies should consider taking “additional measures to perform an audit of their ESG-related statements and disclosures to ensure the accuracy and verifiability of such statements made in these reports, on their websites, and in connection with their representations regarding products in marketing materials and to regulators.” 

The case is SEC v. Vale S.A., 1:22-cv-02405 (E.D.N.Y.).

Lanvin Group announced on Wednesday that it will go public, planning to list on the New York Stock Exchange (under the ticker symbol “LANV”) after it merges with special purpose acquisition company (“SPAC”) Primavera Capital Acquisition Corporation in a move to raise up to $544 million and nab a “pro forma enterprise value of $1.5 billion and a combined pro forma equity value of up to $1.9 billion.” In a statement, Lanvin Group, which rebranded from Fosun Fashion Group last fall, asserted that “through the business combination,” it is aiming “to catalyze growth” both from an acquisition perspective and as a result of “growth across Europe, North America, and Asia.” 

The news about the impending SPAC for Lanvin Group, which maintains majority stakes in Sergio Rossi, Wolford, Caruso, St. John, and of course, Lanvin, among other brands, follows from Perfect Corp revealing early this month that it will go public on the Nasdaq by merging with Provident Acquisition Corp in a deal expected to value the New Taipei City-based startup, which provides software to beauty and fashion companies, at upwards of $1 billion. Before that, Zegna Group made its stock market debut in December by merging with Investindustrial Acquisition Corp., in furtherance of a deal that gave a valuation of $3.1 billion. 

While SPACs are not novel way of raising capital, dating back to the 1990s, they have seen a marked rise in recent years. Last year, a “record” number of de-SPACing transactions were carried out, up from 248 in 2020 (and a total of $83.3 billion raised) to 613 in 2021. An alternative to the traditional initial public offering (“IPO”) process, which is a notoriously costly and time-consuming transaction, mergers with SPACs have been viewed as a quicker, more efficient, and more cost-effective way to go public for target companies, such as Lanvin Group, Perfect Corp, and Zegna Group, among others. 

“Despite the large number of SPACs competing for acquisition targets” in recent years, Akin Gump attorneys Kerry Berchem and Patricia Precel, state that many SPACs – which are essentially shell companies seeking to merge with private companies with the intention of taking them public – “have been able to find targets and close their de-SPAC transactions.” Nonetheless, they assert that SPACs appear to be facing obstacles in 2022, which could serve to tame such sweeping year-over-year growth when it comes to the number of SPAC transactions, as “there are still many SPACs competing for targets, including those with shorter time frames to complete a transaction, [and given that] the SEC may issue new rules governing SPACs aimed at preventing SPACs from evading investor protections associated with a traditional IPO.” 

Beyond that, there is the chance that litigation may sour such deals. Not merely a potential threat, SPAC-centric litigation has come into fruition by way of what Paul Weiss previously characterized in a client note as “a substantial number of lawsuits” that have been filed by SPAC shareholders, who are “contesting the terms of – or disclosures surrounding – de-SPAC merger transactions.”

The rise in SPAC-related litigation has resulted in only one substantive ruling, which came by way of the Delaware Court of Chancery in January 2022 (In re Multiplan Corp. Stockholder Litigation), in which the court denied a motion to dismiss, thereby, enabling the plaintiffs’ claims against the SPAC’s sponsor and its directors – namely, that the defendants breached their fiduciary duties by neglecting to disclose vital information in connection with the merger of Churchill Capital Corp. III (the SPAC) and Multiplan Inc. – to proceed. According to the court, Delaware’s entire fairness standard of review applies to a de-SPAC transaction challenged on the basis of misleading statements or omissions in the SPAC’s proxy statement.

Reflecting on the potential impacts of the court’s decision, Mayer Brown LLP partners John Ablan, Philip Brandes, and Brian Massengill stated in a note for Harvard Law School’s Forum on Corporate Governance that “although the court’s opinion is only a denial of a motion to dismiss and not a final ruling on the merits, it is an important development for SPACs and SPAC sponsors, directors and officers,” nonetheless. Among other things, “the court’s conclusions signal potential increased litigation risk for SPAC directors in connection with business combination transactions. “A very common feature of SPACs,” they state that “the differing incentives for Class A versus Class B stockholders may present an inherent conflict of interest requiring the application of the ‘entire fairness’ standard to a de-SPAC business combination transaction.” 

As for whether such headwinds in the space will deter future transactions, the recent trio of fashion deals, including the impending Lanvin SPAC, seems to suggest that more may still be to come even if the numbers are generally falling this year. “Only 24 SPAC mergers worth $28.3 billion have been announced so far this year, versus the 93 deals worth $233 billion in the first quarter of 2021,” per Reuters.

