Emerging ESG disclosure standards at odds with U.S. anti-ESG crusade

Governments around the world are developing and adopting standards requiring companies within their respective jurisdictions to make disclosures about how ESG-related factors may affect the companies’ financial performance:

• The SEC’s proposed rule compelling public companies to disclose material climate-related risks to their business (as well as their own greenhouse gas emissions), proposed in March 2022, is expected to be finalized this fall.
• The EU recently finalized the European Sustainability Reporting Standards (ESRS), with extensive requirements for EU-based companies to disclose not only how an array of ESG-related factors (not limited to climate change) may materially impact the company financially, but also how the company may negatively impact people or the environment.
• The UK government has announced it intends to develop Sustainability Disclosure Standards (SDS) for UK companies based on the standards proposed by the International Sustainability Standards Board (ISSB) in June 2023 – and other governments around the world are being urged to follow suit.

As has been widely reported and discussed, there is significant variation across these different sets of standards. However, all of the regimes share a key common denominator: the recognition that ESG-related factors like climate change can have a material financial impact on companies, and that investors need that information to assess a company’s return potential. The EU’s defined standard of financial materiality closely tracks that under U.S. securities laws: whether a misstatement or omission of the information could reasonably be expected to influence investors’ decisions.

This apparent global consensus among financial regulators is at odds with a basic premise of the anti-ESG crusade in the U.S., targeting asset managers that integrate ESG considerations in their investment and proxy voting decisions. Several state attorneys general have opined that consideration of ESG factors is a breach of an asset manager’s fiduciary duties, because such considerations are by definition irrelevant to company financial performance and thus further only the manager’s social or political agenda. Some state legislatures have gone a step further, adopting statutes that purport to define ESG considerations as being “non-pecuniary” in nature and thus inconsistent with a manager’s fiduciary duties.

Something will have to give. As the new reporting standards take effect, companies around the world will make mandatory disclosure of their financially material risks and opportunities relating to ESG factors. In analyzing companies for potential investments and exercising proxy votes, asset managers will not be able to ignore those disclosures simply because certain state officials consider them to be financially immaterial by definition. Indeed, managers might subject themselves to client claims that they are breaching their fiduciary duties by failing to consider factors that issuers themselves deem financially material to their businesses. 

As such, if and/or when anti-ESG regulators or activists pursue legal claims alleging manager breach of fiduciary duty, a manager’s reliance on portfolio companies’ own published assessment of their ESG-related financial risks – as mandated by the law of their homes countries – should stand as a powerful defense to assertions that investment and voting decisions are being made on “non-pecuniary” bases. Similarly, when managers are asked by public pension officials to certify that investment and voting decisions are made for “pecuniary” purposes, the emerging disclosure regimes should provide ample basis to confirm that ESG factors and pecuniary factors are one and the same.