Industry calls for Biden to introduce mandatory ESG disclosure framework, carbon pricing and reversal of anti-ESG rulings.
The first three weeks in office for US President Joe Biden have proven to be a flurry of activity – largely centring on reversing executive orders enacted by the previous administration.
It’s clear that climate change will be a priority for Biden over the next four-year term. After all, he’s recommitted the US to the Paris Agreement, pledged to achieve net-zero emissions by 2050, appointed climate-focused personnel and promised to host a climate summit within his first 100 days.
“The difference between the last administration and the Biden administration seems to be that priorities are in different places. The shift is very much toward managing the climate crisis,” says Colleen Orr, Senior Policy Analyst at the Principles for Responsible Investment (PRI).
“However, in Washington, there are a lot of forces behind anti-climate action lobbying, so it will remain challenging to enact country-wide change,” she says.
For the first time since 2009, the Democrats simultaneously control the Senate, House of Representatives and the White House, following the results of the Georgia senatorial election re-run. Although this does put Biden in a strong position to follow through on climate-focused campaign pledges, pushing radical change through the Senate will not be simple, even with Vice President Kamala Harris holding the tiebreaker vote.
Orr says it will be easier for Biden to issue executive orders or apply ESG-focused changes through other agencies or departments, such as the US Securities and Exchange Commission (SEC) or the Department of Labour (DoL).
“It would be more challenging for the administration to go the legislative route for climate action,” Orr says.
Although legislative changes are more difficult to implement, Leola Ross – Director of Research and Strategy at Russell Investments – argues that it is the better long-term approach.
“Ultimately, executive orders only last as long as the administration,” she says. “To affect real change, legislation is required and this sort of activity takes prioritisation and time. The Biden administration will, most certainly, look for and create opportunities to bring about legislative change, with an expected focus on those areas of common ground between Democrats and Republicans in Congress.”
Establishing a mandatory ESG disclosure framework
Regulatory changes need to be introduced in order for the US to match the pace of change seen elsewhere. This includes establishing a mandatory ESG disclosure framework, clarifying the financial benefits of ESG within retirement funds and re-evaluating proxy voting and shareholder rights rules.
Top of the agenda for Biden is a standardised ESG disclosure framework for corporates, drawing on existing models offered by organisations like the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the Climate Disclosure Standards Board (CDSB).
“We would like to see mandatory disclosure of ESG information, including climate information from issuers, so that investors can make the best decisions on consistent and comparable input data,” Orr says.
According to a 2020 US Government Accountability Office report, existing US climate risk disclosures lack consistency, comparability and reliability, which is impeding the ability of markets to allocate resources effectively.
The report assessed 32 US companies, based on proxy statements, voluntary sustainability reports and 10-K filings, as well as any “examples of limitations noted by investors”. It noted that investors are seeking “information on ESG issues to better understand risks that could affect company financial performance over time”, adding that many were forced to rely on additional ESG data “to address gaps and inconsistencies in companies’ disclosures”.
Bryan McGannon, Director of Policy and Programmes at US SIF – the US-based forum for sustainable and responsible investors – says that ESG disclosure criteria in the US currently works on a “company-by-company basis within their sustainability reports”, resulting in voluntary and inconsistent data.
Mandatory versus voluntary
Despite evidence of “positive discussions from both industry and the commissioners at the SEC” to build a mandatory framework, McGannon anticipates difficulties ahead.
A key impediment is the ongoing debate surrounding voluntary versus mandatory ESG disclosures. Former SEC Chairman Jay Clayton defended voluntary parameters on disclosures in 2018, insisting that flexible requirements can adequately address ESG concerns.
A 2020 report from the Commodity Futures Trading Commission further argued that financial regulators already have “broad authority” to require the disclosure of “material information”, including climate risk, which negates demand for a mandatory framework.
“Although third-party standards relating to ESG topics may allow for comparability across companies, that does not mean that issuers should be required to follow these frameworks in order to comply with SEC rules. Each company, and each sector, has its own circumstances, which may or may not fit within a standard framework,” Clayton said.
