II. What Is Sustainable Finance & Why Does It Matter
Sustainable finance means that investors and financial advisers evaluate investments in terms of both obtaining a financial return on investment and promoting environmental sustainability. Examples of how finance can advance environmental sustainability include loans for solar and wind energy facilities, green bonds that supports environmentally sustainable projects, and creating standard to evaluate investments based on their environmental sustainability. Sustainable finance is a manifestation of the broader movement to promote positive corporate social responsibility and the triple bottom line, which are approaches to business that elevates the importance of the environment, social impact, and corporate governance.
In the past, ESG disclosures on investments and publicly traded companies were rare, but in recent years mainstream investors have increasingly demanded ESG disclosures on investments and publicly traded companies because investors have recognized that ESG issues impact the financial performance of investments and companies. In a report about ESG disclosures, the Sustainability Accounting Standards Board projected that climate change will have a material impact on ninety-one percent of industries. In January 2020, BlackRock, the largest asset manager in the world with seven trillion dollars under management, shifted its investment approach by making environmental sustainability a key issue in its risk management strategy. As a result, American financial services professionals and securities lawyers need to learn about sustainable finance because the U.S. SEC will implement ESG and climate change focused disclosure regulations on investment securities to address climate change in the next few years.
III. The What & How of the EU’s Sustainability Disclosure Regulation
A. Applicability of the EU’s Sustainability Disclosure Regulation
The EU’s Sustainability Disclosure Regulation applies to both financial products and financial adviser companies. The EU’s Sustainability Disclosure Regulation applies to the following types of financial adviser companies: investment firms that provide investment advice, asset managers, insurance companies, pension fund managers, retirement fund managers, alternative investment fund managers, and credit institutions that provide portfolio management. Specifically, the EU’s Sustainability Disclosure Regulation requires financial adviser companies with more than 500 employees to “publish on their websites information about their policies on the integration of sustainability risks in their investment advice or insurance advice.” In addition, financial adviser companies must publish a “description of the principal adverse sustainability impacts and of any actions” taken to address principal adverse sustainability impacts from the investment. Financial adviser companies with fewer than 500 employees have the option to explain their environmental sustainability and impact mitigation strategies policies or explain why environmental sustainability and impact mitigation strategies policies are not considered in their business. In short, the EU’s Sustainability Disclosure Regulation requires financial services firms to disclose information to the public about how the firm’s environmental sustainability policies are integrated into its investment choices.
The EU’s Sustainability Disclosure Regulation applies to the following financial products: managed portfolios, alternative investment funds, pension products, and insurance‐based investment products. By December 30, 2022, the previously mentioned types of financial products must provide disclosures to consumers about “the methodologies used to assess, measure and monitor the environmental or social characteristics or the impact of the sustainable investments selected for the financial product, including its data sources, screening criteria for the underlying assets and the relevant sustainability indicators used to measure the environmental or social characteristics or the overall sustainable impact of the financial product.” In essence, the EU’s Sustainability Disclosure Regulation mandates that the previously listed types of financial products come with information about whether and to what degree the financial product promotes environmental sustainability and the impacts of the financial product on environmental sustainability.
B. Compliance with the EU’s Sustainability Disclosure Regulation
On July 8, 2021, EU Director-General John Berrigan of Financial Stability, Financial Services and Capital Markets Union delayed the enforcement date for the European Supervisory Authorities’ Regulatory Technical Standards from January 1, 2022, to July 1, 2022. The delay in enforcement was due to the challenges financial participants have had in complying with the European Supervisory Authorities’ Regulatory Technical Standards.
The EU’s Sustainability Disclosure Regulation delegated authority to the European Supervisory Authorities, which regulates financial markets in the EU, to make regulatory technical standards on the “content, methodologies and presentation of information. . . [on] the sustainability indicators in relation to adverse impacts on the climate and other environment‐related adverse impacts.” Thus, the European Supervisory Authorities’ regulatory technical standards provide detail and guidance on the enforcement of the EU’s Sustainability Disclosure Regulation.
Under the European Supervisory Authorities’ Regulatory Technical Standards, financial market participants must publish an annual “principal adverse sustainability impacts statement” on their website. To comply with the European Supervisory Authorities’ Regulatory Technical Standards, financial market participants must publish the disclosures required under the EU’s Sustainable Finance Disclosure Regulation (SFDR) in a manner that is “easily accessible, non-discriminatory, free of charge, prominent, simple, concise, comprehensible, fair, clear and not misleading.”
