The U.S. House of Representatives passed an Environmental, Social, and Governance-specific bill as part of a larger corporate governance push on June 16, giving a greenlight to the ESG Disclosure and Simplification Act and the Disclosure of Tax Havens and Offshoring Act by a narrow margin of 215 to 214. The bill – which still needs approve from the Senate – would require the Securities and Exchange Commission to establish standardized ESG metrics, including for climate risks, political spending, executive pay, and taxation rates, and to mandate that publicly-traded companies make disclosures accordingly in “any filing … that requires audited financial statements” in order to improve transparency as companies increasing make voluntary ESG-centric statements to appeal to eco-conscious consumers.
According to the newly-passed House bill, “ESG matters are material to investors. Yet, the Securities and Exchange Commission (“SEC”) “does not require companies to disclose information related to [such] matters,” and at the same times, it does not require companies to adhere to any uniform standards for disclosing such information. Given that companies’ ESG disclosures are of interest to investors and in light of the fact that investors have reported that companies’ “voluntary disclosures of ESG metrics are inadequate,” the bill states that the SEC needs to establish standards for disclosure for ESG issues.
Beyond that, Baker McKenzie’s Reagan Demas and Maria Piontkovska state that companies will also need to disclose: (1) “information regarding the identification of the evaluation of potential financial impacts of, and any risk-management strategies relating to: physical risks posed to the covered issuer by climate change; and transition risks posed to the covered issuer by climate change; (2) a description of any established corporate governance processes and structures to identify, assess, and manage climate-related risks; (3) a description of specific actions that the covered issuer is taking to mitigate identified risks; (4) a description of the resilience of any strategy the covered issuer has for addressing climate risks when differing climate scenarios are taken into consideration; and (5) a description of how climate risk is incorporated into the overall risk management strategy of the covered issuer.”
As part of the bill – which will allow for “allow for intra- and cross-industry comparison, to the extent practicable, of climate-related risk exposure through the inclusion of standardized industry-specific and sector-specific disclosure metrics” – the SEC may define and require companies to report on industry-specific metrics. The bill specifically cites “finance, insurance, transportation, electric power, mining, and non-renewable energy” as key sectors, but also leaves the door open “any other sector determined appropriate by the [SEC].”
If enacted, the bill states that the SEC will be permitted to use a “phased approach” when applying any disclosure requirements “to small issuers, and may determine the criteria by which an issuer qualifies as a small issuer for purposes of such phased approach.” Still yet, the legislation would require the SEC to establish a permanent Sustainable Finance Advisory Committee that will focus largely on sustainable finance (i.e., finance with respect to investments taking into account environmental, social, and governance considerations), including by identifying challenges and opportunities for investors, and recommending policy changes to facilitate the flow of capital towards sustainable investments.
The protection of climate and environment has become “an important parameter of public policy and economic decisions,” and is proving to be increasing relevant for regulators across the globe, according to Hogan Lovells attorneys Christian Ritz and Dr. Sebastian Gräler. In fact, the House’s approval of the ESG Disclosure and Simplification Act comes as the SEC closed the period of public comment in connection with its “endeavor to craft a rule proposal for” climate and ESG disclosures. Nonetheless, the bill is expected to face pushback before the Senate, particularly in light of opposition from Republicans and business interest groups.
Ultimately, a key takeaway – regardless of whether the legislation comes into fruition or not – centers on companies’ supply chains, which are not specifically referenced in the bill, but are relevant, as “given the breadth and depth of [modern] corporate supply chains, any ESG and climate risk analysis must inevitably take into account ESG and climate impacts of entities and operations” within their supply chains,” per Demas and Maria Piontkovska. “Accurately measuring these risks requires companies to have a transparent view of their supplier and sub-supplier operations, and will require listed companies subject to any SEC disclosure operations to request and analyze ESG impact data from its non-listed suppliers both within and outside the U.S.”
Therefore, they say that it remains critical for companies to: (1) “ensure they have risk-based responsible sourcing and ESG compliance programs in place to ensure accurate oversight and visibility into supply chain impacts; and (2) confirm that any existing risk assessment processes, policies and procedures provide companies with reasonably accurate data to report on ESG and climate impacts both in supply chains and in extended enterprise operations.”