by Zachary Halaschak, Economics Reporter |
| February 18, 2022 07:00
The pressure is increasing on companies to follow environmental, social, and governance standards from both the private sector and the government.
The Biden administration is prioritizing proposed rulemaking that would require companies to produce climate-related disclosures, most notably through the Securities and Exchange Commission, a form of indirect pressure on fossil fuel companies.
The SEC is debating the extent to which it can compel companies to disclose details about how much energy they buy and how they handle climate risks. Such self-reported disclosures to investors have already become commonplace in business, and adding government-mandated ESG disclosure rules is a big goal for the administration.
The SEC has been working on the disclosure rule for months now, with Chairman Gary Gensler initially announcing that the draft would be released by October and then later pushing that deadline back to January. Now it is unclear when exactly it will be unveiled, although some are beginning to get restless, including Sen. Elizabeth Warren, who called for “quick action” on the matter earlier this month.
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The proposed rule is part of President Joe Biden’s broader climate agenda, which envisions cutting greenhouse gas emissions by more than half by the end of the decade when compared to 2005 levels.
At the heart of the SEC’s troubles with releasing a proposed rule is the scope of the reporting requirements. Some of the more hard-charging climate activists want to see stringent reporting requirements, while others fear putting those in place would entail too much red tape for companies to handle and legal challenges for the SEC.
In analyzing corporate climate emissions, the SEC organizes them into three categories, known as scopes. Scope 1 includes the emissions that a company directly generates — this scope will certainly be included in a proposed rule. Scope 2 refers to indirect emissions, such as those involved in the use of electricity, and Scope 3, which is the most controversial, measures the emissions of other entities, such as suppliers or customers in a company’s value chain.
Gensler and the SEC must be careful with how they proceed because if they are too heavy-handed in the rulemaking, they could face lawsuits that have the potential to strike the rule down, delivering a massive blow to Biden’s climate agenda.
There is only one Republican SEC commissioner, and any rule must pass by a majority vote, meaning that all three Democrats, including Gensler, have to agree on the climate disclosure rule.
At the heart of the intraparty debate over the scope of ESG climate reporting requirements is the legal concept of “materiality," according to Bloomberg. Materiality is what dictates what information companies must disclose to shareholders, but the definition under current law is vague, and the courts have not established a clear precedent on what the concept entails.
Gensler is reportedly worried about the new climate reporting rule being successfully challenged in court and struck down if the SEC is too liberal with what it establishes as materiality, while the other two Democrats are reportedly pushing for more aggressive climate reporting guidelines. If Gensler’s concerns win out, Scope 3 emissions would likely not be required to be reported.
Another flashpoint in the debate is whether auditors should approve of companies’ disclosures. While the other two Democrats feel that auditing is necessary to determine compliance with the rule, Gensler reportedly fears that requiring audits could also add to the legal pushback.
“I think that the chairman has an agenda, but I’m not sure that his two fellow Democrat commissioners will necessarily follow him across the board on this,” James Copland, the director of legal policy at the conservative Manhattan Institute, told the Washington Examiner.
“I think the SEC runs the risk of stepping well outside its lane,” Copland said. “Whether reviewing federal courts would actually gut those regulations or not depends on how they do it, how it’s litigated, and what judges it gets in front of, et cetera — but I do think they’re running a significant risk on that.”
Mandating these disclosures is a form of indirect pressure on companies to rein in their exposure to fossil fuels. The rule would not require companies to change their corporate strategy at all, but disclosing investments in fossil fuels could cause investors to pressure those companies to divest or change their strategy.
Proponents of strict reporting requirements see insulating the world from the risks posed by climate change as important because the warming climate will cause harm to the environment and society. They also argue that failing to be open about a company’s exposure to the fossil fuel industry could put shareholders in jeopardy.
Those who push back on the notion of strict reporting requirements see them as overly burdensome and exceed the scope of what companies should be prioritizing — which is creating shareholder value.
ESG has become popular with the rise of stakeholder capitalism versus traditional shareholder capitalism. The idea of stakeholder capitalism has overtaken many large corporations and represents the notion that, in general, companies shouldn’t care just about their bottom lines but also have some sort of wider responsibility to society. The philosophy has existed in various permutations for decades, although it has been repackaged as ESG in more recent years.