In light of “the scope of the MultiPlan ruling, and the novel application of traditional fiduciary duty principles in the SPAC contexts,” boards of directors that may be considering SPAC transactions may be proceeding with caution. According to Berchem and Precel, boards would be well served to “follow additional developments in the case, identify real and perceived conflicts in the oversight of any SPAC related transaction, give careful consideration to disclosures and risk factors, and consider obtaining a fairness opinion from a financial advisor if there are conflicts of interest among a SPAC’s directors.”

In terms of Lanvin Group’s plans in the wake of its merger with the SPAC, it is looking to super-charge the growth of its “uniquely positioned” brands in order to capture a greater share of the global luxury goods market, which it says is expected to reach $430 billion by 2025. With a “strong foundation” in Europe, and “nearly half of [its] revenue currently derived from EMEA,” the Group is looking to place “a strategic emphasis on realizing the brands’ untapped potential in both Asia and North America, where its brands are at an inflection point to achieve rapid and significant future growth.” Greater China accounted for just 14 percent of the Group’s global revenues in 2021, while the North American market contributed 33 percent, with more than half of that coming exclusively from St. John. 

Against this background, and given its “unparalleled access and track record in backing international consumer brands and powering their growth” in the fast-growing Asian market, and given that its brands “are also beginning to unalock the huge growth potential of the North American market by opening new retail stores, expanding e-commerce channels, and launching dedicated marketing and brand collaborations,” Lanvin Group claims that it is “well-positioned to capture the enormous growth potential driven by flourishing demand for luxury goods globally.” 

The U.S. Securities and Exchange Commission released proposed rules on Monday that would – if enacted – require publicly-listed companies to make disclosures that outline the effects of climate change on their business (and how they plan to manage these impacts) and that detail their greenhouse gas emissions. The official release of the proposed rules – and call for public comments about them – come after SEC Chair Gary Gensler announced in 2021 that the commission would use its statutory authority to draft climate-related rules and require companies to make corresponding disclosures, citing the demands of “investors representing trillions of dollars,” who are looking for “more consistent, comparable, and decision-useful info about the climate risk of the companies in which they invest.”

At a high level, the SEC’s proposal calls for changes that do not necessarily call on companies to change their overarching operations, but that would require them to report more information in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a “material impact on their business, results of operations, or financial condition,” and “certain climate-related financial statement metrics in a note to their audited financial statements.” According to the SEC, “The required information about climate-related risks also would include disclosure of [the various Scopes of a] registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.” 

Much of the proposed regulations are based on the Task Force on Climate-related Financial Disclosures, an existing framework that aims to help public companies and other organizations disclose climate-related risks and opportunities. (If the TCFD sounds familiar, that may be because it is has been adopted by a number of luxury goods groups, such as Kering, LVMH, Hermès, and Richemont, as well as mass-market entities like Uniqlo-owner Fast Retailing and Zara’s parent Inditex, among others; it is also standard that BlackRock CEO Larry Fink has backed in his annual letter to CEOs.)

Specifically, the proposed rule changes would require publicly-traded entities – and “international companies with operations in the U.S.,” per S&P Global – to disclose information about: “(1) [their] governance of climate-related risks and relevant risk management processes; (2) how any climate-related risks [they] identified have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term; (3) how any identified climate-related risks have affected or are likely to affect [their] strategy, business model, and outlook; and (4) the impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of [their] consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.”

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Sales for LVMH amounted to 64.2 billion euros ($71.55 billion) for the 2021 fiscal year, an increase of 44 percent compared to the year before and 20 percent compared to pre-pandemic 2019, the French luxury goods group reported on Thursday. Organic revenue growth was up by 36 percent and 14 percent compared to 2020 and 2019, with the group saying that its performance for the year “confirms a return to strong growth momentum following the severe disruption to the first half of 2020 resulting from the global pandemic,” and noting that “within the context of a gradual recovery from the health crisis,” it is “confident in its ability to maintain its current growth momentum.”

Delving into the performance of Fashion & Leather Goods over the course of 2021, Bernard Arnault-led LVMH revealed that its largest division “reached record levels,” with revenues totaling 30.8 billion euros ($34.32 billion) for the year – up from 21.2 billion euros and 22.2 billion euros in 2020 and 2019, respectively. Operating margins were up for 2021, as well, totaling 41.6 percent (from 33.9 percent and 33 percent in 2020 and 2019). These results were helped along by a strong fourth quarter, according to the group.

Louis Vuitton, Christian Dior, Fendi, Celine, and Loewe achieved “record levels of revenue and profitability,” while Marc Jacobs “also performed particularly well.” (The big name missing here is, of course, Givenchy.) Louis Vuitton and Dior, in particular, turned “an exceptional performance,” complete with enduring rises in profitability, which LVMH confirmed was “already at an exceptional level.” Specifically, Dior – which saw the success of its new Caro bag and its caning pattern, as well as strong demand for micro bags, and the launch of seasonal capsule collections – boasted “exceptional growth in all its product categories among local customers” over the course of the year. Meanwhile, demand for Louis Vuitton was driven by its “reinvention of iconic models,” along with new artistic collaborations.

