The public policy issues relating to ESG and the creation of a sustainable economy center on evolving notions of corporate responsibility as well as ongoing developments in modern portfolio theory.
The public policy issues relating to ESG and the creation of a sustainable economy center on evolving notions of corporate responsibility as well as ongoing developments in modern portfolio theory. In contrast to the historical practice of defining corporate responsibility by reference to shareholder returns, emerging viewpoints have increasingly focused on a larger pool of stakeholders, including customers, employees, suppliers, and communities, in evaluating questions of corporate responsibility. This paradigm shift is at the core of the debate over recent United States rulemaking with respect to fiduciary duties, the role of proxy advisors, and disclosures, as well as the European Union Sustainable Finance Action Plan. A key element in this debate is the question of materiality, i.e., what information an investor would consider to be material in the analysis of a potential investment. Often overlooked in the debate about materiality is the temporal dimension to ESG and sustainable economy considerations. Which of these considerations would be deemed material could change substantially based on the investment time frame, as ESG and sustainable economy considerations tend to become increasingly material over time, particularly for institutional investors with very long-term obligations to beneficiaries.
SEC and Sustainability Disclosures
For over a decade, disclosure requirements relating to climate risks have been at the forefront of discussions relating to ESG and sustainability disclosures. In 2010, the SEC issued interpretive guidance requiring public companies to disclose the material impact that climate change has on their businesses, including the costs of complying with climate-related laws. This guidance is widely considered to be incomplete, as the SEC has not proposed any rules to specify what climate risks are material, the threshold that would trigger disclosure obligations, nor has it provided any system or guidelines for measuring and reporting climate-related risks. In its review of the effects of SEC’s climate-related risks disclosure requirements, the U.S. Government Accountability Office found that, while public companies disclose climate risks to a certain extent, such disclosure is often inconsistent and thus does not allow investors to make accurate comparisons among different companies with respect to these risks.
Prior to his election, President Biden pledged to require public companies to disclose climate-related risks applicable to their operations, along with their greenhouse gas emissions. While a number of bills have been introduced in Congress to mandate this type of disclosure, the SEC is authorized to mandate the disclosure of climate-related risks independently of any congressional action. During the confirmation hearing for Gary Gensler, President Biden’s candidate for SEC Chair and former Chair of the Commodity Futures Trading Commission (CFTC) during the Obama administration, Democrats on the Senate Banking Committee encouraged now-Chair Gensler to require a more comprehensive disclosure of climate-related risks without delay.
All indications suggest that the SEC will eventually mandate climate-related risk disclosure for public companies. The timing of this decision is unclear. SEC Commissioner Caroline A. Crenshaw and its new chair, Gensler, both support more rigorous disclosures relating to climate risks than are currently required. Commissioner Hester M. Peirce and Commissioner Elad L. Roisman appear skeptical that updates to current disclosure guidelines are needed. Following Gensler’s confirmation, the SEC appears to favor requiring additional climate risk disclosures by a 3-2 majority, which is sufficient for the SEC to take action to enact new climate disclosure requirements. Chair Gensler was sworn into office on 17 April 2021, so we anticipate that the SEC will quickly launch a formal rulemaking process to develop mandatory climate disclosure rules, including public comment periods and other significant actions.
In addition to mandating a more robust disclosure procedure around climate-related risks, the Biden administration is expected to require public companies to disclose more information than is currently required around social and governance issues. Commissioner Allison Herren Lee, who held the position of Acting Chair of the SEC from January 2021 until Chair Gensler’s arrival, had already indicated these matters to be a priority for the SEC by seeking public comment on an ESG disclosure framework, reorienting various divisions’ focus on ESG and sustainability issues, and exploring revisions to rules and guidance regulating shareholder proposals and proxy voting to facilitate ESG shareholder proposals. We believe that Commissioner Lee’s actions as Acting Chair also reflect the priorities of Gensler and are supported by the Biden administration. These reforms are relatively partisan in nature, as the Democratic-appointed SEC Commissioners favor advancing such proposals, while the Republican-appointed SEC Commissioners have voiced opposition.
SEC Division of Corporation Finance Acting Director John Coates has also been supportive of a robust ESG disclosure framework. In a speech on 11 March, he argued that “[t]he SEC should help lead the creation of an effective ESG disclosure system so companies can provide investors with information they need in a cost-effective manner.”1 To be effective, the disclosure system will need to reflect a consensus among investors and companies, be flexible, blend voluntary and mandatory disclosures, and provide specific guidance about key questions, such as what information is most useful and how to verify the accuracy of disclosures. Acting Director Coates expressed concern about the costs investors bear because of a “lack of consistent, comparable, and reliable ESG information” and increasing costs to public companies by virtue of “numerous, conflicting and frequently redundant requests for different information about the same topics.”
Increasing Focus on ESG Across the SEC’s Divisions
The SEC is also reorienting its various divisions’ focus toward ESG and sustainability concerns. According to the SEC Division of Examinations, among its 2021 priorities are an “enhanced focus on climate-related risks.”2 This focus will include “examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change.” Former Acting Chair Lee has stated that “through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework.” Division of Examinations Director Peter Driscoll noted that “our priorities reflect the complicated, diverse, and evolving nature of the risks to investors and the markets, including climate and ESG” and that these priorities include review of investment advisors’ disclosures regarding strategies relating to ESG and sustainability matters.
