The US SEC has proposed two ESG rules for asset managers.

The US SEC has proposed two ESG rules for asset managers. (1) Names Rule would require funds that use ESG terms in their names to follow ESG strategies. (2) ESG Strategy Disclosures would require funds that follow ESG strategies to make certain disclosures.

Names Rule
■ This would require a fund to invest 80% of its assets in ESG if it uses ESG terms in its name. The proposal would bar the use of ESG terminology in a funds name if the fund only considers ESG as "one of many factors" in investment decisions.

ESG Strategy Disclosures
■ This would require funds that have an ESG strategy to provide details in their prospectus of how they consider ESG factors when selecting investments. There are 3 “tiers/layers”. (1) “Integration” (2) “ESG-focused” (3) Impact.

There would be lesser requirements for “integration” funds than for “ESG-focused” funds. There also would be greenhouse gas emission disclosures for funds that have a climate change focus.

An “ESG-Focused Fund” would mean a fund that focuses on one or more ESG factors by using them as a significant or main consideration (1) in selecting investments or (2) in its engagement strategy with the companies in which it invests.

On Impact, the main disclosure will be “an overview of the impact(s) the fund is seeking to achieve, and how the fund is seeking to achieve the impact(s). The overview must include (i) how the fund measures progress toward the specific impact, including the key performance indicators the fund analyzes, (ii) the time horizon the fund uses to analyze progress, and (iii) the relationship between the impact the fund is seeking to achieve and financial return(s)” But also the “impact objectives” will need to be disclosed upfront along with return objectives.


Of note, there is one dissenting commissioner. SEC Commissioner Hester Pierce objected to the Names Rule proposal because she said the 80% investment requirement is too subjective given ambiguity about what constitutes an ESG investment. The better approach is to focus less on the name and more on the disclosures describing the investment strategies. She also objected to the ESG proposal as the SEC already has the power to police asset managers who mislead investors about their ESG efforts. She also complained that the SEC fails to define ESG, which means the proposal will not work because the terms are too broad and it will be nearly impossible to have consistent disclosures among funds.

Comments open for 60 days. Link to proposals below:

List page for SEC rules: https://www.sec.gov/rules/proposed.shtml

Direct links to pdfs of proposals:
Proposing Release: Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices (sec.gov)
https://www.sec.gov/rules/proposed/2022/33-11068.pdf
https://www.sec.gov/rules/proposed/2022/33-11067.pdf

Links to statements, including Hester Peirce's objections:
https://www.sec.gov/news/speeches-statements
https://www.sec.gov/news/statement/peirce-statement-esg-052522

Why consider supporting SEC climate disclosures

  • The SEC is a pseudo-meta regulator of the world 

  • SEC is proposing climate disclosures 

  • If you believe climate disclosures are good you should be writing to the SEC to tell them so

The US SEC (company and financial regulator, securities exchange commission) is proposing to require companies to include climate-related disclosures in annual and regular reports. The SEC commissioners (and politicians) are not unanimous in supporting these proposals. There is a reasonable argument that the SEC is a global meta-regulator. There is an argument that these disclosures will allow easier innovation and assessment of carbon impacts. Thus this is an important step in assisting climate solutions. If you believe this, you should send supporting statements to the SEC while comments are open to 22 May (or contra) as a low cost way of helping potentially a high impact policy. The idea is tractable and impactful. While not very under-researched, most people outside finance seem unaware of this proposal nor of the meta-regulator role of the SEC. This makes the SEC have a uniquely global role.  

Background

On 21 March 2022 - “The Securities and Exchange Commission today proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.”….

“The proposed rules also would require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. These proposals for GHG emissions disclosures would provide investors with decision-useful information to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks. The proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.”

In brief detail:

Board and management oversight and governance of climate-related risks

How any climate-related risks have had or are likely to have a material impact on its business and financial statements over the short-, medium-, or long-term

How any identified climate-related risks have affected or are likely to affect strategy, business model, and outlook

Processes for identifying, assessing, and managing climate-related risks and whether such processes are integrated into the overall risk management system or processes

The impact of climate-related events

Scopes 1 and 2 GHG emissions metrics, separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute and intensity terms

Scope 3 GHG emissions and intensity, if material, or there is a GHG emissions reduction target or goal that includes its Scope 3 emissions; and

Any climate-related targets or goals, or transition plan…

Why is the SEC a meta-regulator?

This ideas has been discussed in financial and policy circles, but in a public popular way by Bloomberg writer, Matt Levine.

The idea (which he has floated from time to time over the years ) is that the SEC is a form of global “meta-regulator” because US business touches the whole world (and so many “stakeholders”, customers, employees, supplies etc.) in so many ways then the way you regulate US business will regulate the world.