Speaking of local customers, LVMH management stated during a post-release call with analysts that local customers “are getting more selective in terms of brand choice,” with the group attracting new local customers in Europe to compensate for the lack of Asian tourists. Also worth noting: LVMH management stated that under the watch of creative director Hedi Slimane and CEO Séverine Merle, Celine has one of the fastest growth rates in the industry.

In terms of Fashion & Leather Goods sales by region, LVMH said that sales in the United States and Asia – which account for the majority of revenue – rose “sharply” in 2021, followed by Europe, finally returned to growth in Q4 compared to 2019, and Japan “with more limited growth.” 

Turning to the Watches & Jewelry division, LVMH saw “a strong rebound of activity in own stores and the successful integration of Tiffany & Co.,” which helped to send revenues up by 167 percent in 2021 compared to 2020, and boosted profits from recurring operations almost six times compared to 2020 and up 128 percent compared to 2019. The division generated the bulk of its sales in Asia (excluding Japan) and the U.S., which LVMH says are “the best performing regions.” Tiffany, alone, saw “record performance in terms of revenue, profits and cash flow, and increased its global attractivity as a result of its high impact innovations and collaborations” during its first year under the LVMH umbrella. The New York-headquartered brand – which benefitted from “strong interest” in its Knot collection, and the rapid development of iconic lines T and HardWear – was also responsible for “increased intangible assets” and “increased inventories” for the division.

Elsewhere in the group, the U.S. was responsible for the greatest increase in Perfumes & Cosmetics sales, which grew by 27 percent in 2021 compared to 2020. LVMH specifically highlighted the “enormous success” of Dior’s Miss Dior and Sauvage fragrancesnoting that in 2021, Sauvage became the highest selling fragrance in the world (women’s and men’s lines, included), which is “a worldwide first for a male fragrance.” 

Selective Retailing, the division that houses the likes of Sephora and duty-free venture DFS, saw organic revenue rise by 18 percent compared to 2020 but was nonetheless, down by 18 percent compared to 2019 due to the impact of travel retail. While DFS suffered from “the very limited recovery in international travel, travel restrictions in China, and quarantine measures in Hong Kong,” not all was lost, as growing demand from local customers helped to boost sales at the seven T Gallerias outposts in Macao. Still yet, Sephora helped buoy the Selective Retailing division by “surpassing its 2019 level of activity, benefiting from the strong rebound in its stores and the continued momentum of its online sales.” 

In addition to growing e-commerce sales for Sephora, LVMH also pointed to Loewe and Marc Jacobs, stating that Loewe’s “online sales grew significantly” and Loewe enjoyed “a highly impressive surge in online sales.” In what is likely a nod at least in part to the role of e-commerce, LVMH states that “investments in [Celine’s] omnichannel strategy played a key role in the Maison’s new gains.”

As a whole, the group reported “continued strong growth of online sales alongside the gradual return of customers in stores,” noting that in terms of efforts, including continued online endeavors, it “made the choice to keep the distribution [of its major Maisons] highly selective, limit promotional offers and develop online sales through their own websites” in order to “preserve their exceptional image – a key element of their lasting appeal.” Going forward, LVMH says it expects to double-down on “the digitization of its Maisons to enrich customers’ experiences online and in stores.”

In a post earnings call on Thursday, LVMH chairman and CEO Bernard Arnault stated that he believes that the group “has enough wiggle room to raise prices” – which has been a common move across the luxury landscape over the past couple of years, in particular – “and protect its margins in an inflationary environment,” per Reuters. He cautioned, however, that management has to “remain reasonable” when it comes to boosting prices of the group’s offerings in the year ahead.

On the topic of group’s ambitions on the metaverse, LVMH does not appear as gung-ho as some of its rivals, with Arnault saying that LVMH “is not interested in selling 10 EUR virtual shoes,” noting that “at this stage, we are very much in the real world, selling real products.” On this same note, he further asserted, “We have to be wary of bubbles,” he said. “At the beginning of the internet, there were all sorts of things popping up and then the bubble burst. There may be relevant applications, but we have to see what universes might actually be profitable.” In terms of NFTs, in particular, Arnault stated that “it will be interesting to see how it generates profit, [as] NFTs are generating profits, and I’m sure this will have a positive effect if things are done properly.”

As for what the group is interested in is what Arnault called “more useful features in the future to support real life activities,” as indicated by LVMH’s recent expansion of the Aura Blockchain Consortium, which now includes Aura SaaS, a blockchain-based platform that aims to “help brands to address authenticity, ownership, warranty, transparency and traceability … [with] lower license and onboarding fees.”