What is “ESG”?
“ESG” is perhaps the most divisive acronym of this year’s legislative session. But what does it mean?
“Environmental, Social, Governance” is a framework used to evaluate investments and business decision’s impacts on the environment and society. ESG criteria considers things like a company’s carbon footprint and employee wellbeing. ESG practices are being adopted by many companies and investors, but as they continue to grow, so does the opposition.
The SEC’s Pending Climate-Related Disclosure Rules
In March 2022, the Securities and Exchange Commission (SEC) published its “Proposed Rules to Enhance and Standardize Climate-Related Disclosures for Investors.” The rules would mandate the disclosure of Scope 1 (direct emissions), Scope 2 emissions (indirect), and in certain cases Scope 3 emissions (indirect emissions from both upstream and downstream activities). Additionally, companies would need to disclose climate-related risks faced by their business, processes for evaluating those risks, as well as how the company intends to meet its climate goals where they have been openly disclosed. All required disclosures will be made in a company’s annual Form 10-K reports. The rules are expected to be finalized by the end of 2023, but no updates have been announced since the close of the comment period in June 2022. However, even once final, businesses can expect challenges and a strong likelihood of a Supreme Court stay of implementation of the new rules pending judicial review.
Recently Introduced Anti-ESG Federal Legislation
At the end of July, House Republicans introduced a slew of anti-ESG legislation to combat ESG-friendly legislation and the anticipated SEC rules. The following bills were introduced:
- H.R. 4790 – The Guiding Uniform and Responsible Disclosure Requirements and Information Limits Act
- This bill would amend the federal securities laws to create a Public Company Advisory Committee within the SEC to protect investors and market fairness. Additionally, the bill would limit mandated disclosures requirement, such as those in the proposed SEC rules.
- H.R. 4655 – The Businesses Over Activists Act
- This bill seeks to amend the Securities and Exchange Act of 1934 to prohibit the SEC from compelling the inclusion or discussion of shareholder proposals or proxy.
- H.R. 4767 – The Protecting Americans’ Retirement Savings from Politics Act
- This bill seeks to amend shareholder and proxy voting processes in a way that prioritizes growth over political issues while allowing for the exclusion of ESG proposals.
State ESG Legislation
Instead of passively waiting for new federal rules, many state legislatures have taken ESG matters into their own hands. As of August 2023, 22 states have adopted some form of ESG legislation. 18 of these states have adopted anti-ESG laws, while only 4 have adopted pro-ESG laws.
- Anti-ESG Legislation
Notable anti-ESG states include Alabama, Arkansas, Florida, Idaho, Indiana, Kansas, Kentucky, Montana, New Hampshire, North Carolina, North Dakota, Texas, Utah, and West Virginia.
A key theme in anti-ESG legislation from these states is the ban on the use of ESG criteria when managing public retirement systems or public funds. ESG opponents feel that the use of ESG criteria greatly harms beneficiaries, as it has the potential to lead to lower returns. Typical anti-ESG legislation includes a ban on the use of ESG criteria when making investment decisions that involve public funds. This may include an emphasis on fiduciary duties or a prohibition on divestment from certain industries.
Indiana took this concept one step further in House Enrolled Act No. 1008, by prohibiting public retirement systems from contracting with service providers who make any “ESG commitments.” The legislation was passed in hopes to protect investment decisions to ensure that they are made with the sole purpose of maximizing the target rate of return. The public retirement system must replace service providers who have made ESG commitments where there is a comparable service provider who has not. This law went into effect July 1, 2023.
Idaho passed a similar law, House Bill 190, which bans banks and credit unions that hold state funds from boycotting an individual or company because of its affiliated industry. Listed industries include fossil-fuel based energy, timber, minerals, agriculture, and firearm sales, manufacturing or distribution. The law became effective July 1, 2023.
The most comprehensive anti-ESG legislation to date is Florida’s House Bill 3. ESG criteria may not be used when making public pension investment decisions, local government investment decisions, or awarding state or local contracts to vendors. Additionally, the issuance of ESG bonds are prohibited. Florida will likely influence future anti-ESG legislation throughout the country.
- Pro-ESG Legislation
Left-leaning states such as California, Colorado, Illinois, and Vermont have implemented ESG criteria mandates or taken general protective measures that allow investors to continue the use of ESG criteria where they see fit.
Typical pro-ESG legislation includes divestment from certain industries, mandated disclosures and the adoption of more sustainable investment policies.
Colorado’s S.B. 23-016 was signed into law May 11, 2023 and requires the Colorado Public Employees’ Retirement Association to disclose financial risks stemming from climate change on an annual basis. The law takes effect January 1, 2025.
The California Climate Corporate Data Accountability Act (SB 253) has the potential to be the most impactful pro-ESG law. California is home to one of the world’s largest economies. If passed, the bill would mimic the proposed SEC rules by mandating the disclosure of Scope 1 and Scope 2 emissions for companies doing business in the state and earning at least $1 billion in annual revenue. Additionally, beginning in 2027, companies would have to disclose Scope 3 emissions. We will continue to monitor its progress as it moves through the state legislature.
General Counsel Role and Business Advice in Light of Above
Navigating a company’s role in society is one of the great management challenges of our time. In the face of the ESG backlash, companies’ reactions vary. Some are going quiet about their initiatives and accomplishments; this has been referred to as “greenhushing.” However, others are doubling down on their commitments to sustainability. Whichever path chosen, legal departments are being looked to to help steer their company forward,
To best prepare your company, consider the following actions:
- Legal should consider both sides of the ESG debate and stay informed of all nuances.
- Certain environmental, social and governance issues may impact a company’s ability to be successful in both the near and long term; others might not. At its core, ESG is about companies recognizing emerging risks as well growth opportunities to their businesses and their boards’ oversight of all of it.
- More robust ESG data, not less, could lead to companies making more informed decisions and to better governance.
- To that end, understand your climate goals, if any.
- Be mindful of communicating any emission reduction goals, as this could lead to mandatory disclosures of Scope 3 emissions in the future.
- Consider adopting a system to track emissions.
- This may be an environmental management system certified under ISO 140001 or another method of tracking data.
- Know the communities your company conducts business in and understand their values.
- Gaining a deeper understanding of your customer base can best guide your ESG or non-ESG related goals.
- Consider creating an ESG committee.
- Fostering internal dialogue around this controversial topic will best prepare you for ESG related changes.
- Understand your company’s climate-related risks in both the long and short term.
- Be mindful of potential impacts or supply chain shortages your company may face if climate disaster strikes.