The degree of specificity and granularity asked for in the SEC's current proposal put forth in March is quite extensive and will likely be diluted in a final regulation. At its heart, the regulation would require disclosure of climate-related risks, which the company would have to identify are having or will likely have a material impact on the company's business and on its consolidated financial statements, and the effect of climate-related risks on the company's business model and strategy. Some of this may need to be scaled back for materiality levels but, as a matter of common sense: Shouldn't issuers disclose these kinds of risks?
Why do we require disclosure of these kinds of risks? So that reasonable and prudent investors can take them into account in their investing decisions. In fact, the Canada Pension Plan Investment Board, which oversees management of the Canada Pension Plan, with assets of C$550.4 billion ($430.6 billion), has called for a degree of "show me" that should please both the right and the left.
Scores of companies are making commitments to reach "net zero" by a particular date. On the right, one may think that is window dressing; on the left, one may be pleased with the commitment. But both sides do not want public statements that cannot be backed up. "Companies are not providing any insight into how they are going to achieve net zero," Richard Manley, managing director, head of sustainable investing and the main author of the CPP Investment Board's framework, said in recently published remarks. He argues that, as an investor allocating capital, CPP needs to understand carbon abatement capacity and the cost to achieve it.
Similarly, in 2020, two Republican SEC commissioners argued that asset managers should not be permitted to play "the name game." An SEC regulation known as the Names Rule requires that if a fund's name suggests a particular focus, then 80% of its investments must be in assets with that focus. Commissioner Hester Peirce and former commissioner Elad Roisman both spoke against "greenwashing." Ms. Peirce stated "funds must clearly disclose their investment strategies so that an investor can make informed decisions about whether a fund that claims to be an ESG fund is an ESG fund as that investor defines it."
Based on the political stereotypes of the left and right, one might not expect Republican commissioners to be concerned about greenwashing. Now maybe they took that position because they do not believe ESG funds can meet their objectives, but if the rules require a clear showing that these funds do meet this test, then both sides' objectives are achieved.
These kinds of disclosures serve a clear purpose. They allow investors to factor in these opportunities and risks. This leads us to the Department of Labor, which regulates the kinds of risks ERISA investors may in fact take into account.
It may seem obvious that any investor would want to consider these material risks. Yet somehow even this issue itself has become polarized. The Trump administration made it clear that climate and related risks may be considered by ERISA fiduciaries. However, this was taken to be a setback for ESG advocates because the language of the rule made no express reference to ESG, and it stated that ERISA fiduciaries may consider only "pecuniary factors," meaning "a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan's investment objectives."
This prompts the obvious point that various ESG-related factors are in fact pecuniary. Before we even get to the Biden administration's proposed rules, we can stop and recognize that climate change poses a clear pecuniary risk — or opportunity — for many potential investments, such as waterfront property, various agricultural activities, the future market for fossil fuels, or industrial manufacturing.
Politically, the Trump rule was perceived as negative toward ESG, and the Biden administration has proposed a new rule. The Trump rule relied heavily on the ERISA plan's duty of "prudence and loyalty" to the plan participants, so — pointedly — the Biden administration named its rule "Prudence and Loyalty in Selecting Plan Investments. "
This proposed rule agrees that fiduciaries may not subordinate the interests of beneficiaries and may not sacrifice return or take additional risk. However, acting Assistant Secretary of Labor Ali Khawar stated (quite correctly and consistent with the Trump rule), that climate change and other ESG factors can be financially material and that, when they are, proper consideration can result in better long-term risk adjusted return. Sure seems like a lot of similar principles.
DOL has issued a request for information asking for comments regarding what other ways ERISA can be used to protect retirement funds from the risks of climate change, and the outcome of that RFI is yet to be seen. Also, the granularity and extent of the current SEC disclosure proposals will probably need to be scaled back. But philosophically, it seems that both sides agree on a lot and ought to firm up the common ground that can result from such adamant agreement.
ESG-related risks can be material and pecuniary. They should be properly disclosed so that investors including ERISA fiduciaries can take them into account. Agreed?
Charles E.F. Millard, New York, serves as a senior adviser for Amundi U.S. He is the former director of the U.S. Pension Benefit Guaranty Corp. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.
