The Beginning of ESG Regulation in the US?
Taking a leaf out of the EU's book
The US has made a big step forward in its ESG regulatory journey. Last week, the Securities and Exchange Commission (SEC) enacted a rule that will require public companies to disclose climate risks for the first time.
The move by the SEC is two years in the making, after making initial proposals in March 2022. While the SEC has previously issued guidance on disclosures related to climate change, the new measures approved last week marks the first time it has implemented legally-binding rules specifically for environmental disclosures.
The new rules will require US public companies (including financial institutions) to provide information in annual reports and registration statements on climate risks facing their businesses, their plans to address those risks, the financial impact of severe weather events and in some cases, greenhouse gas emissions stemming from their operations. Roughly 12,000 companies will be in scope of the new rules.
The new measures trim down the requirements of the SEC’s initial proposal, with the removal of the requirement for public companies to report on ‘Scope 3’ emissions. These are emissions produced outside of a company’s direct operations and can account for a significant chunk of a company’s carbon footprint. Only large filers, defined as companies with a public float valuation of $700 million or more, will have to report on their Scopes 1 and 2 emissions. These emissions are from direct operations and those created indirectly through energy purchases respectively. Disclosures would begin from fiscal year 2026.
While the new SEC rule won’t require some companies to report Scope 1 or 2 emissions, the SEC noted that many companies will be required to disclose on these areas to comply with reporting requirements being introduced in other jurisdictions. One such example is the EU’s Corporate Sustainability Reporting Directive (CSRD). In fact, because the SEC’s environmental requirements are by comparison very minimal, a number of firms will already be fulfilling more stringent reporting requirements under EU regulations.
The US has lagged behind other jurisdictions, such as the EU, in terms of its ESG regulatory policies, with the US ESG policy environment becoming increasingly divided. For example, more than 20 states have proposed or passed anti-ESG bills at the state level. Noticeably, Texas was the first state to have passed anti-boycott legislation in 2021 to prevent local entities from conducting business with banks that choose to adopt ESG policies. Additionally, the recent departures of State Street and JPMorgan from the Climate Action 100+ engagement initiative, a scheme designed to bolster climate action among the world’s largest corporates, highlights the dwindling support for ESG in the US.
The new rules should go a long way in creating a more cohesive and harmonised ESG regulatory environment in the US and prevent financial firms from deviating from ESG practices. The rules should also help to increase transparency and ensure that more consistent information is available for investors, while also giving greater insight into a firms’ ESG activities and compliance. However, SEC chairman Gary Gensler noted there is more work to be done, with doubts around whether current methods of data collection used by financial firms are sufficient. The new rules have also led to opposition among industry participants, with the changes likely to require a significant infrastructural and operational overhaul of firms’ ESG practices.
With the enactment of the new climate disclosure rules, it seems the US ESG regulatory journey has officially begun. With this in mind, in-scope firms should start giving consideration to how they can achieve compliance.
The rules will likely require a top-down approach, with corporate board oversight needing to be reviewed and augmented in order to ensure competency in disclosing ESG practices. Board members should understand their role in terms of ensuring data quality and set ESG-related targets that are communicated across the firm. It is also down to board members to integrate climate risk assessment and mitigation efforts into their overall enterprise risk management processes. In-scope firms should then optimise their emissions data, using systems that provide tracking, reporting and assurance of their data, while pinpointing any gaps or vulnerabilities in their data management systems.
At the same time, companies should proactively conduct peer benchmarking and ensure that their ESG practices are measuring up well, in terms of sustainability and efficiency. This is to ensure that the firm stays competitive, while ensuring efficient access to and receipt of investment through the capital markets. This would be due to increased investor appetite for their products, as investors seek to satisfy their own ESG demands amid an increasingly ESG-conscious market. There is a theoretical argument that consumers now purchase more of a firm’s products due to lower emissions.
Looking ahead, in-scope firms should view the new ESG rules as the start of regulated climate-related disclosures. Ultimately, the new rules will require firms to get their ESG ducks in a row and give key considerations to their operating models, ESG vulnerabilities and client expectations. Effective climate management and disclosure is becoming an essential part of overall corporate strategy. Companies that fail to recognise this will not only come under regulatory scrutiny, but also miss out on new competitive advantages that could benefit themselves and their customer base.