April 17, 2024 • 31 mins
As ESG has shifted from a niche investment strategy to the mainstream, it has become a hot-button political issue among top-level state and national officials. That includes laws banning ESG on one side of the aisle and mandating exclusionary screens on the other, and the trend may accelerate heading into the US elections. On this week’s episode of ESG Currents, BI Senior ESG Analyst Rob Du Boff is joined by Ropes & Gray partners Michael Littenberg, Josh Lichtenstein and Rob Skinner, who have extensive experience representing corporate and asset-management clients facing legal, compliance and regulatory issues around ESG.
This episode was recorded on April 10.
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Episode Transcript
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Speaker 1 (00:07):
ESG has become established as a key business theme as
companies and investors seek to navigate the climate crisis, energy transition,
social mega trends, mounting regulatory attension and pressure from all stakeholders.
The rapidly evolving landscape has become inundated with acronyms, buzzwords
and lingo, and we aim to break these down.
Speaker 2 (00:27):
With industry experts.
Speaker 1 (00:29):
Welcome to ESG Currents, brought to you by Bloomberg Intelligence,
your guide to navigating the evolving ESG space, one topic
at a time. I'm Rob Dubaff, Senior ESG Analyst. ESG
has moved from what I would say was a wonky
investment strategy to a hot button political issue among top
level state and national elected officials. This includes laws banning
(00:53):
ESG on one side of the aisle and mandating it
on the other side. And the trend is likely to
further accelerate as we barrel into election season in the
US and hanging over all of this our global efforts
to standardize ESG, which could very well be derailed by
the backlash. Joining us today discuss are Michael Littenberg, Josh
(01:13):
Lichtenstein and Rob Skinner, Partners at the law firm of
Ropes and Gray. They bring extensive experience on behalf of
corporate clients in the asset management industry, including tackling the legal,
compliance and regulatory issues around ESG. Thanks for joining us, gentlemen.
So first off, maybe a lay of the land, Michael
(01:36):
tell us, how have ESG and anti ESG laws evolved
in recent years?
Speaker 3 (01:41):
Sure?
Speaker 4 (01:42):
And thank you so much Rob for having us here today.
So I'm going to start with with ESG. And there
are a lot of ESG laws, a lot more of
them than there used to be, and they're still coming
fast and furious. And to paraphrase Leon Trotsky, you may
not be interested in ESG regulation, but it's in interested
in you. And we've seen ESG regulation across many different
(02:07):
substance of areas and jurisdictions. Some of the types of
legislation that we've been seeing our broad based sustainability disclosure
like the EU Corporate Sustainability Reporting Directive. We're seeing climate disclosure,
which I know we'll talk about more today, deforestation legislation,
legislation around human rights, around pay equality, around conflict minerals,
(02:28):
and that's just to name a few areas. And the
laws affect really almost every industry, and they directly or
indirectly affect most companies of any size, whether based in
the United States or based elsewhere in the world. Now,
the anti ESG laws, that is a much newer phenomenon.
I think there we've gone from zero to one hundred
(02:48):
miles per hour in just a couple of years. And
luckily I'm able to phone a friend here, My partner,
Josh Lichtenstein, is probably the foremost expert in the world
on that. So I'd like to let Josh answer that,
if that's okay with you.
Speaker 2 (03:01):
Yeah, thanks for having us here today. We've seen an
enormous amount of development in this entirely new area of
these anti ESG laws. So what we've been seeing is
state pension plans, which of course exist, you know, for
the purpose of securing the retirement of state workers, being
utilized as basically the policy tools in a number of
(03:24):
Red states to enforce these sort of anti ESG policies
we're Onadly speaking, there are two different types of anti
ESG policies we see. We've seen some states like Texas
or Oklahoma that have adopted lists of asset managers and
financial institutions they will no longer do business with on
the basis of perceived boycotting of certain protected industries. Usually
(03:48):
that's fossil fuels, arms manufacturing, but there's some other industries
that can creep in as well. But then we also see,
you know, we see a larger number of states. Florida
is probably the most, but there are a larger number
of states which I have adopted instead what we call
a pecuniary factors type rule. That basically means is that
they're saying that when you make an investment decision with
(04:11):
respect to their retirement assets, you can only consider material
economic factors. That might sound like it shouldn't be very
hard to comply with, because of course, when you're investing assets,
you'd expect to be doing it based on what's going
to drive returns or mitigate risk. But the term pecuniary
factors has a loaded history to itself. It first entered
the lexicon during the Trump administration when the Department of
(04:33):
Labor put out a similar anti ESG rule that applied
to private pension plans. That's no longer in effect, but
the term is really understood to have a very very
strong sense that ESG type factors are unlikely to actually
be financially relevant, right, So what do you.
Speaker 1 (04:53):
Think is kind of motivating the two sides here? I'll
turn over to Rob as this one.
Speaker 5 (04:58):
We see a lot of activity in both the legislative area,
but also increasingly in the litigation and enforcement area, where
anti ESG sentiments and also anti green washing sentiments are
coming to the fore on the left, if you will.
There's a big focus, particularly at the SEC about so
(05:19):
called greenwashing, and Chair Ginstler certainly has shown himself and
his staff to have a strong concern that people engaged
in ESG investing are overstating what they are delivering and
that their rhetoric and marketing isn't backed up by what
they're doing on the ground. By way of ESG integrated investing,
(05:42):
we've seen high profile settlements designed to drive this message
home very aggressively to the industry, and I think the
mess of the industry has gotten the message. I don't
think that anybody in the administration is opposed to ESG
integration and investing. They just want to make sure that
it is not done in a way that is inflating
(06:04):
or misrepresenting what's actually happening. From the right. I think
what we really see in both the litigation, enforcement and
legislative areas is frankly primarily a political narrative in search
of a legal theory. ESG investing is somehow a piece
(06:25):
of the woke culture that that Republicans are are wanting
to fight against. It is based on a fundamentally false
premise that ESG integrated investing is necessarily in search or
in pursuit of a social agenda rather than financial returns,
(06:46):
a premise that has been you know, misproven or disproven
time and again in the mouths of asset managers and
in their actions, whether that is voting, selecting securities, engaging
with companies, what have you. Nevertheless, whether there it is
in the you know, in the legislative or enforcement arena,
we see Republicans wanting to make what I think ultimately
(07:09):
is primarily a political statement uh and rat and trying
to wrap a legal theory around that, around that statement.
