Don’t look now, but the Biden Administration continues to position its pieces on the regulatory chessboard to advance the administration’s plans for more corporate disclosure of ESG risks.
First, last Thursday the president issued an executive order on the subject, addressing climate change and how the administration might use financial regulation to further enhance climate-change disclosures. One significant player in that push will be the Securities and Exchange Commission, since it has the ability to require more climate change disclosure from listed companies.
Then Democratic SEC commissioner Allison Herren Lee gave a speech Monday that forcefully defended the agency’s power to require ESG disclosures. Appearing at an ESG event sponsored by the CFA Institute and the AICPA, Lee debunked four “myths” about the materiality of ESG disclosures in a detailed, heavily footnoted speech that read like a pre-emptive rebuttal to whatever lawsuit against new ESG disclosures that Republican interest groups will inevitably file.
What should compliance officers make of all this? As we’ve said on these pages before, more requirements for disclosure of climate change risks and related ESG issues are coming. Pay attention to how this chess game unfolds, and start thinking now about new policies, procedures, and controls you’ll need to have in place to extract ESG data from your operations and then put that information into a report.
So what, precisely, did the White House and then commissioner Lee have to say? Let’s take a look.
Biden’s Climate Change Order
This executive order is decidedly less prescriptive than some of the previous orders we’ve seen from the White House, but still directs numerous federal agencies to publish several reports about the risks of climate change and to consider how they might revamp regulations so that government contractors and other private-sector firms will need to confront climate change more directly.
Let’s start with the reports, since they’re the directives that include specific deadlines. By Sept. 20, the Administration is supposed to develop a “comprehensive, government-wide strategy” regarding:
- The measurement, assessment, mitigation, and disclosure of climate-related financial risks to the federal government;
- The financing needs to achieve net-zero greenhouse gas emissions for the U.S. economy by 2050; and
- The areas where private and public investments can play complementary roles in meeting those financing needs.
Second, by Nov. 20 the Treasury Department, working with other financial regulators that are all part of the Federal Stability Oversight Council, must deliver a report that discusses:
- The need for any actions to enhance climate-related disclosures “to mitigate climate-related financial risk to the financial system;”
- A look at current approaches to managing climate-related risks to the financial system, plus any impediments regulators have encountered in adopting those approaches; and
- Recommendations on how climate-related financial risk can be mitigated, “including through new or revised regulatory standards as appropriate.”
An interesting point here is that the Biden Administration keeps talking about climate change as a risk to the financial system (rather than, say, as a threat to public health or environmental safety). Why do that? Because when climate change is framed a threat to financial stability, you can tackle it by regulating how banks address climate change — and by regulating the banks, you can reach a much larger range of businesses that depend on the banks.
The Biden order also casts an eye to government contractors. It directs several government agencies to consider amending the Federal Acquisition Rule to require “major” government contractors to publicly disclose greenhouse gas emissions and to set science-based reduction targets (for greenhouse gas emissions, presumably).
Federal contracts would also give preference to bidders with a lower “social cost” of greenhouse gas emissions, although the order doesn’t define exactly how those costs are to be calculated and compared.
And when, exactly, would those changes to FAR be proposed? The order doesn’t say — so it’s hard to judge how much this directive is serious or just Green New Deal posturing. (For comparison purposes, when the Biden Administration released an executive order on cybersecurity just one week earlier, the language was clear that proposals to change FAR would be forthcoming in 60 days.)
Still, using the banking system and federal procurement to drive climate change policy will be an effective way to sweep a lot of large companies into whatever new disclosure regime is to come.
Commissioner Lee’s ESG Speech
Then we have commissioner Lee’s speech from Monday, laying out the legal logic for the SEC to require enhanced ESG disclosures of listed companies. She pounded on four points that Lee described as “myths.”
Myth 1: ESG matters that are material to investors are already required to be disclosed.
Not true, Lee said: “Public company disclosure is not automatically triggered by the occurrence or existence of a material fact.” What’s necessary under Supreme Court case law is a duty to disclose material information — and, “A duty to disclose can also arise by virtue of an explicit SEC disclosure requirement, such as those set forth in Regulation S-K.”
Myth 2: Where a duty to disclose climate and ESG matters does exist, such disclosures are being made.
Wrong again, Lee said. “A principles-based standard that broadly requires disclosure of “material” information presupposes that managers, including their lawyers, accountants, and auditors, will get the materiality determination right. In fact, they often do not.”
What’s needed by that logic, then, is a disclosure requirement that’s clear and specific.
Myth 3: SEC disclosure requirements must be limited to material information.
In fact, Lee said, Section 7 of the Securities Act gives the SEC broad power to require various disclosures that might not be material, and the SEC has a long history of doing just that. For example, disclosures around related-party transactions and executive compensation might not be material to a company, but they’re still required.
Myth 4: Climate and ESG are matters of social or “political” concern, and not material to investment or voting decisions.
Ummm, trillions of dollars held by ESG-focused investment funds disprove this point. As Lee said, “We are increasingly seeing all manner of market participants embrace ESG factors as significant drivers of decision-making, risk assessment, and capital allocation precisely because of their relationship to firm value.”
Anyway, the bigger point in Lee’s speech is how grounded those smaller points were in case law, SEC rulings, data, and legislation. She clearly knows that Republicans unhappy with action on climate change will challenge any new SEC rule in court; and provided a cornucopiea of legal citations for whomever at the Justice Department will end up filing the agency’s motion to dismiss.
And the even larger point, of both Lee’s speech and the Biden executive order, is that the Administration is moving forward strategically and carefully with ESG disclosure ambitions. They want their plans to stick. They want their plans to have a real effect.
We don’t yet know precisely how all these climate change and ESG ambitions will translate into specific requirements for large companies and your suppliers — but the ambitions are on their way. Don’t let that catch your company by surprise.