The push for ESG and reporting requirements isn’t just coming from the government, but also from companies themselves.
One company that has made ESG a top priority (and faced both praise and backlash for doing so) is BlackRock, a massive $10 trillion investment firm, the world’s largest.
BlackRock CEO Larry Fink said in 2020 that climate change would be a “defining factor” in its investment assessments. Fink reiterated his firm’s commitment to ESG during his hotly anticipated annual letter to CEOs released this year.
“As stewards of our clients’ capital, we ask businesses to demonstrate how they’re going to deliver on their responsibility to shareholders, including through sound environmental, social, and governance practices and policies,” he said.
In a 3,300-word letter earlier this year, Fink repudiated those who believe prioritizing ESG initiatives means the money manager doesn’t value returns for shareholders. He argued that decarbonizing and working to address climate change don't subtract value from shareholders, but rather protect the long-term interests of shareholders.
“Few things will impact capital allocation decisions — and thereby the long-term value of your company — more than how effectively you navigate the global energy transition in the years ahead,” he wrote.
For some companies, ESG and political dalliances have been good for profits. For example, Ben & Jerry’s ice cream has been very vocal in environmental and social causes, which gains them media attention and thus more attention from customers. Some progressive-minded customers choose Ben & Jerry’s over other brands specifically because of the company’s commitment to their environmental and social activism.
Richard Morrison, a research fellow with the libertarian Competitive Enterprise Institute, told the Washington Examiner that most companies push ESG because they don’t want to end up on a "bad list" or be perceived as worthy of boycotts and negative media attention for their lack of ESG focus.
Companies that tout their commitment to transparency and ESG disclosures have to be careful not to shoot themselves in the foot, though.
Brian Marks, the executive director of the University of New Haven’s Entrepreneurship and Innovation Program, told the Washington Examiner that a big factor with ESG is whether companies are actually “walking the walk” and not just paying lip service to environmental and social priorities. Some corporations have been caught obfuscating the truth about their products in order to reap the benefits of the ESG without following through.
For instance, Volkswagen, which had been touting its low emission diesel vehicles, was caught in a massive scandal after it was uncovered that the company had been cheating on U.S. emissions tests and the vehicles actually emitted far more greenhouse gas than the company touted.
While the Biden administration and some companies have embraced the ESG shift and are hoping to make disclosures the norm, they are facing opposition from some Republican states who are trying to use their power to push back.
Last year Texas Gov. Greg Abbott signed a bill that banned state investments in businesses that cut ties with the oil and gas industry. Abbott also signed legislation banning state and local governments from working with corporations whose policies restrict the firearms industry.
Another example is West Virginia. The Mountain State’s Senate recently passed a bill authorizing the state’s treasurer to produce a list of firms that refuse to do business with fossil fuel companies and to reject such companies from consideration for state financial contracts.
“It's real simple,” West Virginia Sen. Rupert Phillips, the bill’s chief sponsor, recently told the Washington Examiner. “Why should we take our tax dollars that our coal miners and our gas industry has produced and invest it into a bank that is trying to shut them down?”
Additionally, last month West Virginia’s state Treasurer Riley Moore announced that his state would end the use of a BlackRock investment fund. Moore said that BlackRock “has urged companies to embrace ‘net zero’ investment strategies that would harm the coal, oil and natural gas industries, while increasing investments in Chinese companies that subvert national interests and damage West Virginia's manufacturing base and job market.”
The pushback has created a scenario where companies need to walk the fine line of not upsetting shareholders and inviting activist investors to wage war, while also working to not lose valuable business in states that are pushing back on the ESG drive.
CLICK HERE TO READ MORE FROM THE WASHINGTON EXAMINER
Reuters reported Thursday that BlackRock executives reassured elected officials and other energy industry stakeholders in Texas earlier this year that they want the Lone Star State’s oil and gas firms to “succeed and prosper” and that the firm would keep doing business with them.
“We will continue to invest in and support fossil fuel companies, including Texas fossil fuel companies,” the executives said in a letter.
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