Speaker 4 (07:18):
Uh.
Speaker 5 (07:18):
Sometimes in trined by statute, but also in in litigation
enforcement activities.
Speaker 1 (07:23):
Yeah, I know, I think to that last point, you know,
I've seen it being you know, talked about as promoting
some kind of you know, leftist radical left agenda and investment. Uh,
you know, and I've been a Wall Street professional for
i'll retact the number of years. But certainly, I certainly
don't think of myself as kind of this leftist, uh communist,
(07:43):
I guess, for lack of a better word. It is
interesting though, I mean, I guess, you know, full disclosure
here in my past life, I was an oil and
gas analyst and really you know, use the term woke,
and that was my first real exposure to the fact
that there could be this anti Stuy backlash. Is when
I was reading or from the Texas Railroad Commission, which,
if you don't know, that's the you know, the local
(08:05):
regulator of all things oil and gas in Texas, which
is kind of a big deal down there, and literally
they use the term you know, woke ideology, and that
was kind of shocking to me because you see those
in corners of the internet, but to hear an elected
public official use that term woke for the first time
was kind of shocking. Now it's become kind of regular,
but you know, I do wonder if maybe there is
(08:26):
a little bit of a point to it. I understand,
obviously in Texas you're protecting you know, you do have
a fiduciary duty. You know, if you're investing on behalf
of say oil and gas employees and their pension fund,
you know, is kind of shrinking their industry the best thing.
I mean, do do either side of this argument, Do
they have a point?
Speaker 5 (08:44):
I think at the end of the day, they do
not have a point. I mean, just compare what the
oil and gas companies themselves are saying in their own
disclosures about their own financial risks, you know, putting aside
Exon's recent actions to try to you know, exclude certain
shareholder proposals from its from its you know, annual proxy.
As a general matter, oil and gas companies recognize that
(09:08):
climate change and the necessary regulatory changes that climate change
is going to bring about, and the need in the
long run at least to move away from a carbon
intensive economy poses real business risks for oil and gas companies.
They're not hiding from that fact. They're not They're not
calling discussions about that, you know, a woke ideology. It
(09:31):
is the real world ideology. I mean, it is the
It is the real world set of facts that oil
and gas companies face. Some challenges based on what the
science says, and where the regulatory environment is necessarily headed.
So there is a big disconnect here between politicians who
say they are protecting oil and gas companies by by
(09:55):
prohibiting consideration of those very risks, and the companies themselves
who recognize those risks.
Speaker 2 (10:03):
I just wanted to rob to the point that you
raised at the beginning of that question about fiduciary duties.
I just wanted to very quickly flag that generally speaking,
you know, there are sort of two different constituencies within
the state. There's like the political level, and that's where
these new rules are going into effect. But then you
actually have the people that are responsible for investing the
assets of the plans, and they're generally apolitical, and you know,
(10:27):
their focus, their fiduciary focus is really just on driving
the returns for the plans so the plans can pay
the retirees. And so it was actually very interesting because
while states have certainly for years used their pension plans
to advocate for various political or social causes, but what's
somewhat unique about what we're seeing with the anti ESG
(10:48):
backlash is we see at the political level these rules
coming into effect, and we see them really constraining the
things that the investment professionals on behalf of the plans
can actually do in discharging their fiduciary duties. So it's
sort of like weighing the interests of different groups.
Speaker 1 (11:05):
Yeah, and I guess that was my next question. I mean,
you both laid out kind of logical discussions for why
there's an investment case for these types of considerations, So
I guess just make it make sense for me. How
how can federal laws or state laws really dictate how
asset managers do their jobs.
Speaker 2 (11:21):
It's an interesting question. It's not really that the states
are directly dictating how managers do their jobs. It's really
more that what the states are doing is they're imposing
limits or rules on how the state's assets can be deployed.
And so, you know, if asset managers want to continue
(11:43):
to fundraise from and manage the capital of these states,
then that's where we see you know, these rules really
applying because the asset allocators and the pension boards investing
the assets of the states have to make decisions about
which managers they are willing to or want to hire,
and they are the ones who are really subject in
(12:04):
most cases to these restrictions. So when we think about
the effect of these laws on asset managers, it's really
sort of more on a secondary level, where the managers
are basically agreeing, either by contract or otherwise, to act
in a way that makes the state asset allocators the
(12:25):
pension boards comfortable selecting or continuing to use that asset manager.
Speaker 5 (12:31):
And outside of the context of state money, there are
certainly state and federal laws that impose some general standards
on how asset managers do their work. So there is
the Federal Investment Advisors Act of nineteen forty, as well
(12:53):
as state common law principles that impose fiduciary duties on
asset managers, you know, generally to act in the client's
best interests and to act with a certain level of
duty of care consistent with how the community considers asset
managers to work. And then there are also laws like
consumer protection statutes and securities laws that require, in connection
(13:18):
with purchases and sales of securities, that professionals not be
misleading and not deceive.
Speaker 3 (13:26):
Investors.
Speaker 5 (13:27):
Now, within those general guidelines, of course, there's quite a
bit of discretion for how asset managers work, but also
quite a bit of discretion for regulators to determine in
their views what types of actions are consistent with the
best interest of advisors investors and what types of actions
(13:49):
might be misleading. So there is, as a practical matter,
a fair bit of exposure under these state and federal
laws to asset managers being set and guessed by federal
and state regulators in terms of how they're doing their
job and what decisions they're making, and whether they are
acting in a conflicted manner.
Speaker 1 (14:09):
Right, So you have these anti ESG laws and then
you know, almost the other side of the coin, you
have other states mandating divestment from fossil fuels or other industries.
Is there really any difference between those two types of laws.
Speaker 2 (14:24):
So from my perspective, I would say that these laws
are somewhat different. You know, the laws that we're seeing,
as we've discussed before, the laws that we're seeing from
the Red States. The anti ESG laws are generally speaking,
pretty restrictive on broad categories of investment, and you know,
(14:49):
they impact the way that investment decisions can be made.
And then in some cases we have states where there
are specific industries that the laws are meant to Retecht
like fossil fuels or arms manufacturing. These investment laws that
we're seeing are a bit different because what they're really
doing is they're imposing a single industry restriction on the
(15:14):
way that assets of the pension plans can be invested.
