“To expect the unexpected shows a thoroughly modern intellect.” – Oscar Wilde
It’s a common refrain that the United States is politically polarized. Accepting this as true, while refraining from political commentary, can raise interesting questions like, “What are issues that unite the American public?” Examination finds an unlikely answer — one recent survey estimates that 72% of Americans now believe in climate change. This foundational belief is driving a steady set of activities in corporate America, and financial services (“FS”) is no exception. In corporate culture, these activities fall under the broader umbrella of corporate social responsibility, sustainability, or — more contemporarily — environmental, social, and governance (“ESG”). Setting and executing ESG-related goals is complicated in FS because of endemic risk, macro-economic interconnectivity, and ESG’s inherent complexity.
Europe has long been the vanguard of ESG, but the U.S. is stirring and catching up. While passing European-style legislation is unlikely, ESG is manifesting with a uniquely U.S. flavor — corporations are leading the way.
Corporate Leadership is Driving U.S. ESG
“Of course, peer pressure has a strong positive component. It provides the social cohesion that allows the very development of communal affiliation.” – Charles D. Hayes
Industry shifts are often the result of institutions responding to each other and reaching critical mass where the industry follows. The first evidence of ESG critical mass in U.S. corporate culture was companies keeping emissions reduction commitments despite the U.S.’s 2017 withdraw from the Paris Climate Accord.1
In this instance, the invisible hand has likely teamed up with customer, shareholder, and employee pressure on ESG issues to create real change. Specifically, the historical link between carbon emissions and economic growth has likely been broken. Since 1990, per capita U.S. GDP has increased by >50% while per capita carbon emissions have decreased by 14%.2 Decoupling economic growth from carbon emissions is expected to accelerate as technical developments improve making ESG-conscious decisioning both best practice and economically accretive.
U.S. Regulatory Environment
“Life is about not knowing, having to change, taking the moment and making the best of it, without knowing what’s going to happen next.” – Gilda Radner
Polarization makes durable ESG legislation (e.g., the E.U.’s SFDR3 ) unlikely. The Corporate Governance Improvement and Investor Protection Act of 2021, which requires companies to measure and disclose ESG risks, is an illustration of this deadlock (i.e., the bill narrowly passed the House and is not expected to be brought to the Senate floor). This leaves U.S. ESG regulation to executive actions and subject to the whims of successive administrations. President Obama’s Executive Order (“E.O.”) 13653, designed to reduce carbon emissions through inter-agency cooperation, was rescinded by President Trump in 2017. President Biden reinstated it on his first day in office — whiplash that would not befall legislation.
On March 21, the Securities and Exchange Commission proposed a comprehensive set of rules that require publicly traded firms to measure and disclose emissions.4 Firms with material indirect emissions (i.e., produced by suppliers and customers) will be required to track and disclose these figures, as well.5 The rule is material, but it will be subject to the whims of future administrations like E.O. 13653.
Regardless of the final implementation of the rule, some form of ESG reporting regime is likely in the U.S. and the implications for tracking, auditing, and reporting are material. One possible scenario is a regulatory regime where FS firms are required to gather information on clients6 that clients are not required to collect themselves.7
Banks Only Want to Do Compliance Once
“If you don’t have time to do it right, when will you have time to do it over?” – John Wooden
Global companies want to build solutions with flexibility and strong data governance to minimize risk of non-compliance in specific markets and of costs from redundant work. With ambiguous international ESG requirements, FS firms should use the best heuristics available to create strategies that meet these goals. We expect the combination of corporate leadership and the chance of a material regulatory regime in the U.S. to make implementing requirements similar to their strictest regulatory regime (i.e., the E.U.) a valid approach for many U.S.-based financial institutions.
“The activist is not the person who says the river is dirty. The activist is the person who cleans up the river.” – Ross Perot
Concluding an ESG piece with a quote from an industrialist is not intended to be incendiary — it is intended to provoke conversation. The quote is relevant because it is easy to focus on American political gridlock in the ESG space, but that focus belies the fact that many different parties are driving progress — i.e., in cleaning the metaphorical river.
1 “Despite Paris Accord Exit, Companies Expect Little Change,” Despite Paris Accord Exit, Companies Expect Little - Change - WSJ, 2017
2 “Many countries have decoupled economic growth from CO₂ emissions, even if we take offshored production into account,” Many countries have decoupled economic growth from CO₂ emissions, even if we take offshore production into account - Our World in Data, 2021
4 Press release: SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors https://www.sec.gov/news/press-release/2022-46
6 For FS firms, the term “client” is meant to reference clients and counterparties
7 Given that the SEC rule covers only publicly traded companies