October 26, 2021 - by Tess Virmani. As financial market participants await the SEC’s release of their proposed rulemakings on climate and ESG-related corporate disclosures as well as on investment fund rules for ESG funds, we take stock below of what we know – or at least can reasonably glean – about what to expect in these rulemakings. (Spoiler alert: ESG regulation is coming in the U.S.; the form and scope in which it will emerge is still unclear but not for long.)
No agency has been as vocal about focusing their attention on climate change and ESG issues as the SEC. The Biden administration has been clear that implementing measures targeting climate change and ESG matters is one of the administration’s top priorities, but the wheels began to move for the SEC in May 2020 under the last administration. The SEC Investor Advisory Committee urged the SEC to update reporting requirements for issuers to include material, decision-useful ESG factors and subsequently the SEC convened an ESG Subcommittee under the Asset Management Advisory Committee (AMAC) to review ESG practices of investment products, and to explore whether any recommendations were warranted to improve practices. The work of that Subcommittee informed the AMAC’s ESG recommendations delivered to the SEC Commission in July 2021. These recommendations for SEC action include:
- best practices to enhance ESG investment product disclosure, including alignment with the terminology developed by the Investment Company Institute ESG Working Group, and a clear description of each product’s strategy and investment priorities, as well as a description of non-financial objectives such as environmental impact or adherence to religious requirements.
- best practices for investment products to describe each product’s planned approach to shared ownership activities and any notable recent ownership activities outside proxy voting
- steps to foster meaningful, consistent, and comparable disclosure of material ESG matters by issuers, including encouraging issuers to adopt a framework for disclosing material ESG matters and to provide an explanation if no disclosure framework is adopted.
- The study of third-party ESG disclosure frameworks for the disclosure of material ESG matters and the acquisition of relevant expertise to assess how frameworks could play a more authoritative role in the near future. This could provide a roadmap for potential establishment of a standard setting body to develop ESG disclosure standards with consistent applications of those standards by issuers being enforced by the SEC.
While the SEC is undoubtedly on a path of taking significant rulemaking and enforcement actions with respect to climate and ESG disclosure, it is notable that not all of the SEC Commissioners are of the same view. While “truth in advertising” as a principle enjoys bipartisan support, Commissioner Hester Peirce has been vocal in her concerns with a single set of mandated ESG disclosures. Rather than a prescriptive ESG rule, she suggests working within the SEC’s existing regulatory framework and issuing guidance and FAQs on how ESG topics can be addressed within that framework. Similarly, Commissioner Elad Roisman has voiced concerns over tricky questions on ESG (e.g., what are the precise items of material “E,” “S,” and “G” that investors need to make informed decisions) that would need to be resolved in a rulemaking and the increased costs of ESG disclosure. It remains to be seen how these viewpoints get reconciled in a proposed rulemaking, but with a 3 to 2 split in favor of ESG disclosure, we can expect to see rulemaking advance.
What say the people? Responses to SEC Acting Chair Lee’s invitation for public comment
In March, SEC Acting Chair Lee invited public comment on climate change disclosures, including 15 broad questions on which input was sought. In response to that request, SEC Chair Gensler shared that more than 550 comment letters were submitted (as of July 2021) and comment letters continue to be submitted long after the suggested deadline of June 13th. Beyond that, Davis Polk conducted a review of a representative sample of 30 comments which ranged from “questioning the SEC’s authority to imploring the SEC to mandate comprehensive, internationally aligned and assured disclosures in SEC filings.” While a detailed discussion of the comments is beyond the scope of this writing, we note a few key takeaways: 1) the largest group of all commenters was the “standard setter & non-profit/sustainability” group, but the “asset managers/investors/ investor” group was nearly as large; 2) with respect to standards – the majority of the sample argued in favor of the SEC adopting industry-specific standards (though views were mixed as to whether that should be a single global standard) and any adopted standard should draw on existing frameworks; and 3) with respect to liability – the majority of the sample argued for a safe harbor or other liability protection, that disclosures should be furnished rather than filed, and disclosures should be made outside of 10-Ks and 10-Qs. Perhaps of particular interest to LSTA members, views on whether the SEC disclosure should apply to private companies were evenly mixed with a third in favor, a third opposed and a third reflecting mixed views. This question also drew congressional comment – members of the House Financial Services Committee wrote a letter to Chair Gensler inquiring why such a question was posed when “the SEC does not have the statutory mandate to compel privately-held business to publicly disclose, directly or indirectly, data of any sort.” SEC staff face a tall order in reviewing and digesting the numerous comments received.