So rather than saying, you know that you can't invest
with managers who are discriminating against or boycotting a particular industry,
they're just making the decision sort of wholesale to remove
an asset class from the universe of potential investments. Now,
(15:36):
in both cases it obviously has a real impact on
the way that the state assets get invested, and in
both cases it can definitely raise questions about the ability
to construct an appropriately diversified portfolio. But you know, there
really are I think a number of differences between these laws,
And one of the best ways to think about it is,
if I'm an asset manager and I want to manage
(16:00):
money for a blue state that is subject to one
of these investment laws, it's very straightforward to know what
I counter or can't do. I know, I'm not allowed
to invest in the two hundred largest publicly traded you know, emitters,
for example. But if you want to manage money for
a red state that has these pecuniary factors type restrictions,
(16:21):
it's a lot harder to know what the universe of
practical restrictions is.
Speaker 1 (16:26):
Yeah, I guess that's what we're seeing is that some
of these asset managers can be labeled as boycotting energy,
even though maybe they're investing quite a bit of money
in the oil and gas sector. So let's switch gears here.
The SEC recently finalized its climate disclosure rule. Now that's
(16:46):
been in the work for two years and received a
record number of comments from both sides. But for the
benefit of our listeners, can you quickly sum up what
made it into the final rule and, more importantly, how
this may impact investors.
Speaker 4 (16:59):
Many of the disclosures under the rules are now materiality based. Previously,
most of the disclosures were bright line for any company
that was subject to the rules, So now many of
the disclosures are only required if their material to investors.
The rules phase in over time, starting with the largest companies.
The first disclosures are required in twenty twenty six for
(17:23):
fiscal year twenty twenty five, although that's likely to change
or somewhat up in the air. At least due to
the litigation surrounding the rules. The final pieces of the
rules phase in for fiscal twenty thirty three, and then
there's also compliance accommodations under the rules for smaller companies.
In terms of what all of this means for investors,
(17:45):
it's somewhat of a mixed bag. How you think about
it from an investor standpoint depends upon whether you're a
glass half full or half empty sort of person. Benefits
to investors, there will be benefits to investors under the rules.
For ext example, there'll be more consistency and comparability and disclosures. Currently,
I think it's very hard to compare a lot of
(18:07):
the voluntary sustainability reports, so this is certainly an improvement
over that, But not all investors feel that the rules
go far enough, in particular around Scope three emissions disclosures,
although even there there's different views in the investment community
around the usefulness of that information.
Speaker 1 (18:25):
And I would say that the focus on materiality kind
of puts the gives a bit more discretion to the
companies as far as determining whether in scope that's right.
Speaker 4 (18:36):
I mean, it creates more discretion for companies, but it
also creates more work for companies because now they have
to go through a materiality analysis to determine what they
need to disclose.
Speaker 1 (18:49):
So now within just a few hours, the lawsuits against
the things start flooding in. Oh, what's the legal argument
behind many of these suits?
Speaker 3 (18:57):
So that's right.
Speaker 4 (18:58):
I mean the first suits were file the same day
that the rules came out. Ultimately there were suits that
were filed in six different courts. They've been consolidated in
the Eighth Circuit and Rob Skinner will talk a little
bit more about that in just a minute. But essentially
there's three legal arguments that the petitioners are making. First,
(19:20):
they're arguing that the SEC doesn't have authority to adopt
rules in this area, that it's within the remit of
another federal agency, the Environmental Protection Agency, which has a
greenhouse gas emissions reporting program. The petitioners here are also
arguing that the disclosures required by the rules violate the
(19:41):
First Amendment of the US Constitution since they're compelled speech
that is potentially disparaging to the companies that are making
the disclosures. And then the third principal argument is that
the SEC hasn't jumped through all of the process hoops
that it's required to follow in connection within h and
see rule making, so meaning that it hasn't complied with
(20:03):
the requirements of the Administrative Procedure Act. And in that regard,
the petitioners are alleging that the rule making is arbitrary
and capricious since the SEC failed to adequately take comments
into account and it also hasn't conducted an adequate cost
benefit analysis. Now, the APA challenges are interesting because there's
(20:25):
challenges that are being asserted on both the left and
the right. On the right, you know, the argument is
essentially that the rules go too far, and on the
left the argument is that the rules don't go far enough.
Speaker 1 (20:38):
Now, our own Illegal and Policy Teams commits these suits
will ultimately kill the SEC rule. There's already a stay
in place, but it's mainly because, as you mentioned, it
now sits with the Eighth Circuit, which is a bit
of a conservative leaning court, and then ultimately could wind
its way up to the Supreme Court. And we know
(20:59):
who makes up court currently. So what are your opinions
on this.
Speaker 6 (21:04):
You're correct that the Eighth Circuit Court of Appeals is
heavily dominated by judges who were appointed by Republican presidents,
So it's a certainty that you know, any panel selected
from within that court is going to have is going
to be controlled by Republican nominees.
Speaker 3 (21:22):
And if the Eighth.
Speaker 5 (21:23):
Circuit decision is then appealed by one side or the
other to the Supreme Court, of course it also has
a you know, a Republican nominated majority as well. I think, however,
it's important that it is not always an easy bet
to align somebody's typical political views or political party with
(21:44):
what their views are going to be regarding the level
of discretion to be given to an administrative agency in
terms of executing on its statutory remit. After all, the
sec for decades has been implementing rules requiring the disclosure
(22:06):
of information UH that falls outside UH the financial statements
of companies, because the agency concluded such information would be
useful to investors. So the mere fact that this is
requiring something that again this agency has decided is UH,
(22:26):
you know, useful information for investors doesn't necessarily mean that
it falls outside UH its statutory authority. And they're perfectly
legitimate arguments that the that the Commission will have as
to why this is easily within its within its remit uh.
And why it doesn't, you know, fall afoul of the
first Amendment, given again that the that the Statute has
(22:50):
been interpreted plenty of times to require various levels of
quote speech, that is, disclosures by companies for the purpose
of keeping investors in form about companies prospects. Now, all
that said, there are certainly some trends. In addition to
the political makeup of both the benches, there are some
(23:13):
trends in the law that sort of blow in favor
of a successful challenge here. One is that the Supreme
Court this very term is considering dialing back the so
called Chevron doctrine, which for a long time has instructed
(23:34):
courts to be fairly deferential to the judgments of administrative agencies.