The SEC Division of Enforcement is also prioritizing ESG issues. As Acting Chair, Commissioner Lee created a 22-member Climate and ESG Task Force within the Division of Enforcement.3 The Acting Deputy Director of Enforcement will lead the Task Force, whose members will be drawn from the SEC’s headquarters, regional offices, and specialized units within the Division of Enforcement. The Task Force “will develop initiatives to proactively identify ESG-related misconduct,” particularly “any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.” It also will review “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”
Republican-appointed Commissioner Peirce and Commissioner Roisman issued a joint statement that “these new climate-related announcements raise more questions than they answer, [but] we look forward to working with SEC staff in the relevant divisions as they review disclosures, assess the adequacy of our guidance and rules, examine for compliance with our rules, and pursue securities law violations.”4 They further cautioned former Acting Chair Lee against imposing new obligations outside of the rulemaking process.
Lee also appointed the SEC’s first senior policy advisor for climate and ESG, thereby cementing the importance of ESG issues to the current SEC.5 Satyam Khanna serves in this role. Previously, he served as a counsel to former SEC Commissioner Robert Jackson and as a member of the SEC’s Investor Advisory Committee.
Reform of the Shareholder Proposal Process to Facilitate ESG Proposals
In addition to updating ESG disclosure guidance and potentially implementing new rules, the SEC is likely to revise rules issued under the Trump administration governing the shareholder proposal process and investment advisers’ proxy voting obligations in order to facilitate more shareholder votes on ESG and sustainability issues. In her speech addressing ESG, Lee said that the SEC will consider taking the following steps:
“Reversing last year’s mistaken” shareholder proposal rule;
Revising Rule 14a-8;
Evaluating new proposals from SEC staff to revise SEC and staff guidance on the no-action process for shareholder proposals, particularly with respect to ESG proposals;
Revising SEC guidance on proxy voting responsibilities of investment advisers. In particular, the SEC may explore rules regarding ESG-specific policies and procedures requirements; and
Revising fund voting disclosures on Form N-PX to improve the standardization and clarity of description of ballot issues.
Lee cited “the soaring demand for opportunities to invest in vehicles with ESG strategies” as the basis for her desire to reform the proxy voting responsibilities of investment advisers.6 Moreover, she is concerned about ensuring that investors’ ESG preferences are furthered by the votes their advisers cast: “We know investors are demanding ESG investment strategies and opportunities, but funds may not always reflect those investor preferences in their voting.”7
Senator Pat Toomey (R-PA), the ranking member of the Senate Banking Committee, has criticized all of these efforts, arguing that the SEC is engaging in “mission creep.”8 He is particularly concerned by the formation of the Task Force and the former Acting Chair’s support for mandated political expenditure disclosures, arguing that the SEC is abusing its power and politicizing its mission by seeking to mandate disclosure of what he considers to be “non-material” information.
Notable Actions by Other Agencies and Executive Departments
Commodity Futures Trading Commission
The Commodity Futures Trading Commission (CFTC) has established a Climate Risk Unit (CRU). Acting Chair Rostin Behnam formed the unit because “climate change poses a major threat to U.S. financial stability, and I believe we must move urgently and assertively in utilizing our wide-ranging and flexible authorities to address emerging risks.”9 The CRU “is intended to accelerate early CFTC engagement in support of industry-led and market-driven processes in the climate—and the larger ESG—space critical to ensuring that new products and markets fairly facilitate hedging, price discovery, market transparency, and capital allocation.” To do so, the CRU will meet with market participants to discuss climate-related risks and the impact of severe weather events on derivatives markets; review derivatives products that address climate-related risk; participate in interagency and international working groups; and consider whether to implement a regulatory sandbox for climate-related products, tools, and services.
The CRU was formed in response to the findings of a 2020 report from the Climate-Related Market Risk Subcommittee of the CFTC’s Market Risk Advisory Committee about managing climate risk in the financial system.10 Acting Chair Behnam praised the report as “exceed[ing] all expectations in tackling the challenges of how to safeguard the financial system in the face of the uniquely complex risks presented by climate change and how to facilitate the transition to a low-carbon, climate-resilient economy.”11
The U.S. Department of Labor
On 10 March 2021, the U.S. Department of Labor (DOL) announced that it will not enforce the “Financial Factors in Selecting Plan Investments”12 or the “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights”13 final rules “until [the DOL] publishes further guidance.”14 The DOL “intends to revisit the rules” which they believe have “already had a chilling effect on appropriate integration of ESG factors in investment decisions.” These rules were issued by the Trump administration in order to preclude ERISA plan fiduciaries from considering ESG factors as part of their investment selection process. Rather, the rules required fiduciaries to focus on “pecuniary interests”; ESG issues were to be considered only as a tie-breaker between investment opportunities. The DOL also indicated its interest in hearing from ESG advocates as it likely revises the rule: “Stakeholders have also questioned whether those rulemakings were rushed unnecessarily and failed to adequately consider and address the substantial evidence submitted by public commenters on the use of environmental, social, and governance (ESG) considerations in improving investment value and long-term investment returns for retirement investors.”