In that sense by demanding climate data, the SEC is suggesting climate is relevant for US business and thus the world.

Levine writes:

“I sometimes say that, in the U.S., the SEC is the all-purpose meta-regulator, and here you can see why. Public companies exist in society, so everything that matters to society is probably material to public companies, and what public companies do about any issue probably matters to society. And regulating what public companies have to say about that issue will affect how they act on it. The title of Commissioner Peirce’s dissenting statement is: “We are Not the Securities and Environment Commission - At Least Not Yet.” But they are! They’re the Securities and Everything Commission.”


What is the theory of change mechanism? 

The idea is that is it hard to manage what you do not measure and therefore measurement and disclosure are the first steps in solving a problem.

Market advocates argue that once sufficient transparency is produced that investors / market forces will then (most efficiently or more efficiently than central planning) produce the desired outcome under acceptable trade offs.  

The strong-form argues for limited policy intervention.  The weak-form argues that market forces work alongside policy will be most effective. 

There is evidence that transparency can lower the cost of capital and that it’s helpful at IPO and in overall making stock/debt markets more efficient. 

Mechanisms could be (drawing on Levine): 

The disclosure regime effectively deputizes public companies to be climate enforcers: If their suppliers don’t start measuring and reducing their emissions, the companies won’t be able to do the required disclosure.


If your disclosure under this item says “Our board is not informed about climate-related risks in any systematic way, and never really considers them,” that will look bad. Investors will complain, the SEC will look at you with suspicion, it will be unpleasant. To check this box, you will have to start providing the board with regular reports about climate risk, and devoting time to it in board meetings. (This is true even if you are, like, a software company with a modest environmental footprint.) Perhaps this will all be surly and pro forma and your behavior won’t change, but the (reasonable) theory seems to be that if you force boards to talk about climate change they will end up doing something about it too.

Large Funds as Universal Owners

Matt Levine also highlights a somewhat new piece of thinking on the idea of “Universal Ownership” and how this is different (recall certain passive investors may own 3 - 5 % of all American companies in their tracking mandates).

Several large institutional investors and financial institutions, which collectively have trillions of dollars in assets under management, have formed initiatives and made commitments to achieve a net-zero economy by 2050, with interim targets set for 2030. These initiatives further support the notion that investors currently need and use GHG emissions data to make informed investment decisions. These investors and financial institutions are working to reduce the GHG emissions of companies in their portfolios or of their counterparties and need GHG emissions data to evaluate the progress made regarding their net-zero commitments and to assess any associated potential asset devaluation or loan default risks. [SEC]

Then Matt:

Notice that this is weird. This is not “investors need this information to understand the company providing the information,” but rather “look, investors these days are diversified, and many of them care about the systemic risks to their portfolios, not about how any one company runs its business.” If it’s material to an institutional investor that its portfolio be carbon-neutral, then it needs to know the carbon emissions of each portfolio company, even if those emissions are not actually material to that company.

This strikes me as very new! And basically correct, I mean: Investors are often diversified and systemic these days, so the SEC’s rules might as well reflect how investing actually works. Still it is a novel and surprising concession, asking a company to disclose stuff because it is useful to its shareholders as universal shareholders, not (just) because it is relevant to the company’s own business.

What is the cost? Risk?

There will be increased reporting and staffing costs for companies.  This may cause lower allocation of capital to more impactful items. Second order costs harder to know but might make more intense companies suffer from a higher investment cost of capital.  (Which advocates would argue is a feature not a bug). Major risks seem limited but see counter arguments below.

What is the benefit?

The first order benefit is that it allows investors (and the public) to know and therefore assess the carbon footprints of large corporates and their climate strategies. This information is difficult to ascertain outside the company. 

It allows more accurate allocation of capital for those investors interested and allows easier comparison of strategies between companies. 

It allows market forces to act better. 

It may allow more efficient litigation if required on if companies follow relevant laws as regards risks (eg carbon risks). 

Why is this a long term benefit ?

If you believe carbon impact is a significant risk then this regulation has plausible probability (I estimate 72%) that it will allow better innovation and risk management. 

In particular, if you give some weight (say 40%) to the SEC as meta-regulator idea then this has a plausible chance  of positive  global systemic benefit. 

The cost of the regulations seem acceptable and the risks of unintended consequences low and of acceptable outcome. 

What are the counter arguments?

These are best articulated by one of the SEC commissioners Hester Pearce.  She argues the regulations are unnecessary and costly. And by extension creep the SECs mission into environmental regulation.  (see link end)

John Cochrane has adjacent arguments although these apple more to the Fed and climate, but worth considering. For the Fed it is overstepping remit and also the wrong area of government to be tackling the challenge as he views limited risk to financial stability.  (see link end)


Is this tractable? Under researched ? impactful ? Should people support it ?