And secondly, recent years have seen a growth in the
so called major Questions doctrine, which says that administrative agencies
should not be in the business of making important policy determinations,
(23:56):
that those sorts of things should be left to other branches.
So I think that there is good reason to think
that the challengers here have some reason for optimism. Uh.
But understanding that, uh, this isn't a straight political question, uh,
in the way that some others might be.
Speaker 1 (24:18):
Uh.
Speaker 5 (24:18):
So we're gonna have to wait and see how it
plays out.
Speaker 1 (24:21):
Yeah, I guess. You know. One of the things I
hear about Chevron doctrine is that, you know, ultimately, if
if there's no deference to agencies like the SEC, then
then that ultimately leaves up to the courts to decide
whether you know, something is is material unless it needs
to be disclosed. Is that how we should think about it?
Speaker 5 (24:41):
I mean, this rule tees up nicely.
Speaker 3 (24:46):
Uh.
Speaker 5 (24:47):
The sort of balancing act that Chevron uh as a
doctrine has has been you know, guarding if you will,
for some time now.
Speaker 3 (24:59):
Because the securities laws don't put a lot.
Speaker 5 (25:02):
Of meat on the bones of exactly what information is
useful or necessary for investors, that has been left largely
to the determination of the SEC to decide, you know,
what investors need. Congress hasn't weighed in with much specificity
about that. Now, Congress has the ability to veto the
(25:26):
SEC's determinations about that and does have the power to
rescind rules that that it thinks goes too far, but
it hasn't done that very often, and generally speaking, the
courts have been relatively deferential to determinations by the agency.
Speaker 3 (25:44):
If if the result of.
Speaker 5 (25:47):
This challenge and others is that the agency no longer
has the discretion to make determinations as to what is
material or importance to investors, it's going to be awfully
difficult for the SEC to do its job and awfully
difficult for companies to know to whom they should be
(26:08):
listening in deciding what to disclose to investors. And you know,
the markets, let's face it, have benefited from a consistent
set of rules about what they're supposed to disclose. And
you know, I think that there is some danger if
this challenge is taken to its logical extreme, such that
(26:30):
the SEC's hands are tied across the board, it may
create a fair bit of uncertainty and hopefully not chaos
in the market.
Speaker 2 (26:40):
Got it?
Speaker 1 (26:41):
And I guess a bigger issue for me is you
have this SEC rule that applies to all large public
companies in the US, and then you have a more
extensive rule in California that applies to all companies with
significant revenues in that state. Then you have a very
detailed disclosure regime in Europe. The Corporate Sustainability Reporting direct
which applies to companies with the significant presence in the
(27:03):
EU in terms of employees and revenue. So a large
swath of major US companies check all three of those boxes.
Are they just not on the hook for more detail
disclosures anyway? Is the future of the SEC rule kind
of a moot point here?
Speaker 4 (27:19):
So that's a great question, and that's one that a
lot of US public companies are grappling with, and we've
been having just many, many conversations with clients and other
market participants about so you know, as you pointed out,
so California has two bills that have been adopted SB
two fifty three and two sixty one, and those laws
(27:40):
require greenhouse gas emissions and they go beyond the SEC rules.
They require Scope one, Scope two, and three emissions disclosures.
They also require climate risk disclosures. Although there are challenges
in court to the California legislation and Governor Knew some
of California His expressed concert earns with the timing for
(28:01):
implementation of those laws, which would require disclosures starting in
twenty twenty six. And the EU side the EU Corporate
Sustainability Reporting Directive, it's not limited to just climate, but
that certainly is a component, and it would require extensive
climate disclosure, more extensive than what's required under the SEC
rules and including the Scope three. But there's other jurisdictions
(28:22):
as well. There's the UK, there's Australia, there's Singapore, among
others that are going to require large US based multinationals
to make climate related disclosures. And many of these they
are broader than the SEC rules. As I noted, you know,
they pull in Scope three. In some cases, they have
lower lower different materiality thresholds relative to the SEC's rules,
(28:46):
they have earlier phases, in some cases, there's potentially more
onerous assurance requirements. And then there's all the voluntary disclosures
that companies are making around climate. Large companies are publishing
a lot of climate related information and that's not going
to stop, and that's going to include Scope three disclosures.
And then there's of course all the stakeholder pressures for
(29:07):
climate information and climate risk mitigation, including pressures from investors
and commercial customers among other stakeholders.
Speaker 3 (29:15):
So I do think the SEC rules matter.
Speaker 4 (29:19):
They're going to pick up many companies that are not
otherwise required to make climate disclosures. Under other regimes, and
they will result in disclosures that are easier for US
market participants to locate and compare.
Speaker 3 (29:32):
But even if the US rules go away, you know,
I do think.
Speaker 4 (29:36):
It's fair to say that the climate disclosure train has
left the station for larger US based public companies.
Speaker 1 (29:43):
And could we be in a world where filers have
to maybe have multiple sets of disclosures or you know,
can they present you know, comply with the CSRD in
Europe and then have that count towards the US or
California rules.
Speaker 4 (30:00):
It's still somewhat of an open question because CSRD is
still being implemented.
Speaker 3 (30:04):
We don't yet have all of the detail there.
Speaker 4 (30:08):
But one of the concerns that large US companies do
have that have to manage two different disclosure regimes is
that they are going to have to, at least to
some extent, have different disclosures that are localized for particular markets,
as opposed to, you know, having one disclosure that meets
all requirements globally. My hope is that we do get
(30:29):
to a place where we have a uniform global disclosure
that companies can have because I think it's more efficient
for companies. I think it's more useful ultimately for market participants,
but we're not there yet and it's not clear that
that's where we will ultimately get.
Speaker 1 (30:48):
Yeah, I mean, that's what I'm thinking is that you know,
some of these efforts to water down the US rule,
you know, they run a risk of backfiring, or maybe
you have higher costs, higher complexity just because you have
this mosaic of different standards as opposed to something that's
more closely resembling a unified standard.
Speaker 4 (31:08):
Well, that's right, and you know, and even if you
have ninety percent overlap or interoperability, it's that ten percent
that kills you where there's the differences.
