Increasing interest in sustainable investment has spurred a growing community of executives, investors, and practitioners focused on the management of capital using environmental, social, and governance (ESG) factors. Yet, the growth and evolution, at least in the United States, has failed to usher certainty and clarity, especially for newcomers to this trend.
This state of confusion, at least in part, is due to the fact that the proliferation of potential ESG approaches has not been paired by a concurrent federal government-level push to drive consistency in the marketplace. Recent activity in Congress suggests, however, that the status quo may not persist much longer, particularly for public companies.
To date, the Securities and Exchange Commission, seen as the most natural federal regulator of ESG, has—at most—flirted with the issue of ESG. After issuing guidance on climate-related risk disclosure in 2010, the SEC has avoided providing formal ESG guidance or rules, choosing instead to focus issuers on their more general obligations to disclose material information under existing SEC rules. The SEC has maintained this posture in the face of mounting pressure, including demands from the regulated community.
Nearly a year ago the SEC was presented by a petition calling for rulemaking by investors representing more than $5 trillion in assets under management. That too was not enough.
In their petition, investors advanced six core arguments, three of which are worth highlighting here: First, the petitioners argue that the SEC is already empowered under the law “to require disclosure of ESG information.” Second, they argue that the sort of voluntary ESG disclosure being undertaken by public companies now “is episodic, incomplete, incomparable, and inconsistent.”
Finally, they argue that, absent a clear federal regulatory signal, public companies will continue to face an uneven playing field—as between those choosing and those not choosing to pursue ESG on a voluntary basis.
The SEC may not have been listening, but others seem to be. Over the last several years, states have been playing a growing role in developing the regulatory framework around ESG in the United States. But, despite their massive fiscal footprints and regulatory reach, states are limited in their ability to marshal the sort of market-wide consistency of ESG practice that investors increasingly seek and that the federal government can best provide.
New Bills Offer Clearer Mandates
The more important development, then, is the set of new bills that have been introduced in the Congress—each focused on replacing aspects of the SEC’s discretion with new, clear mandates. The most significant of these bills is the ESG Disclosure Simplification Act of 2019.
The bill has essentially three aims. First, the bill establishes a process by which to define key ESG metrics: It requires the SEC to undertake rulemaking to this end and to establish a Sustainable Finance Advisory Committee to assist with the same.
Second, the bill clarifies Congress’ sense that ESG disclosures are material and, as a logical extension, mandates annual disclosure of ESG metrics, as defined through rulemaking by SEC.
Finally, the bill pushes public companies to analyze the relationship between ESG and their long-term business strategy. Specifically, the bill requires annual disclosure of (a) “a clear description of the views of the issuer about the link between ESG metrics and the long-term business strategy of the issuer” and (b) “a description of any process the issuer uses to determine the impact of ESG metrics on the long-term business strategy of the issuer.”
In addition to this broad, procedural ESG bill, Congress is also considering a series of more substantive bills focused on aspects of ESG. One proposed law, the Shareholder Protection Act of 2019, takes aim at the “S” concern of public company spending on political activities, which is rarely disclosed by public companies in their annual filings and which the bill defines broadly as including even certain payments to trade associations.
The bill has a few core components. First, it requires that political expenditures be “authorized by a vote of the majority of the outstanding shares of the issuer.” Second, for specific expenditures over $50,000, the bill mandates a vote of the board of directors. In addition to the amounts and purposes, these votes are subject to disclosure requirements providing transparency around the actions of institutional investors and individual directors, who are also made subject to certain joint and several liability under the bill.
Another proposed bill, the Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019, focuses on human rights issues as identified by the United Nations. The bill notes that while certain countries have leveraged ESG regulation to mandate risk assessment of the human rights violations, the U.S. has not. It seeks to fill this gap. The bill does so by creating an annual requirement for public companies to assess their human rights risk exposure. The bill asks companies to look not only at their own operational footprint, but within their supply chains, which the bill calls “value chains.”
Finally, the bill mandates that companies do more than assess their risk exposure—it asks for them to identify approaches they have taken to prevent and mitigate violations and to justify instances where, despite being aware of an operational or supply chain vulnerability, the company has taken no action at all.
A fourth proposed bill, the Climate Risk Disclosure Act of 2019 seeks to take on the issue of climate change, which has gained particular prominence among investors focused on ESG. Far more specific than guidance on climate-related risk disclosure issued by the SEC in 2010, this bill mandates annual climate-related risk disclosure.
Although the bill calls for rulemaking by the SEC, it lays out very specific parameters for the rules. First, it calls for sectoral guidance regarding disclosure, identifying “finance, insurance, transportation, electric power, mining, and non-renewable energy” as some sectors that merit bespoke treatment by the regulator.
Second, the bill directs the SEC to not only establish guidance for greenhouse gas emissions disclosure (perhaps, the baseline way to report on climate-related risk) but also to “establish a minimum social cost of carbon” that companies can use to consider their financial risk over “5-, 10-, and 20-year time frames.” The bill also calls for an accounting of the “physical impacts of climate change” to companies under various climate scenarios. Finally, the bill spells out a unique and detailed set of requirements for companies involved in the production of fossil fuels.
Although these bills are still being debated in Congress, they represent a potentially significant and step-wise change in the status quo with regard to federal regulation on ESG. Together, they show the readying of a new playbook on ESG in the U.S. that looks more like what investors have become familiar with in Europe and Japan over the last several years.
However, until that playbook takes the field, sustainable investing in the U.S. will continue to be shaped by state regulators and powerful institutional investors.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Ali Zaidi is of counsel in the Washington, D.C., office of Kirkland & Ellis, and focuses his practice on identifying, mitigating, and managing climate and environmental risks and is a leader in the firm’s Sustainable Investment & Global Impact Group. Zaidi previously served as associate director for natural resources, energy, and science in the White House Office of Management and Budget and deputy director for energy policy in the White House Domestic Policy Council.