However, with reporting guidelines issued by the Task Force on Climate-related Financial Disclosures (TCFD) proving increasingly popular around the world, McGannon argues that it “behoves the SEC to incorporate pieces from existing frameworks” in order to introduce requirements that are “as consistent as possible with global standards”.
Acting SEC Chair Allison Herren Lee has said regulatory intervention is required if the US is to achieve consistency and comparability for non-financial disclosures, including ESG-focused reporting.
“There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed,” Herren Lee said in a speech last year. “It’s time for the SEC to lead a discussion – to bring all interested parties to the table and begin to work through how to get investors the standardised, consistent, reliable and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.”
“Some corporate interests will push back against this, because they will want to stick with a voluntary standard,” McGannon notes.
According to the Governance and Accountability Institute, in 2019 just 51% of S&P 500 firms are reporting in line with the GRI disclosure framework and 14% in line with SASB.
The US SIF backs the view that an ESG disclosure framework should be mandatory, in order to better enable an “apples to apples” comparison of ESG performance across sectors and markets, he says.
Proxy voting and shareholders’ rights
In the last months of his Presidency, Donald Trump finalised the rewriting of the retirement sector rules, essentially making it harder to incorporate ESG investments into retirement plans.
“The Federal Employee Retirement System is the largest retirement system in the US and it currently has no sustainable investment options,” McGannon points out, noting that the Trump administration has made progress by the US in the ESG investing space much harder.
The ruling took effect from January 12, requiring fiduciaries to separate the legitimate use of risk-return factors from ‘inappropriate investments’ that promote non-pecuniary factors, such as ESG funds. Despite this, Morningstar reported in January that sustainable funds in the US continued to attract “record flows from investors” last year.
Furthermore, the final rule directs fiduciaries to only engage in proxy voting decisions when such a decision will have a “financial impact on the retirement plan”, explained Doug Davison, Dispute Resolution Partner at Linklaters.
The retirement industry has already suffered from a lot of “back and forth on [ESG issues], with every new administration changing the rules around retirement”, according to McGannon. This led to regulators becoming extremely cautious of addressing how ESG is defined in retirement funds by largely avoiding the issue altogether, he says.
Both Orr and McGannon are calling for the DoL to rewrite these rules to avoid further confusion, by better outlining how ESG funds are linked to positive financial outcomes. “We would like to see the DoL administration clarify that ESG factors are pecuniary, with fiduciaries adopting more sustainable investment policies,” Orr says.
Biden has since issued an executive order called ‘Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis’, which directs all executive departments and agencies to assess federal regulations and other actions from the last four years that are in “conflict” with national objectives, such as managing the climate crisis.
Cutting through the red tape and reversing Trump’s changes could take up to 18 months, McGannon warns.
Time for carbon pricing?
Many industry observers, including Head of US Policy at PRI Heather Slavkin Corzo, have called for President Biden to consider adopting carbon pricing, or border carbon adjustments, in order to decarbonise the US power and energy sector by 2035.
Last year, the Global Financial Markets Association (GFMA) and Boston Consulting Group (BCG) published the ‘Climate Finance Markets and the Real Economy’ report, proposing the development of a Climate Finance Market Structure (CFMS), which would adopt carbon pricing as its number one priority.
Treasury Secretary Janet Yellen has also been vocal on the issue, citing the need for a US$40 per metric tonne carbon price point by 2035. “I do see Republican support, and not only Democrat support, for an approach that would involve a carbon tax with redistribution – it’s not politically impossible,” Yellen told Reuters last year.
The US wouldn’t be alone in establishing a carbon price. The World Bank has reported that so far around 40 countries and more than 20 cities, states and provinces have implemented some form of carbon price mechanism that covers half of their emissions. This translates to 13% of annual global emissions.
“US SIF supports having a price on carbon,” McGannon says. “It’s our belief that it’s important to put a price on pollution.”