Speaker 1 (31:17):
Well, thank you for your time, gentlemen. You can find
more information on topics like ESG litigation and policy by
going to BIESG go on the Bloomberg terminal. If you
have an ESG quandary you would like to ask bi's
expert analyst, send us an email at ESG Currents at
Bloomberg dot net. You can also read more about today's
guests and view their interactive state ESG regulatory Tracker at
(31:38):
ropesgray dot com.
Speaker 2 (31:40):
Thank you, gentlemen,
ESG has become established as a key business theme as
companies and investors seek to navigate the climate crisis, energy transition,
social mega trends, mounting regulatory attension and pressure from all stakeholders.
The rapidly evolving landscape has become inundated with acronyms, buzzwords
and lingo, and we aim to break these down.
Speaker 2 (00:27):
With industry experts.
Speaker 1 (00:29):
Welcome to ESG Currents, brought to you by Bloomberg Intelligence,
your guide to navigating the evolving ESG space, one topic
at a time. I'm Rob Dubaff, Senior ESG Analyst. ESG
has moved from what I would say was a wonky
investment strategy to a hot button political issue among top
level state and national elected officials. This includes laws banning
(00:53):
ESG on one side of the aisle and mandating it
on the other side. And the trend is likely to
further accelerate as we barrel into election season in the
US and hanging over all of this our global efforts
to standardize ESG, which could very well be derailed by
the backlash. Joining us today discuss are Michael Littenberg, Josh
(01:13):
Lichtenstein and Rob Skinner, Partners at the law firm of
Ropes and Gray. They bring extensive experience on behalf of
corporate clients in the asset management industry, including tackling the legal,
compliance and regulatory issues around ESG. Thanks for joining us, gentlemen.
So first off, maybe a lay of the land, Michael
(01:36):
tell us, how have ESG and anti ESG laws evolved
in recent years?
Speaker 3 (01:41):
Sure?
Speaker 4 (01:42):
And thank you so much Rob for having us here today.
So I'm going to start with with ESG. And there
are a lot of ESG laws, a lot more of
them than there used to be, and they're still coming
fast and furious. And to paraphrase Leon Trotsky, you may
not be interested in ESG regulation, but it's in interested
in you. And we've seen ESG regulation across many different
(02:07):
substance of areas and jurisdictions. Some of the types of
legislation that we've been seeing our broad based sustainability disclosure
like the EU Corporate Sustainability Reporting Directive. We're seeing climate disclosure,
which I know we'll talk about more today, deforestation legislation,
legislation around human rights, around pay equality, around conflict minerals,
(02:28):
and that's just to name a few areas. And the
laws affect really almost every industry, and they directly or
indirectly affect most companies of any size, whether based in
the United States or based elsewhere in the world. Now,
the anti ESG laws, that is a much newer phenomenon.
I think there we've gone from zero to one hundred
(02:48):
miles per hour in just a couple of years. And
luckily I'm able to phone a friend here, My partner,
Josh Lichtenstein, is probably the foremost expert in the world
on that. So I'd like to let Josh answer that,
if that's okay with you.
Speaker 2 (03:01):
Yeah, thanks for having us here today. We've seen an
enormous amount of development in this entirely new area of
these anti ESG laws. So what we've been seeing is
state pension plans, which of course exist, you know, for
the purpose of securing the retirement of state workers, being
utilized as basically the policy tools in a number of
(03:24):
Red states to enforce these sort of anti ESG policies
we're Onadly speaking, there are two different types of anti
ESG policies we see. We've seen some states like Texas
or Oklahoma that have adopted lists of asset managers and
financial institutions they will no longer do business with on
the basis of perceived boycotting of certain protected industries. Usually
(03:48):
that's fossil fuels, arms manufacturing, but there's some other industries
that can creep in as well. But then we also see,
you know, we see a larger number of states. Florida
is probably the most, but there are a larger number
of states which I have adopted instead what we call
a pecuniary factors type rule. That basically means is that
they're saying that when you make an investment decision with
(04:11):
respect to their retirement assets, you can only consider material
economic factors. That might sound like it shouldn't be very
hard to comply with, because of course, when you're investing assets,
you'd expect to be doing it based on what's going
to drive returns or mitigate risk. But the term pecuniary
factors has a loaded history to itself. It first entered
the lexicon during the Trump administration when the Department of
(04:33):
Labor put out a similar anti ESG rule that applied
to private pension plans. That's no longer in effect, but
the term is really understood to have a very very
strong sense that ESG type factors are unlikely to actually
be financially relevant, right, So what do you.
Speaker 1 (04:53):
Think is kind of motivating the two sides here? I'll
turn over to Rob as this one.
Speaker 5 (04:58):
We see a lot of activity in both the legislative area,
but also increasingly in the litigation and enforcement area, where
anti ESG sentiments and also anti green washing sentiments are
coming to the fore on the left, if you will.
There's a big focus, particularly at the SEC about so
(05:19):
called greenwashing, and Chair Ginstler certainly has shown himself and
his staff to have a strong concern that people engaged
in ESG investing are overstating what they are delivering and
that their rhetoric and marketing isn't backed up by what
they're doing on the ground. By way of ESG integrated investing,
(05:42):
we've seen high profile settlements designed to drive this message
home very aggressively to the industry, and I think the
mess of the industry has gotten the message. I don't
think that anybody in the administration is opposed to ESG
integration and investing. They just want to make sure that
it is not done in a way that is inflating
(06:04):
or misrepresenting what's actually happening. From the right. I think
what we really see in both the litigation, enforcement and
legislative areas is frankly primarily a political narrative in search
of a legal theory. ESG investing is somehow a piece
(06:25):
of the woke culture that that Republicans are are wanting
to fight against. It is based on a fundamentally false
premise that ESG integrated investing is necessarily in search or
in pursuit of a social agenda rather than financial returns,
(06:46):
a premise that has been you know, misproven or disproven
time and again in the mouths of asset managers and
in their actions, whether that is voting, selecting securities, engaging
with companies, what have you. Nevertheless, whether there it is
in the you know, in the legislative or enforcement arena,
we see Republicans wanting to make what I think ultimately
(07:09):
is primarily a political statement uh and rat and trying
to wrap a legal theory around that, around that statement.
Speaker 4 (07:18):
Uh.
Speaker 5 (07:18):
Sometimes in trined by statute, but also in in litigation
enforcement activities.
