Climate Disclosure and ERISA ESG Rules Put Companies on Notice

Environmental, social, and governance regulation continues to increase globally, including in the US. Here are three investment-related regulatory developments that will have significant impact in 2023 and beyond.

Climate Disclosure

Last March, the Securities and Exchange Commission proposed long-awaited rules that would mandate enhanced climate-related disclosures by most public companies. In contrast to the current principles-based approach to climate disclosure, the proposed rules take a different tack, providing for specific and detailed disclosures relating to climate matters.

Key components of the proposed rules include:

• Oversight and management of climate risk
• Impacts of climate-related risks on the business, financials, strategy, business model and outlook over the short, medium, and long term
• Processes for identifying, assessing, and managing climate-related risks
• Historical greenhouse gas emissions data (Scopes 1 and 2, and in many cases Scope 3), with third-party assurance
• Climate-related targets and goals, if set Financial statement disclosure on the financial impacts of physical and transition risks

The proposed rules are in part based on, but not identical to, the frameworks published by the Task Force on Climate-related Financial Disclosures and the Greenhouse Gas Protocol.

The proposed climate disclosure rules would arguably be the most significant new public company disclosure and compliance requirements in a generation.

Approximately 1,000 substantive comment letters were submitted to the SEC, far more than for most proposed rules.

Not surprisingly, the comments range from full-throated support for the rules—and in some cases make arguments that the proposed rules do not go far enough—to calls for the SEC to scrap the proposal in its entirety. Many observers expect the SEC to adopt final climate disclosure rules as soon as the first quarter of 2023.

Disclosure Requirements For Funds and Advisers

In May, the SEC proposed wide-reaching classification and disclosure requirements for registered investment companies and registered investment advisers. The proposal intends to combat “greenwashing” and address a perceived “lack of consistent, comparable, and reliable information among investment products and advisers that claim to consider one or more ESG factors.”

It would impose a mandatory taxonomy for funds and advisers’ strategies that consider ESG, breaking them into ESG Integration, ESG Focused and ESG Impact. Triggers for the categories have been criticized for being overly rigid and potentially pushing managers to provide disproportionately detailed descriptions of the degree that ESG factors play a role in their investment processes.

Importantly, the SEC’s proposed taxonomy would not align with the categories applied to non-US funds, such as under the EU Sustainable Finance Disclosure Regulation. The proposal would also mandate greenhouse gas emissions disclosures by funds that consider emissions in their process.

The disclosure proposals come amidst a broader initiative by several SEC divisions to focus critically on current practices by funds and advisers in their use and disclosure of ESG-related factors.

A growing number of SEC examinations and enforcement actions have drilled down on the compliance framework supporting investment firms’ mandate to say what they do, and do what they say, when it comes to ESG claims.

The emphasis of these actions has been on an expectation of thorough compliance oversight, written protocols, and exhaustive documentation of use of ESG factors.

Expanding required public disclosures about ESG practices will only intensify the pressure to further bolster involvement by compliance departments in the investment process as it relates to ESG. The SEC is expected to adopt final ESG disclosure rules for funds and advisers in the first quarter of 2023.

New DOL Rules for ERISA Plans

In November, the Department of Labor published a final regulation addressing investment selection by ERISA fiduciaries and ESG considerations for ERISA-covered retirement plans—including 401(k) plans—and the exercise of shareholder rights, including voting proxies.

The final rule follows the proposed rule closely, but represents a stark change in approach from the previous regulation promulgated by the Trump administration. The final rule adopts a neutral approach to ESG investments.

It clarifies that a plan fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, including ESG factors, if applicable.

This differs from the Trump administration rule, which was widely interpreted as limiting the ability to treat ESG factors as material economic factors. This also deviates slightly from the proposal, which many viewed as creating a soft mandate for fiduciaries to consider ESG factors when making investment decisions.

As a result, plan fiduciaries should be free to consider or reject ESG factors as part of the investment process, without worrying that the DOL has put a thumb on either side of the scale.

The final rule also keeps the long-standing “tiebreaker” rule where fiduciaries may consider non-financial factors to decide between two similar investment options.

But it clarifies that a fiduciary may not need the tiebreaker analysis when adding new funds to a 401(k) plan menu, instead of replacing another fund, and fiduciaries may consider participant requests for a particular type of fund (such as an ESG fund) when making investment decisions.

As a result of these changes, 401(k) plan fiduciaries should feel empowered to consider the full range of potential funds for their participants, including ESG focused funds.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Joshua A. Lichtenstein is a partner at Ropes & Gray and head of the firm’s ERISA and benefits practice.

Michael R. Littenberg is a partner at Ropes & Gray and global chair of the environmental, social and governance, corporate social responsibility, and business and human rights compliance practice.

George B. Raine is a partner in Ropes & Gray’s asset management practice.

Samantha A.M. Elliott, Ropes & Gray, contributed to this article.