SEC is taking ESG-related enforcement steps under current rules
Aside from forthcoming rulemakings, the SEC’s focus on climate and ESG is informing enforcement under the current regulatory framework. In March, the SEC formed a Climate and ESG Task Force in the Division of Enforcement tasked with (1) identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules, and (2) analyzing disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies. Since then SEC staff has been busy examining corporate disclosures in light of the SEC’s 2010 interpretive guidance as well as potential ESG mislabeling by funds. The WSJ has reported that dozens of companies have received requests from the SEC’s Division of Corporation Finance for more information on how climate change might affect their businesses. The SEC has also published a sample letter to companies commenting on their SEC filings and requesting further climate related information that would be important to a reasonable investor. (Hogan Lovells reviews the letter here.) Companies are not alone. Bloomberg has reported that SEC examiners “have been demanding that money managers explain the standards they use for classifying funds as environmental, social and governance-focused” – the second SEC review into possible ESG mislabeling since last year. Industry concerns over enforcement actions grow and Wilmer Hale warned in an August client alert that ESG asset managers and investment funds face a near-term SEC enforcement risk. That sentiment was similarly expressed by Acting SEC Director of Enforcement Melissa Hodgman when she stated that funds advertising ESG investments will be subject to increased scrutiny and should anticipate potential disclosure-related enforcement actions.
Reading the tea leaves…
Each day we come closer to seeing the SEC’s proposed rulemakings, but in the meantime, SEC Chair Gensler has seemingly tipped his hand in prepared remarks this summer.
In July, Chair Gensler stated that three out of every four comments received by the SEC support mandatory climate disclosure rules and that supports his direction to SEC staff that they develop a mandatory climate risk disclosure rule proposal for the Commission’s consideration. He sees such disclosures as being consistent, comparable and decision-useful and has asked the staff to consider whether these disclosures should be filed in the Form 10-K or elsewhere. He further detailed that he asked for staff recommendations about how companies might disclose their Scope 1 and Scope 2 emissions (direct emissions from owned/controlled sources and indirect emissions from the generation of purchased energy), along with whether and when to disclose Scope 3 emissions (all other indirect emissions that occur in a company’s value chain).
Addressing investment funds, Gensler noted that labels like “green” or “sustainable” say a lot to investors, but it is often not clear what these labels actually mean. He stated that he had directed staff to consider recommendations about whether fund managers should disclose the criteria and underlying data they use to ensure they are meeting investors’ targets and to consider whether the SEC might take a holistic look at the Names Rule.
The SEC’s Annual Regulatory Agenda released this spring indicated that the SEC was targeting an October 2021 release of its proposed rulemaking on corporate climate disclosures. However, SEC Chair Gensler stated that proposed rules on corporate climate risk disclosures would be released for public input in “the next handful of months” during testimony before the House Financial Services Committee in October. While Gensler indicated economic impact analysis work was still underway, others have speculated that the SEC may also be waiting until after the release of the FSOC Report on Climate-Related Financial Risk which was just published (early!) on October 21st. Proposed rulemakings on ESG and investment products are not expected until April 2022.
The LSTA will continue to monitor this space and update members as appropriate. If you have questions, please contact Tess Virmani.