Speaker 1 (07:23):
Yeah, I know, I think to that last point, you know,
I've seen it being you know, talked about as promoting
some kind of you know, leftist radical left agenda and investment. Uh,
you know, and I've been a Wall Street professional for
i'll retact the number of years. But certainly, I certainly
don't think of myself as kind of this leftist, uh communist,
(07:43):
I guess, for lack of a better word. It is
interesting though, I mean, I guess, you know, full disclosure
here in my past life, I was an oil and
gas analyst and really you know, use the term woke,
and that was my first real exposure to the fact
that there could be this anti Stuy backlash. Is when
I was reading or from the Texas Railroad Commission, which,
if you don't know, that's the you know, the local
(08:05):
regulator of all things oil and gas in Texas, which
is kind of a big deal down there, and literally
they use the term you know, woke ideology, and that
was kind of shocking to me because you see those
in corners of the internet, but to hear an elected
public official use that term woke for the first time
was kind of shocking. Now it's become kind of regular,
but you know, I do wonder if maybe there is
(08:26):
a little bit of a point to it. I understand,
obviously in Texas you're protecting you know, you do have
a fiduciary duty. You know, if you're investing on behalf
of say oil and gas employees and their pension fund,
you know, is kind of shrinking their industry the best thing.
I mean, do do either side of this argument, Do
they have a point?
Speaker 5 (08:44):
I think at the end of the day, they do
not have a point. I mean, just compare what the
oil and gas companies themselves are saying in their own
disclosures about their own financial risks, you know, putting aside
Exon's recent actions to try to you know, exclude certain
shareholder proposals from its from its you know, annual proxy.
As a general matter, oil and gas companies recognize that
(09:08):
climate change and the necessary regulatory changes that climate change
is going to bring about, and the need in the
long run at least to move away from a carbon
intensive economy poses real business risks for oil and gas companies.
They're not hiding from that fact. They're not They're not
calling discussions about that, you know, a woke ideology. It
(09:31):
is the real world ideology. I mean, it is the
It is the real world set of facts that oil
and gas companies face. Some challenges based on what the
science says, and where the regulatory environment is necessarily headed.
So there is a big disconnect here between politicians who
say they are protecting oil and gas companies by by
(09:55):
prohibiting consideration of those very risks, and the companies themselves
who recognize those risks.
Speaker 2 (10:03):
I just wanted to rob to the point that you
raised at the beginning of that question about fiduciary duties.
I just wanted to very quickly flag that generally speaking,
you know, there are sort of two different constituencies within
the state. There's like the political level, and that's where
these new rules are going into effect. But then you
actually have the people that are responsible for investing the
assets of the plans, and they're generally apolitical, and you know,
(10:27):
their focus, their fiduciary focus is really just on driving
the returns for the plans so the plans can pay
the retirees. And so it was actually very interesting because
while states have certainly for years used their pension plans
to advocate for various political or social causes, but what's
somewhat unique about what we're seeing with the anti ESG
(10:48):
backlash is we see at the political level these rules
coming into effect, and we see them really constraining the
things that the investment professionals on behalf of the plans
can actually do in discharging their fiduciary duties. So it's
sort of like weighing the interests of different groups.
Speaker 1 (11:05):
Yeah, and I guess that was my next question. I mean,
you both laid out kind of logical discussions for why
there's an investment case for these types of considerations, So
I guess just make it make sense for me. How
how can federal laws or state laws really dictate how
asset managers do their jobs.
Speaker 2 (11:21):
It's an interesting question. It's not really that the states
are directly dictating how managers do their jobs. It's really
more that what the states are doing is they're imposing
limits or rules on how the state's assets can be deployed.
And so, you know, if asset managers want to continue
(11:43):
to fundraise from and manage the capital of these states,
then that's where we see you know, these rules really
applying because the asset allocators and the pension boards investing
the assets of the states have to make decisions about
which managers they are willing to or want to hire,
and they are the ones who are really subject in
(12:04):
most cases to these restrictions. So when we think about
the effect of these laws on asset managers, it's really
sort of more on a secondary level, where the managers
are basically agreeing, either by contract or otherwise, to act
in a way that makes the state asset allocators the
(12:25):
pension boards comfortable selecting or continuing to use that asset manager.
Speaker 5 (12:31):
And outside of the context of state money, there are
certainly state and federal laws that impose some general standards
on how asset managers do their work. So there is
the Federal Investment Advisors Act of nineteen forty, as well
(12:53):
as state common law principles that impose fiduciary duties on
asset managers, you know, generally to act in the client's
best interests and to act with a certain level of
duty of care consistent with how the community considers asset
managers to work. And then there are also laws like
consumer protection statutes and securities laws that require, in connection
(13:18):
with purchases and sales of securities, that professionals not be
misleading and not deceive.
Speaker 3 (13:26):
Investors.
Speaker 5 (13:27):
Now, within those general guidelines, of course, there's quite a
bit of discretion for how asset managers work, but also
quite a bit of discretion for regulators to determine in
their views what types of actions are consistent with the
best interest of advisors investors and what types of actions
(13:49):
might be misleading. So there is, as a practical matter,
a fair bit of exposure under these state and federal
laws to asset managers being set and guessed by federal
and state regulators in terms of how they're doing their
job and what decisions they're making, and whether they are
acting in a conflicted manner.
Speaker 1 (14:09):
Right, So you have these anti ESG laws and then
you know, almost the other side of the coin, you
have other states mandating divestment from fossil fuels or other industries.
Is there really any difference between those two types of laws.
Speaker 2 (14:24):
So from my perspective, I would say that these laws
are somewhat different. You know, the laws that we're seeing,
as we've discussed before, the laws that we're seeing from
the Red States. The anti ESG laws are generally speaking,
pretty restrictive on broad categories of investment, and you know,
(14:49):
they impact the way that investment decisions can be made.
And then in some cases we have states where there
are specific industries that the laws are meant to Retecht
like fossil fuels or arms manufacturing. These investment laws that
we're seeing are a bit different because what they're really
doing is they're imposing a single industry restriction on the
(15:14):
way that assets of the pension plans can be invested.
