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US Financial Regulation’s Lone Possibility: ESG Disclosure Rules

About a year ago, we looked at the prospects of new regulation for the financial industry in the U.S. after the 2020 election. Since then, the Biden Administration hasn’t pushed any kind of a blockbuster proposal on this topic, as it had a full plate with its infrastructure and “Build Back Better” social spending plan. That’s left the playing field open to Congress, to some extent, and as we’ll show, the Securities and Exchange Commission (SEC) as the industry’s regulator. Over the past year, interest has steadily increased in regulating adherence to environmental, social and corporate governance (ESG) standards, particularly when making claims about ESG disclosure and credentials in investment products or funds.

Investors are currently at risk of being misled by greenwashing, the act of manipulating environmental ratings, which to-date remain unregulated. The Sustainable Finance Disclosure Regulation (SFDR) is response of the European Union to this situation. Despite the keen environmental and societal concerns among Gen X and Millennials, who are in line to inherit over $35 trillion form the baby boomer generation, the US has yet to begin regulating standards for ESG disclosures and the ESG data that is used to generate investment insights and ratings.

ESG Disclosure Simplification Act

In June, the U.S. House passed the ESG Disclosure Simplification Act of 2021, sponsored by Rep. Juan Vargas, D-Calif, by just one vote – and the bill still has to pass the evenly divided Senate. If enacted, it would direct the SEC to issue rules requiring publicly traded companies to disclose ESG metrics in solicitations and financial statements.

The chairman of the Senate Banking Committee, Sherrod Brown, D-Ohio, supports ESG disclosure rules and began reviewing the House bill after its passage. Should anything happen to change the political make-up of the Senate before next year’s election or if the Republicans take back the Senate, the chairmanship of the committee would go to Sen. Patrick Toomey of Pennsylvania, or after Toomey retires at the end of his term, Sen. Tim Scott of South Carolina. Both senators have stated opposition to setting ESG disclosure rules.

In the meantime, in late July 2021, SEC chairman Gary Gensler called for a climate risk disclosure proposal by the end of 2021. In October, the agency issued a request for comment on climate change disclosures.

Other paths to regulation

The SEC has also pursued a few other paths toward regulating climate risk disclosures and ESG compliance. Earlier in 2021, the SEC, under the acting chair who preceded Gensler, directed its Division of Corporation Finance to focus on climate-related disclosures in public company filings. The SEC also formed a task force about climate and ESG issues.

As of this writing, the SEC had not yet issued its promised formal climate risk disclosure proposal. However, the SEC’s information resource for investors published a bulletin emphasizing, in part, that ESG fund investors should “be sure to understand what [they] are investing in.” This bulletin also states that:

  • The SEC does not issue scores for any of the three elements of ESG.
  • Funds may weigh ESG factors differently.
  • Funds may have different criteria for ESG factors.
  • ESG fund managers may use third-party ESG scores.
  • A fund may still follow ESG principles even if not advertised or named as such.

These points from this bulletin run counter to the prospect of the SEC setting its own standards that issuers would have to follow. This raises the question of whether the SEC does not want to go any further with placing responsibility on issuers rather than investors until it completes its disclosure proposals.

Uncertainty around further regulation

Drilling down on the possibility of ESG disclosure rules in this way leaves uncertainty similar to the overall uncertainty of one year ago about any changes to US financial regulation. What’s borne out since last December is that ESG is a rare area where there has been any movement at all in the US concerning new financial services industry rules.

Even that is another mixed bag, as any action that does come will likely only be at the regulatory agency level, not from the Biden Administration or Congress. Practically, the SEC’s stances matter for the industry. This can be a double-edged sword for both those pushing for more ESG rules and those opposing them. That is because a change in political control takes longer to manifest through appointments of agency heads. On the other hand, with Democrats currently in narrow control, they get their regulatory philosophy put into practice even without successful action at the executive or legislative levels. That achievement, however, is only as durable as their majority.

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