Regulation of sustainability in corporate governance standards

Experts discuss the future of sustainability in financial regulation.

In response to a growing understanding of climate change as a financial risk, President Joseph R. Biden issued an executive order in early spring, asking officials to submit reports on how to manage climate-related financial risk. by fall 2021.

This decree reflects the growing interest in environmental, social and corporate governance (ESG) practices that seek to incorporate broader societal values ​​into financial decision-making. Analysts predict that by 2025, ESG-aligned assets could reach $ 53 trillion, representing more than a third of all assets under management globally.

With the growing popularity of ESG comes concerns about the current global and local mosaic of diverse ESG policies and regulations. The US Securities and Exchange Commission (SEC), for example, issued a risk alert in April regarding inconsistencies in ESG approaches.

To mitigate the negative impact of the discrepancies, as well as to respond to President Biden’s executive order, the SEC has issued a request for public comment on any disclosure requirements the agency may impose to help make ESG and climate risk disclosures more consistent.

Some experts argue that the information needed to disclose any climate-related risks a business might create would exceed the requirements of the current law, which only requires disclosure of “material” risks. Others argue that it is not possible to have the kind of clear, precise and comparable data on climate risks that the Biden administration seems to be looking for on climate risks. Others, however, remain optimistic that, despite the difficulty of assessing climate risks, the severity of the problem supports rather than undermines regulatory efforts to force greater disclosure of climate risks.

The European Union has already adopted regulations for the disclosure of sustainable risks as part of its Green Deal. Administrative agencies in the United States are now faced with the task of figuring out how to navigate a tangled regulatory framework that is currently impacting sustainable finance and determining effective measures to disclose climate risks.

How can US regulators create a regulatory framework that effectively balances economic, social and environmental needs? In this week’s Saturday seminar, experts discuss the future of sustainability in financial regulation.

  • The SEC should require information on sustainability in financial reports, says Jill Fisch of the University of Pennsylvania Law School in an article in Georgetown Law Journal. Fisch suggests including a sustainability discussion and analysis section in annual financial reports as a practical and cost-effective first step. She says disclosure would require issuers to identify and discuss the three most important sustainability issues that a company’s board of directors deems important to the business. Fisch argues that such a sustainability analysis will also allow investors to assess risk management issues, business practices and economic vulnerability.
  • In an article published in the Villanova Law Review, Virginia Harper Ho of the University of Kansas Law School assesses industry concerns about “disclosure overload” – fear of flooding investors with intangible information in a way that obscures relevant information . Ho notes that fears of overburdening investors are over. Instead, most investors fear under-disclosure of information. The open question, explains Ho, is how to incorporate and standardize information on ESG risks into existing reporting forms so that company management considers these long-term risks to be significant.
  • Until precise financial data on the profitability of ESG investments becomes available, regulators are effectively regulating ‘in the dark’, say Dirk A. Zetzsche of the University of Luxembourg and Linn Anker-Sørensen of EY in a recent work document. Without precise and detailed information on financial regulations for sustainability, new sustainability frameworks can lead to misallocation of resources and miscalculated risks that undermine financial stability, explain Anker-Sørensen and Zetzsche. Not only can this lack of information challenge financial markets, but the unreliability of currently available data can jeopardize market acceptance of sustainability reporting regimes in the future. Anker-Sørensen and Zetzsche argue that innovation should be encouraged but also carefully regulated, such as through regulatory sandboxes and other smart regulatory tools in the fintech sector.
  • In a recent report published by Ceres, Veena Ramani of FCLTGlobal, offers 50 recommendations to seven US agencies to manage climate risk in financial systems. Ramani recommends that the Federal Housing Finance Authority recognize climate risk in the housing market and study the impact of climate change on government-sponsored businesses, such as Sallie Mae. It also recommends establishing long-term strategies to deal with the disproportionate impact of climate change on vulnerable communities. Ramani urges SEC to encourage credit assessors to disclose more about how climate risk is used in rating decisions and to establish that companies must engage in sound ESG practices to comply with their fiduciary obligations to their investors.
  • Financial regulators must guide financial institutions towards clean energy to protect the financial system, economy and humanity, says David Arkush of Public Citizen in a report for the Roosevelt Institute. Arkush claims that overinvestment in assets that produce high carbon emissions has contributed to a “carbon bubble” that can “burst dramatically” if regulators do not oversee a rapid transition in greenhouse gas emissions. Arguing that the widespread uncertainty of serious climate threats requires proactivity, Arkush urges financial regulators to integrate climate risks into prudential guidance and review frameworks.
  • In a dissertation published by the Strathclyde Center for Environmental Law and Governance, Chrysa Alexandraki of the University of Luxembourg examines the EU action plan on sustainable growth as a model for sustainable development in other parts of the world . Alexandraki explains that the key piece of legislation in the EU’s coordinated sustainability effort is the EU Taxonomy Regulation, which sets out the criteria for economic activities to be considered environmentally sustainable. Although the EU directive focuses on the sustainable regulation of finance, Alexandraki notes that the overall promotion of transparency, consolidated by legislation, will have positive effects in other sectors.

The Saturday Seminar is a weekly feature that aims to put in written form the type of content that would be conveyed in a live seminar involving regulatory experts. Every week, Regulatory review publishes a brief overview of a selected regulatory topic, then distills recent research and academic writing on that topic.

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