So rather than saying, you know that you can't invest
with managers who are discriminating against or boycotting a particular industry,
they're just making the decision sort of wholesale to remove
an asset class from the universe of potential investments. Now,
(15:36):
in both cases it obviously has a real impact on
the way that the state assets get invested, and in
both cases it can definitely raise questions about the ability
to construct an appropriately diversified portfolio. But you know, there
really are I think a number of differences between these laws,
And one of the best ways to think about it is,
if I'm an asset manager and I want to manage
(16:00):
money for a blue state that is subject to one
of these investment laws, it's very straightforward to know what
I counter or can't do. I know, I'm not allowed
to invest in the two hundred largest publicly traded you know, emitters,
for example. But if you want to manage money for
a red state that has these pecuniary factors type restrictions,
(16:21):
it's a lot harder to know what the universe of
practical restrictions is.
Speaker 1 (16:26):
Yeah, I guess that's what we're seeing is that some
of these asset managers can be labeled as boycotting energy,
even though maybe they're investing quite a bit of money
in the oil and gas sector. So let's switch gears here.
The SEC recently finalized its climate disclosure rule. Now that's
(16:46):
been in the work for two years and received a
record number of comments from both sides. But for the
benefit of our listeners, can you quickly sum up what
made it into the final rule and, more importantly, how
this may impact investors.
Speaker 4 (16:59):
Many of the disclosures under the rules are now materiality based. Previously,
most of the disclosures were bright line for any company
that was subject to the rules, So now many of
the disclosures are only required if their material to investors.
The rules phase in over time, starting with the largest companies.
The first disclosures are required in twenty twenty six for
(17:23):
fiscal year twenty twenty five, although that's likely to change
or somewhat up in the air. At least due to
the litigation surrounding the rules. The final pieces of the
rules phase in for fiscal twenty thirty three, and then
there's also compliance accommodations under the rules for smaller companies.
In terms of what all of this means for investors,
(17:45):
it's somewhat of a mixed bag. How you think about
it from an investor standpoint depends upon whether you're a
glass half full or half empty sort of person. Benefits
to investors, there will be benefits to investors under the rules.
For ext example, there'll be more consistency and comparability and disclosures. Currently,
I think it's very hard to compare a lot of
(18:07):
the voluntary sustainability reports, so this is certainly an improvement
over that, But not all investors feel that the rules
go far enough, in particular around Scope three emissions disclosures,
although even there there's different views in the investment community
around the usefulness of that information.
Speaker 1 (18:25):
And I would say that the focus on materiality kind
of puts the gives a bit more discretion to the
companies as far as determining whether in scope that's right.
Speaker 4 (18:36):
I mean, it creates more discretion for companies, but it
also creates more work for companies because now they have
to go through a materiality analysis to determine what they
need to disclose.
Speaker 1 (18:49):
So now within just a few hours, the lawsuits against
the things start flooding in. Oh, what's the legal argument
behind many of these suits?
Speaker 3 (18:57):
So that's right.
Speaker 4 (18:58):
I mean the first suits were file the same day
that the rules came out. Ultimately there were suits that
were filed in six different courts. They've been consolidated in
the Eighth Circuit and Rob Skinner will talk a little
bit more about that in just a minute. But essentially
there's three legal arguments that the petitioners are making. First,
(19:20):
they're arguing that the SEC doesn't have authority to adopt
rules in this area, that it's within the remit of
another federal agency, the Environmental Protection Agency, which has a
greenhouse gas emissions reporting program. The petitioners here are also
arguing that the disclosures required by the rules violate the
(19:41):
First Amendment of the US Constitution since they're compelled speech
that is potentially disparaging to the companies that are making
the disclosures. And then the third principal argument is that
the SEC hasn't jumped through all of the process hoops
that it's required to follow in connection within h and
see rule making, so meaning that it hasn't complied with
(20:03):
the requirements of the Administrative Procedure Act. And in that regard,
the petitioners are alleging that the rule making is arbitrary
and capricious since the SEC failed to adequately take comments
into account and it also hasn't conducted an adequate cost
benefit analysis. Now, the APA challenges are interesting because there's
(20:25):
challenges that are being asserted on both the left and
the right. On the right, you know, the argument is
essentially that the rules go too far, and on the
left the argument is that the rules don't go far enough.
Speaker 1 (20:38):
Now, our own Illegal and Policy Teams commits these suits
will ultimately kill the SEC rule. There's already a stay
in place, but it's mainly because, as you mentioned, it
now sits with the Eighth Circuit, which is a bit
of a conservative leaning court, and then ultimately could wind
its way up to the Supreme Court. And we know
(20:59):
who makes up court currently. So what are your opinions
on this.
Speaker 6 (21:04):
You're correct that the Eighth Circuit Court of Appeals is
heavily dominated by judges who were appointed by Republican presidents,
So it's a certainty that you know, any panel selected
from within that court is going to have is going
to be controlled by Republican nominees.
Speaker 3 (21:22):
And if the Eighth.
Speaker 5 (21:23):
Circuit decision is then appealed by one side or the
other to the Supreme Court, of course it also has
a you know, a Republican nominated majority as well. I think, however,
it's important that it is not always an easy bet
to align somebody's typical political views or political party with
(21:44):
what their views are going to be regarding the level
of discretion to be given to an administrative agency in
terms of executing on its statutory remit. After all, the
sec for decades has been implementing rules requiring the disclosure
(22:06):
of information UH that falls outside UH the financial statements
of companies, because the agency concluded such information would be
useful to investors. So the mere fact that this is
requiring something that again this agency has decided is UH,
(22:26):
you know, useful information for investors doesn't necessarily mean that
it falls outside UH its statutory authority. And they're perfectly
legitimate arguments that the that the Commission will have as
to why this is easily within its within its remit uh.
And why it doesn't, you know, fall afoul of the
first Amendment, given again that the that the Statute has
(22:50):
been interpreted plenty of times to require various levels of
quote speech, that is, disclosures by companies for the purpose
of keeping investors in form about companies prospects. Now, all
that said, there are certainly some trends. In addition to
the political makeup of both the benches, there are some
(23:13):
trends in the law that sort of blow in favor
of a successful challenge here. One is that the Supreme
Court this very term is considering dialing back the so
called Chevron doctrine, which for a long time has instructed
(23:34):
courts to be fairly deferential to the judgments of administrative agencies.
And secondly, recent years have seen a growth in the
so called major Questions doctrine, which says that administrative agencies
should not be in the business of making important policy determinations,
(23:56):
that those sorts of things should be left to other branches.
So I think that there is good reason to think
that the challengers here have some reason for optimism. Uh.