At the entity-level, the European Supervisory Authorities’ Regulatory Technical Standards requires that financial market participants publish an annual “principal adverse sustainability impacts statement” that details how the financial market participant integrates sustainability considerations in how they make investment decisions. On the entity-level disclosures, the measurements for environmental sustainability include the following: (1) the level of greenhouse gas emissions from the entity, (2) the percentage of the entity’s investments in fossil fuel companies, and (3) the percentage of the entity’s investments in renewable energy.
At the product-level, the European Supervisory Authorities’ Regulatory Technical Standards requires initial disclosures and annual disclosures about the degree to which the financial product evaluates investment decisions based on sustainability and the investment’s performance on sustainability indicators that are established in the European Supervisory Authorities’ Regulatory Technical Standards. On the product-level disclosures, the measurements for environmental sustainability include the following: (1) whether the financial product is intended to promote environmental sustainability, (2) what steps were taken to ensure the financial product achieved its environmental sustainability goals, and (3) the percentage of investments in the financial product that are environmentally sustainable.
IV. Development of Laws & Regulations on Sustainable Finance in the United States
A. What Is the Status of Laws & Regulations on Sustainable Finance in the United States
Under U.S. securities laws, an affirmative duty to disclose information arises when there is “insider trading, a statute requiring disclosure, or an inaccurate, incomplete or misleading prior disclosure.” The U.S. SEC’s Rule 10b-5 makes it unlawful to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” For example, Item 103 of Regulation S-K creates an affirmative duty to disclose information about, inter alia, “material pending legal proceedings.”
The U.S. SEC has used its enforcement power against entities that failed to disclose material facts about environmental matters. If climate change-related risks are “material” to investors, then publicly traded corporations are required to disclose climate change-related risks. In recent years, some investors have argued that climate change-related risks constitute material information for investment choices.
From the Securities Act of 1933 to the Investment Advisers Act of 1940, Congress established the materiality standard for securities disclosures to “substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.” In interpreting U.S. securities statutes, the U.S. Supreme Court in TSC Industries v. Northway (1976) defined “materiality” in the context of securities disclosures in the following way: “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” The TSC Industries Court explained that a disclosure is material when “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
On February 8, 2010, the U.S. SEC issued an interpretive guidance document called “Commission Guidance Regarding Disclosure Related to Climate Change.” The Commission Guidance Regarding Disclosure Related to Climate Change recommended that, under Item 503(c) Regulation S-K, publicly traded companies should consider providing risk guidance on how climate change legislation and regulation may impact their business. In its Commission Guidance Regarding Disclosure Related to Climate Change, the U.S. SEC suggested that, under Item 4.D. of Form 20–F, foreign private issuers (meaning foreign companies) should discuss “environmental issues that may affect the company’s utilization of its assets.”
After the U.S. SEC issued the Commission Guidance Regarding Disclosure Related to Climate Change, some companies included risk factors from weather event, but few companies increased their disclosures of climate change risks. In fact, in 2009, only 800 out of 75,000 (slightly over one percent) of Form 10-K disclosures with the U.S. SEC provided disclosures about climate change risks. In 2011, after the Commission Guidance Regarding Disclosure Related to Climate Change was issued, approximately 2,100 out of out of 75,000 (slightly under three percent) of Form 10-K disclosures provided disclosures about climate change risks. In 2020, less than twenty percent of companies in consumer staples, financial services, and healthcare made disclosures about greenhouse gas (GHG) emissions on their Form 10-K disclosures.
B. The U.S. SEC’s ESG Policy Agenda
In 2021, the U.S. SEC set an agenda to address climate change through regulations that require ESG and climate change disclosures for publicly traded corporations. In her request for public comments on the U.S. SEC’s ESG policy agenda, Acting Chair of the U.S. SEC Allison Herren Lee made climate change disclosure regulations a priority for the U.S. SEC when she called for “consistent, comparable, and reliable information on climate change.” On February 24, 2021, then Acting Chair of the U.S. SEC Allison Herren Lee directed the Division of Corporation Finance to (1) evaluate the effectiveness of the Commission Guidance Regarding Disclosure Related to Climate Change, (2) consult with public companies on developing new disclosure rules on climate change risks, and (3) update the Commission Guidance Regarding Disclosure Related to Climate Change.
