Is ESG the next big legislative battleground?


Despite coming into the corporate lexicon in 2004, ESG remained fairly invisible for over a decade. With the fight for the climate heating up, ESG has become a huge part of the climate change discussion.

“ESG has become a huge industry”, said Regnology SVP of product management Bodo Windmöller. “Considering the rapid growth of ESG-labelled funds launched by asset managers in the last 3-5 years, national financial regulators have begun to assess a range of practices related to forms of sustainable finance, focusing primarily on ESG taxonomies, approaches and marketing to investors.”

According to Investopedia, Environmental, Social, and Governance (ESG) investing refers to a set of standards for a company’s behaviour used by socially conscious investors to screen potential investments. While many companies have used ESG to make their businesses more sustainable in all of these areas, the biggest pushback on ESG has come from politicians.

Florida Governor Ron DeSantis recently made a big splash when he barred fund managers for state and local entities in the state from considering ESG factors in investment decisions. Meanwhile, 25 US states were recently detailed to be planning to ban ESG in retirement plans.

“ESG is one policy that appears to follow political party lines closely,” said Cathy Vasilev, co-founder and COO of Red Oak Compliance Solutions. “Expectations indicate that several Republican state attorney generals and Republicans in Congress will attack the proposed ESG legislation.

“One of their biggest concerns is that ESG is part of a more significant Democratic effort to prioritise climate change and other societal issues to the detriment of the fossil-fuel industry. I expect the fossil fuel industry will be generous in backing any Republican candidate willing to fight the ESG initiatives. We have yet to hear the last of this, and I wonder if the SEC will be able to effectively roll this out in 2023.”

Vasilev noted that the SEC is funded by Congress, and several Republicans in Congress have made ESG a top issue. “In fact, the House Financial Services Committee has already made it clear that they plan to call the SEC chairman Gary Gensler to testify on the agency’s ESG initiatives”.

Representative Beth Van Duyne (R-TX) has proposed a bill that would stop the SEC from following through on its pending climate-disclosure rule, preventing the agency from using its authority under the 1934 Securities Exchange Act. ‘Without congressional support, the SEC will have an uphill battle to pass the ESG initiatives,’ concluded Vasilev.

Meanwhile, Arctic Intelligence CEO Anthony Quinn remarked that pushback on regulatory change from companies and politicians is nothing new – and should not understate the importance of ESG.

He explained, “There is always going to be pushback from companies and politicians (especially those that are paid lobbyists for companies pushing back) on regulatory change but it is hard to see this having a huge legislative reaction simply because ESG initiatives are designed to reduce the harm individuals and organisations in the public and private sector may cause to the environment.

“It is hard to argue against why holding people more accountable for environmental or social impacts caused by their activities makes for bad governance.  ESG is hugely important to the human race and one companies, politicians and individuals should openly embrace”.

The area of ESG has developed substantially since its earlier days, with Erik Becker – product director at Regnology – explaining that regulators and legislators have made progress to strengthen sustainable finance guidance and practice in a number of ways.

Some of these ways include taxonomies to clarify meaning, disclosure of material aspects in economic and social design as well as governance, ESG fund product disclosures and ESG disclosures by rating agencies and benchmarks.

According to Becker, ESG has always been a fuzzy topic where a lot of different goals have been subsumed under. A part of this fuzziness is driven by the fact the world of ESG reporting is complex – there is over 600 ESG frameworks and standards globally currently.

The best-known ESG standards worldwide are the Global Reporting Initative, the International Sustainability Standards Board and the Task Force on Climate-Related Financial Disclosures.

Becker said, “Policy development across Europe, US and Japan offer some examples of distinct ways in which steps are being considered to make ESG practices more transparency, consistent and resilient.

“But even if these are (for the most part) consistent with the global ESG standards mentioned, there are still differences respectively possible divergences that will make it difficult to compare companies across jurisdictions in the future.”

One example, Becker claims, is the understand of materiality. “While the ISSB uses the so-called financial materiality as a basis, the European Financial Reporting Advisory Group (EFRAG) defines the double materiality, i.e., the effect of companies on society and the effect of society on companies in the Corporate Sustainability Reporting Directive (CSRD).

“This approach was already laid out at the European level in the non-binding guidelines for the NFRD (Non-Financial Reporting Directive) and has now been defined in detail by EFRAG. The SEC (Securities and Exchange Commission) follows the ISSB guidelines.”

ESG divergence

With all the ongoing controversy seen in the ESG space, what will this mean long term for the industry?

Both Windmöller and Becker explained, ‘Given the vast and diverse nature of the topic it is of course natural that different political interest across the world pursue differing agendas and of course also question the overall endeavor.

“We at Regnology assume that this will however not mean a de-regulation of the topic but rather a maturing of the different regulations and most probably not a harmonization of the ESG regulation but rather further divergence.”

According to the two, there is no signals in the EU for a major change in direction, with it seeming more like European regulators are triyng to fashion like GDPR set ESG standards that will have implications for international firms even beyond their operations in Europe.

Becker and Windmöller concluded, “Overall, the likely divergence in policies across the world will make it harder for global companies to set their own “ESG-agenda” while complying with the various local regulations. It remains to be seen how far the European initiatives will force a convergence and a de-facto standard for multinationals.”

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