Senators Toomey, Mike Crapo (R-ID), and Richard Burr (R-NC) issued a letter to the DOL, expressing concern that the decisions reflect “Wall Street asset managers’” preferences and will “harm Americans’ retirement savings by allowing plan fiduciaries to sacrifice investment returns to promote nonpecuniary policy objectives.”15 The senators are the ranking members of the Banking, Finance, and Labor committees, respectively. Senators Toomey and Burr have announced their plans to retire at the end of 2022.
The Federal Reserve Board
The Federal Reserve Board of Governors is researching the need for financial institutions to provide climate-related risk disclosures to investors and how to examine financial institutions’ resilience to climate-related risks. In a speech to the 2021 U.S. Climate Finance Summit hosted by the Institute of International Finance, Federal Reserve Board Governor Lael Brainard said that “current voluntary disclosure practices are an important first step, but they are prone to variable quality, incompleteness, and a lack of actionable data. Ultimately, moving toward standardized, reliable, and mandatory disclosures could provide better access to the data required to appropriately manage risks.”16 Her views align with former Acting Chair Lee’s views on ESG and sustainability disclosures. Governor Brainard also stated that “robust risk management, scenario analysis, and forward planning can help ensure financial institutions are resilient to climate-related risks and well-positioned to support the transition to a more sustainable economy.” Predictably, these efforts will be met with some resistance. Senator Toomey and the Republican members of the Senate Banking Committee have sent a letter to the Federal Reserve Board of Governors to warn against the implementation of any climate-related risk regulations. The senators stated that they “question both the purpose and efficacy of climate-related banking regulation and scenario analysis,” asserting that the Federal Reserve “lacks jurisdiction over and expertise in environmental matters.”17
1 Press Release, John Coates, Director, SEC Division of Corporation Finance, ESG Disclosure – Keeping Pace with Developments Affecting Investors, Public Companies and the Capital Markets (Mar. 11, 2021)
2 Press Release, SEC Division of Examinations, SEC Division of Examinations Announces 2021 Examination Priorities: Enhanced Focus on Climate-Related Risks (Mar. 3, 2021)
3 Press Release, SEC, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021)
4 Press Release, Hester M. Pierce and Elad L. Roisman, SEC Commissioners, Enhancing Focus on the SEC’s Enhanced Climate Change Efforts (Mar. 4, 2021)
5 Press Release, SEC, Satyam Khanna Named Senior Policy Advisor for Climate and ESG (Feb. 1, 2021)
6 Allison Herren Lee, Acting Chair, SEC, Address at the ICI Mutual Funds and Investment Management Conference: Every Vote Counts: The Importance of Fund Voting and Disclosure (Mar. 17, 2021)
8Pat Toomey, Richard Shelby, Mike Crapo, Tim Scott, M. Michael Rounds, Thom Tillis, John Kennedy, Bill Hagerty, Cynthia Lummis, Jerry Moran, Kevin Cramer, Steve Daines, Senators, U.S. Sen. Comm. on Banking, Housing, and Urban Affairs, Toomey, GOP Banking Members Caution Federal Reserve Against Climate Regulations (Mar. 18, 2021)
9 Press Release, CFTC, CFTC Acting Chairman Behnam Establishes New Climate Risk Unit (Mar. 17, 2021)
10 Climate-Related Market Risk Subcommittee, Market Risk Advisory Committee of the U.S. Commodity Futures Trading Commission, Managing Climate Risk in the U.S. Financial System
11 Rostin Behnam, Acting Chairman, CFTC, Opening Statement of Acting Chairman Rostin Behnam before the CFTC Market Risk Advisory Committee (Feb. 23, 2021).
12 Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72,846 (Nov. 13, 2020) (to be codified at 29 C.F.R. pt. 2509, 2550).
13 Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85 Fed. Reg. 81,658 (Dec. 16, 2020) (to be codified at 29 C.F.R. pt. 2509, 2550).
15 Richard Burr, Mike Crapo, Pat Toomey, Senators, U.S. Sen. Comm. on Banking, Housing, and Urban Affairs, Toomey, Crapo, Burr Urge DOL to Put Americans’ Retirement Savings Above ESG Objectives (Mar. 18, 2021)
16 Lael Brainard, Governor, Board of Governors of the Federal Reserve System, Address at the 2021 IIF U.S. Climate Finance Summit, The Role of Financial Institutions in Tackling the Challenges of Climate Change (Feb. 18, 2021)
17 Pat Toomey, Richard Shelby, Mike Crapo, Tim Scott, M. Michael Rounds, Thom Tillis, John Kennedy, Bill Hagerty, Cynthia Lummis, Jerry Moran, Kevin Cramer, Steve Daines, Senators, U.S. Sen. Comm. on Banking, Housing, and Urban Affairs, Toomey, GOP Banking Members Caution Federal Reserve Against Climate Regulations (Mar. 18, 2021)