In 2021, U.S. SEC Chair Gensler made climate change risk disclosures a major priority. On July 11, 2021, U.S. SEC Chair Gensler placed a notice of proposed rulemaking for climate change disclosures on the spring 2021 Unified Agenda of Regulatory and Deregulatory, which is overseen and published by the Office of Management and Budget’s Office of Information and Regulatory Affairs. On July 16, 2021, U.S. SEC Chair Gensler directed the U.S. SEC to create mandatory disclosure regulations on climate change that include the following: (1) disclosures on a company’s GHG emissions, (2) disclosures on a company’s climate change risk management strategy, (2) metrics on the financial impacts of climate change, and (4) the company’s performance on achieving environmental sustainability goals. On July 16, 2021, U.S. SEC Chair Gensler appointed Mika Morse to develop disclosure regulations on climate change as the U.S. SEC’s climate counsel. On September 1, 2021, U.S. SEC Chair Gensler directed U.S. SEC staff to review frameworks and standards, including the Task Force on Climate-related Financial Disclosures, for climate change risk disclosures. Based on U.S. SEC Chair Gensler’s policy agenda, the U.S. SEC will likely require companies to disclose climate change risks on their 10-K Forms.
V. Comparison of the Laws & Regulations on Sustainable Finance in the EU and United States
A. Differences & Similarities on Sustainable Finance Laws in the EU and United States
The United States has pursued an industry-driven approach to corporate disclosures on climate change, but the EU has taken a systematic regulatory approach to corporate disclosures on climate change. The EU has had mandatory climate change disclosures since the 1990s. If companies fail to comply with the EU Sustainability Disclosure Regulation, then the EU or Member States can impose financial penalties and criminal penalties on the non-complying company. The U.S. has not required mandatory disclosures, and the last time it updated its advisory guidance on climate change disclosures was in 2010.
As a result, most U.S. companies issue voluntary and stand-alone ESG reports. One of the major flaws with the industry-driven approach for ESG and climate change disclosures is that there is no standardization for data collection, metrics, and reporting of ESG and climate change issues. Moreover, voluntary disclosures can constitute “greenwashing,” which means bad faith publicity stunts on commitments to environmental sustainability that mask corporate practices that are harmful to the environment.
B. How the EU’s Sustainable Disclosure Regulation Might Influence the U.S. SEC
As the U.S. SEC develops mandatory ESG and climate change disclosure regulations, the United States can learn from the EU’s regulatory framework. The EU has long been the global leader in implementing securities regulations that promote disclosures on ESG in general and climate change in particular. In fact, the learning process has already begun: U.S. SEC Chair Gensler instructed the U.S. SEC to coordinate policy harmonization on ESG disclosures and climate change disclosures between the United States and the EU.
A key challenge with ESG financial disclosures is the absence of comparable and reliable standards and metrics for ESG. As a result, most U.S. companies issue voluntary and stand-alone ESG reports. One of the major flaws with the industry-driven approach for ESG and climate change disclosures is that there is no standardization for data collection, metrics, and reporting of ESG and climate change issues. Moreover, voluntary disclosures can constitute “greenwashing,” which means bad faith publicity stunts on commitments to environmental sustainability that mask corporate practices that are harmful to the environment.
VI. Conclusion
A. Takeaways for American Corporations
By July 1, 2023, corporations regulated under the EU’s Sustainability Disclosure Regulation must publish entity-level disclosures on principal adverse impact on sustainability factors. By January 1, 2023, providers of regulated financial products regulated under the EU’s Sustainability Disclosure Regulation must publish disclosures about the adverse sustainability impacts of the financial products. Importantly, the EU’s Sustainability Disclosure Regulation will not require regulated companies or products to change their behavior to comply with substantive standards; instead, the EU’s Sustainability Disclosure Regulation is about information gathering and reporting.
B. Takeaways for American Policymakers
At the national level, there is support for climate change disclosure regulations from Congress, companies, investors, and non-profit advocacy organizations. In Congress, Senator Elizabeth Warren and Representative Sean Casten introduced the Climate Risk Disclosure Act of 2021, which would require publicly traded companies to make annual disclosures about the climate change risks that publicly traded companies face. Approximately eighty-percent of S&P 500 companies already make voluntary disclosures about GHG emissions. The Task Force on Climate-Related Financial Disclosures has over 1,500 member organizations that support its work on climate change disclosures. As a result of the broad-based support in the U.S., it appears that there is political support for the U.S. SEC to issue climate change disclosure regulations.
At the global level, there appears to be an opportunity for the United States to lead standard-setting on climate change disclosure regulations. Support for new global standards on climate change disclosures on investments and publicly traded corporations has a wide range of supporters: President Joe Biden, U.S. Department of Treasury Secretary Janet Yellen, the International Monetary Fund, the United Nations, and the Financial Stability Board. Moreover, the Financial Stability Board’s report on climate change disclosures recommended global standards to promote consistent and reliable climate change disclosure information across jurisdictions. Given the support for climate change disclosure regulations from across the world, there appears to be an opportunity for the Biden Administration to implement Executive Order 14030 Climate-Related Financial Risk at home and around the world.