But understanding that, uh, this isn't a straight political question, uh,
in the way that some others might be.
Speaker 1 (24:18):
Uh.
Speaker 5 (24:18):
So we're gonna have to wait and see how it
plays out.
Speaker 1 (24:21):
Yeah, I guess. You know. One of the things I
hear about Chevron doctrine is that, you know, ultimately, if
if there's no deference to agencies like the SEC, then
then that ultimately leaves up to the courts to decide
whether you know, something is is material unless it needs
to be disclosed. Is that how we should think about it?
Speaker 5 (24:41):
I mean, this rule tees up nicely.
Speaker 3 (24:46):
Uh.
Speaker 5 (24:47):
The sort of balancing act that Chevron uh as a
doctrine has has been you know, guarding if you will,
for some time now.
Speaker 3 (24:59):
Because the securities laws don't put a lot.
Speaker 5 (25:02):
Of meat on the bones of exactly what information is
useful or necessary for investors, that has been left largely
to the determination of the SEC to decide, you know,
what investors need. Congress hasn't weighed in with much specificity
about that. Now, Congress has the ability to veto the
(25:26):
SEC's determinations about that and does have the power to
rescind rules that that it thinks goes too far, but
it hasn't done that very often, and generally speaking, the
courts have been relatively deferential to determinations by the agency.
Speaker 3 (25:44):
If if the result of.
Speaker 5 (25:47):
This challenge and others is that the agency no longer
has the discretion to make determinations as to what is
material or importance to investors, it's going to be awfully
difficult for the SEC to do its job and awfully
difficult for companies to know to whom they should be
(26:08):
listening in deciding what to disclose to investors. And you know,
the markets, let's face it, have benefited from a consistent
set of rules about what they're supposed to disclose. And
you know, I think that there is some danger if
this challenge is taken to its logical extreme, such that
(26:30):
the SEC's hands are tied across the board, it may
create a fair bit of uncertainty and hopefully not chaos
in the market.
Speaker 2 (26:40):
Got it?
Speaker 1 (26:41):
And I guess a bigger issue for me is you
have this SEC rule that applies to all large public
companies in the US, and then you have a more
extensive rule in California that applies to all companies with
significant revenues in that state. Then you have a very
detailed disclosure regime in Europe. The Corporate Sustainability Reporting direct
which applies to companies with the significant presence in the
(27:03):
EU in terms of employees and revenue. So a large
swath of major US companies check all three of those boxes.
Are they just not on the hook for more detail
disclosures anyway? Is the future of the SEC rule kind
of a moot point here?
Speaker 4 (27:19):
So that's a great question, and that's one that a
lot of US public companies are grappling with, and we've
been having just many, many conversations with clients and other
market participants about so you know, as you pointed out,
so California has two bills that have been adopted SB
two fifty three and two sixty one, and those laws
(27:40):
require greenhouse gas emissions and they go beyond the SEC rules.
They require Scope one, Scope two, and three emissions disclosures.
They also require climate risk disclosures. Although there are challenges
in court to the California legislation and Governor Knew some
of California His expressed concert earns with the timing for
(28:01):
implementation of those laws, which would require disclosures starting in
twenty twenty six. And the EU side the EU Corporate
Sustainability Reporting Directive, it's not limited to just climate, but
that certainly is a component, and it would require extensive
climate disclosure, more extensive than what's required under the SEC
rules and including the Scope three. But there's other jurisdictions
(28:22):
as well. There's the UK, there's Australia, there's Singapore, among
others that are going to require large US based multinationals
to make climate related disclosures. And many of these they
are broader than the SEC rules. As I noted, you know,
they pull in Scope three. In some cases, they have
lower lower different materiality thresholds relative to the SEC's rules,
(28:46):
they have earlier phases, in some cases, there's potentially more
onerous assurance requirements. And then there's all the voluntary disclosures
that companies are making around climate. Large companies are publishing
a lot of climate related information and that's not going
to stop, and that's going to include Scope three disclosures.
And then there's of course all the stakeholder pressures for
(29:07):
climate information and climate risk mitigation, including pressures from investors
and commercial customers among other stakeholders.
Speaker 3 (29:15):
So I do think the SEC rules matter.
Speaker 4 (29:19):
They're going to pick up many companies that are not
otherwise required to make climate disclosures. Under other regimes, and
they will result in disclosures that are easier for US
market participants to locate and compare.
Speaker 3 (29:32):
But even if the US rules go away, you know,
I do think.
Speaker 4 (29:36):
It's fair to say that the climate disclosure train has
left the station for larger US based public companies.
Speaker 1 (29:43):
And could we be in a world where filers have
to maybe have multiple sets of disclosures or you know,
can they present you know, comply with the CSRD in
Europe and then have that count towards the US or
California rules.
Speaker 4 (30:00):
It's still somewhat of an open question because CSRD is
still being implemented.
Speaker 3 (30:04):
We don't yet have all of the detail there.
Speaker 4 (30:08):
But one of the concerns that large US companies do
have that have to manage two different disclosure regimes is
that they are going to have to, at least to
some extent, have different disclosures that are localized for particular markets,
as opposed to, you know, having one disclosure that meets
all requirements globally. My hope is that we do get
(30:29):
to a place where we have a uniform global disclosure
that companies can have because I think it's more efficient
for companies. I think it's more useful ultimately for market participants,
but we're not there yet and it's not clear that
that's where we will ultimately get.
Speaker 1 (30:48):
Yeah, I mean, that's what I'm thinking is that you know,
some of these efforts to water down the US rule,
you know, they run a risk of backfiring, or maybe
you have higher costs, higher complexity just because you have
this mosaic of different standards as opposed to something that's
more closely resembling a unified standard.
Speaker 4 (31:08):
Well, that's right, and you know, and even if you
have ninety percent overlap or interoperability, it's that ten percent
that kills you where there's the differences.
Speaker 1 (31:17):
Well, thank you for your time, gentlemen. You can find
more information on topics like ESG litigation and policy by
going to BIESG go on the Bloomberg terminal. If you
have an ESG quandary you would like to ask bi's
expert analyst, send us an email at ESG Currents at
Bloomberg dot net. You can also read more about today's
guests and view their interactive state ESG regulatory Tracker at
(31:38):
ropesgray dot com.
Speaker 2 (31:40):
Thank you, gentlemen,
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