ESG Regulations Swim Against the Tide in the U.S., But the Fight Is Worthwhile

There’s been a great deal of skepticism about the ESG (environmental, social and governance) disclosure regulations being put through U.S. Congress in recent months. Republican control of the Senate and the Donald Trump administration’s tendency toward deregulation, particularly in relation to environmental rules that could curtail the activities of the fossil fuel industry, make it hard for anything related to ESG regulations to gain any traction.

The latest development was the Sept. 27 passing of the ESG Disclosure Simplification Act (during Climate Week, fittingly enough) which mandates the definition of ESG metrics by the Securities and Exchange Commission and makes these metrics far more seamless to audit. But why, despite all the political challenges, should this act become law?

Building momentum for ESG regulations

The value of the legislation is not in changing the world in a single, all-powerful legislative swoop; it’s in building momentum. The first big step was seeing these topics discussed in Congress back in July. The passing of the Simplification Act represents another stride forward on ESG disclosure and a real opportunity for the U.S. to lead the way.

Though progress is slow, the movement seems to be inexorably toward mandatory reporting. Chris Burkett, a partner at multinational law firm Baker McKenzie, says: "Under the current state of political affairs in the U.S., I think it's highly unlikely that this will become law in the near term. However, it is certainly a sign of progress that this is on the Congressional agenda. In my view, it is only a matter of time until ESG reporting is mandatory—the trend is clear and investors will ultimately demand it.”

Speaking at a recent conference held by the Task Force on Climate-related Financial Disclosures (TCFD) in Tokyo, Mark Carney, governor of the Bank of England, observed a growing appetite among investors to support companies that understand their climate risks, following research that showed these companies are likely to expand at a faster rate.

Building the business case

There’s a huge value in laws that focus on specific challenges—like climate change, for example—which umbrella terms like 'ESG’ or ‘sustainability’ simply do not capture. It’s a sad fact of life that businesses will recognize the significance of a particular issue only when it bites away at their bottom line. A specific risk is far more tangible, and its financial implications are clear to business leaders. This is why the TCFD has been so successful in gaining traction. Focusing on a single issue that’s framed as a clearly defined business risk generates a sense of urgency among CEOs.

It is only by discussing environmental issues in the public eye that we can pluck them from the back of executives' minds and bring them to the forefront of corporate thinking. That’s why it’s important for us to see these issues being spoken about in Congress, on the news and in social media. More importantly, policymakers actually went through the effort of putting the Act in writing, for it to be either enacted or built upon.

Building pressure

Passing this legislation is another step toward consistency. Elsewhere, things are happening. The United Kingdom has obliged all listed companies and large asset owners to report on climate-related risks and opportunities in line with the TCFD recommendations by 2022. Relating only to climate change rather than to wider ESG issues, the TCFD gives companies a clear focus for their activities. From what our community is saying, European investors are putting pressure on U.S. companies to align their strategy with the Paris climate agreement. Perhaps as other nations introduce laws that encourage greater environmental awareness, the pressure on the U.S. to do the same will also increase.

Carney said companies should use their next two annual financial reports to test how they document the impact of the climate emergency on their businesses. “The TCFD needs to reach a definitive view of what counts as a high-quality disclosure before they become mandatory,” he said. “In my view the next two reporting periods should balance the urgency of the task and the imperative of getting it right.” Once we derive best practice, we can then go about making it law.

We’re a long way off, but act by act, discussion by discussion, bit by bit, ESG issues are clawing their way into the public consciousness. The ESG Disclosure Simplification Act is another such example. Maybe the act in itself won’t bring about the wholesale change needed, but it’s another step forward. Another blow struck in the fight. In the same way that the reality of global climate change will not go away by itself, demand for disclosure is very much here to stay.

Image credit: Darren Halstead/Unsplash