The policy is possible but faces opposition. On principle right leaning politicians dislike the costs and unintended consequences of regulation. The policy could be very impactful. The debate is not well known outside finance circles. Given this if you are minded, it’s a policy worth giving supporting comment to. Do feel free to comment your support (or not) here: https://www.sec.gov/rules/submitcomments.htm

Press release with links to full report here. 


Further thinking and reading:

On climate policy overall, Chris Stark CEO of Climate Change Commitee (UK statutory body), podcast: https://www.thendobetter.com/investing/2022/2/7/chris-stark-ceo-climate-change-committee-netzero-policy-adaptation-cop-fairness-behaviour-change-podcast

On climate science: Zeke Hausfather on the state of the science

https://www.thendobetter.com/investing/2021/11/22/zeke-hausfather-state-of-climate-science-energy-systems-post-cop26-tipping-points-tail-risks-podcast


On a simple but comprehensive mental model on solving climate, from the head of Stripe, Climate, Nan Ransohoff https://nanransohoff.com/A-mental-model-for-combating-climate-change-846be1769d374fa1b5b855407c93da66

Counter arguments:
Peirce (SEC): https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321

Cochrane: https://johnhcochrane.blogspot.com/2021/07/climate-risk-to-financial-system.html

Carbon Standards notes

In sustainability world. The SASB-VF-ISSB met and ISSB announced it will be working with GRI. All those acronyms… but essentially it means sustainability standards are progressing and many of the entrenched arguments - for instance between a “double materiality” view point or an “investor-centric” view point might be a little closer to some reconciliation. Most investors pay limited attention to the nuances of those arguments but do pay attention to data - especially “material” data - the data we want/need to make investment relevant decisions.

This makes the SEC announcements that they will require carbon emission disclosure very significant. There is hardly a sustainability investor who has not heard but the recap is:

  •  Board and management oversight and governance of climate-related risks

  • How any climate-related risks have had or are likely to have a material impact on its business and financial statements over the short-, medium-, or long-term

  • How any identified climate-related risks have affected or are likely to affect strategy, business model, and outlook

  • Processes for identifying, assessing, and managing climate-related risks and whether such processes are integrated into the overall risk management system or processes

  • The impact of climate-related events

  • Scopes 1 and 2 GHG emissions metrics, separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute and intensity terms

  • Scope 3 GHG emissions and intensity, if material, or there is a GHG emissions reduction target or goal that includes its Scope 3 emissions; and

  • Any climate-related targets or goals, or transition plan…

Columnist Matt Levine has several takes on this but one intriguing idea (which he floats from time to time) is that the SEC is a form of global “meta-regulator” because US business touches the whole world (and so many “stakeholders”, customers, employees, supplies etc.) in so many ways then the way you regulate US business will regulate the world.

In that sense by demanding climate data, the SEC is suggesting climate is relevant for US business and thus the world. There is significant push back on this. Probably best summed up from a regulators view by Hester Peirce, who essentially argue the SEC is not an “Environment Commission. She argues:

“...the proposal will not bring consistency, comparability, and reliability to company climate disclosures.  The proposal, however, will undermine the existing regulatory framework that for many decades has undergirded consistent, comparable, and reliable company disclosures…”

If you believe Levine’s view or even weight it a little bit then this disclosure proposal is quite a significant battle. Do feel free to comment your support (or not) here: https://www.sec.gov/rules/submitcomments.htm

Press release with links to full report here. 

Matt Levine also highlights a somewhat new piece of thinking on the idea of “Universal Ownership” and how this is different (recall certain passive investors may own 3 - 5 % of all American companies in their tracking mandates).

Several large institutional investors and financial institutions, which collectively have trillions of dollars in assets under management, have formed initiatives and made commitments to achieve a net-zero economy by 2050, with interim targets set for 2030. These initiatives further support the notion that investors currently need and use GHG emissions data to make informed investment decisions. These investors and financial institutions are working to reduce the GHG emissions of companies in their portfolios or of their counterparties and need GHG emissions data to evaluate the progress made regarding their net-zero commitments and to assess any associated potential asset devaluation or loan default risks. [SEC]

Then Matt:

Notice that this is weird. This is not “investors need this information to understand the company providing the information,” but rather “look, investors these days are diversified, and many of them care about the systemic risks to their portfolios, not about how any one company runs its business.” If it’s material to an institutional investor that its portfolio be carbon-neutral, then it needs to know the carbon emissions of each portfolio company, even if those emissions are not actually material to that company.

This strikes me as very new! And basically correct, I mean: Investors are often diversified and systemic these days, so the SEC’s rules might as well reflect how investing actually works. Still it is a novel and surprising concession, asking a company to disclose stuff because it is useful to its shareholders as universal shareholders, not (just) because it is relevant to the company’s own business.