The US and EU are both heading toward tougher regulations on ESG disclosure and standardisation. But there is a contrast between the difficulties America is facing in establishing Environmental, Social and Governance regulations versus the progress made in Europe.
ESG regulation in the financial sector is rapidly evolving. On the one hand, there is growing awareness among investors and companies that higher Environmental, Social and Governance disclosure and standardisation will provide consistent, comparable, and reliable information and help them better judge opportunities and risks in their decision-making processes. On the other hand, concerns are rising over potential policy uncertainties and legal challenges.
In this article, we compare the current ESG regulatory situations in the financial sectors of the US and the EU. We also provide at the end some thoughts on the two jurisdictions' climate policies targeted at economic activities.
US: Recent ESG movements signal a rocky regulatory road ahead
ESG disclosure mandates will be evolutional but face strong headwinds. In March 2022, the US Securities and Exchange Commission (SEC) released its long-awaited proposed rules on mandating certain climate-related disclosure for listed companies. Those rules include disclosure of Scope 3 emissions, carbon offsets, and climate-related risks for relevant companies.
After receiving significant comments from various market players, the SEC is expected to publish the final climate disclosure rules this April. Gary Gensler, Chair of the SEC, has signalled that the Commission is considering giving more flexibility to several provisions in the original proposal, including mandatory disclosure of Scope 3 emissions, as well as a requirement to disclose climate costs that are 1% or more of each line-item total of a company’s financial statement.
And the SEC also plans to release disclosure mandate proposals that go beyond climate change. The Commission aims to release proposed/draft disclosure rules on human capital management in April. And it's hoping to publish proposed rules on ESG fund disclosure for asset managers, final rules on fund names, as well as on corporate board diversity.
The final climate disclosure rules may be less stringent than some are hoping for
Despite all that, the final climate disclosure rules may be less stringent than some are hoping for - that all these mandates in the works will lead to higher ESG data transparency, standardisation, and comparability. This can then more effectively allocate capital to companies or projects with higher performance or make more significant progress in managing sustainability.
However, the disclosure proposals remain vulnerable to legal challenges. In June 2022, the Supreme Court ruled that the Environmental Protection Agency (EPA) does not have the authority to put a limit on greenhouse gas emissions from power plants. This ruling sets a precedent for future lawsuits and indeed, in February this year, some Republicans from Congress published a letter arguing that the SEC’s proposed rules on climate-related data disclosure exceed the agency’s authority.
Dividing ESG views in the US can introduce more risks to investors
The US is witnessing an increasingly divided policy environment regarding ESG. Congress recently voted to adopt a resolution that would block a recent rule set by the Department of Labor (DOL) to allow private employer-sponsored retirement plans (ERISA) to consider ESG and climate factors. This is one of the most recent examples of federal anti-ESG efforts from policymakers, with over 600,000 retirement plans worth $12tn in assets under the bill's impact.
In reaction, President Biden vetoed the passed bill, the first veto of his term. But even a veto might not be able to keep the Department of Labor's ESG rule in place. In January, 25 states announced a lawsuit against the Biden administration over the DOL rule. And again, with the 2022 Supreme Court decision setting a precedent, the risk of the DOL rule being overturned needs to be considered.
The anti-ESG pushback is strong
More than 20 states have proposed or passed anti-ESG bills at the state level. Noticeably, Texas was the first to have passed anti-boycott legislation in 2021 to prevent local entities from conducting business with banks that choose to adopt ESG policies or are divesting from Texan fossil fuel companies. It has triggered other states to follow suit. There are also state-level efforts to reject anti-ESG measures. For instance, Wyoming has just voted down two new pieces of anti-ESG legislative proposals. And the policy fraction is further complicated by several other states proposing or passing bills to support ESG integration in investments.
Dissenting standpoints from regulatory federal decision-makers, as well as drastically different ESG regulatory approaches across states, can lead to higher policy uncertainty and more risks of asset owners pulling money out of asset managers. Investors may also find it harder to have a unified strategy without heightened reputation risks. A survey of 300 international and wholesale investors with more than $27tn in assets under management shows that 47% of the investors are concerned about facing political/legal pressure on an anti-ESG basis if they implement ESG investing (versus 30% in Europe and 37% in Asia). 54% of them expect to see more pressure against ESG investing in their domestic market in the future (versus 35% in Europe and 51% in Asia).
Nevertheless, investors and issuers with strong ESG beliefs can still find a way to carry on. Clean energy is an area that will see sustained investment and ESG debt issuance, supported by the Inflation Reduction Act (IRA).
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