“Carbon pricing is certainly one mechanism for managing greenhouse gas emissions,” Ross agrees. “The success of this approach, or any selected mechanism, comes down to the nuances of how the policy is constructed, its implementation and the breadth of support it receives.”
Climate-focused personnel appointments
Already, Biden has made a series of personnel appointments with the climate crisis in mind, including Yellen as Treasury Secretary. By putting key ESG-focused personnel in influential positions, Biden is clearly displaying his “ambitious priorities on climate and ESG”, McGannon notes.
“Specifically, the Department of Transportation, Department of Interior, Environmental Protection Agency, SEC and the Treasury will all play vital roles,” Ross adds.
John Kerry, who helped negotiate the Paris Agreement in 2015, has been appointed Special Presidential Envoy for Climate.
“Kerry has got the credibility and drive to make sure the US is sitting at the table in the climate discussion,” McGannon says. “He has robust goals in place to meet international obligations.”
Addressing business leaders at the G20 forum last month, Kerry made his position on the climate crisis known. He said there needs to be a “wholesale transformation of the global economy”, with coal being phased out up to five times faster than recent trends have recorded.
Former BlackRock Executive Brian Deese will be drawing on his experience implementing sustainable investing strategies to lead the National Economic Council. The President said Deese is “a trusted voice [he] can count on to […] take on the existential threat of climate change in a way that creates good-paying American jobs”.
Ex-Chief of the Environmental Protection Agency (EPA) Gina McCarthy has assumed the role of Biden’s White House Climate Coordinator. She will be coordinating domestic efforts across the federal government to drastically lower US emissions.
Ross anticipates that Biden will also appoint a new head of the Commodity Futures Trading Commission (CFTC) “with a mandate to increase focus on climate risk management”.
The SEC has made its own climate-conscious appointments, recently announcing Satyam Khanna will serve as its Senior Policy Advisor for Climate and ESG.
“Having a dedicated advisor on [ESG] issues will allow us to look broadly at how they interact with our regulatory framework across our offices and divisions,” Herren Lee said.
Khanna previously served on the Biden-Harris Presidential Transition’s Federal Reserve, Banking and Securities Regulators Agency Review Team, and the SEC’s Investor Advisory Committee. He also worked as a senior advisor to PRI.
“The Biden administration’s nominees and confirmed leaders across agencies have been positive as they are predominantly focused on climate, alongside urgently addressing the pandemic. That alone is leaps and bounds from where we were even a year ago,” Orr says.
Next steps for Biden
Will all these changes protect America’s finances, economy and people from the systemic risks posed by climate change?
Biden will certainly be better equipped to assess levels of future climate risk across sectors and industries by encouraging bank regulators to run climate stress tests on US banks, Orr says. “This will give us a clear picture of climate exposure across the financial system, which we simply don’t have right now.”
However, climate isn’t the only issue.
Now Biden has the people in place to execute an ambitious climate plan, and industry experts would like to see Biden broaden his view on ESG issues. “We have the opportunity to be proactive,” McGannon says.
In recent days, Biden has been addressing the most urgent issue, publishing his priorities for managing the Covid-19 pandemic. He has further announced plans to provide US citizens with a ‘Covid Relief’ package.
Most importantly, Biden must not forget about the broader ‘S’ in the ESG climate, McGannon adds. Going forward, US SIF would like to see the President focus on human capital, diversity, supply chains and employee benefit issues.
“The ‘S’ in ESG is often overlooked but it’s becoming increasingly important,” Ross agrees. “The pandemic has brought the widening financial security crisis into sharp focus.”
“Climate is the hook to start having a conversation about other ESG issues like social problems. We’re going to continue pushing to make sure that happens,” McGannon says.
“There has been a major sea change in the last two weeks alone. There’s a lot of hard work ahead of us to capitalise on these feelings of optimism. But the fact this administration is so openly talking about climate and other ESG issues is a really bright spot for those of us working in policy in the US,” he adds.