President Joe Biden plans to use every tool at his disposal in the fight against climate change, including financial regulation. While not an intuitive choice, supporters say mandating that public companies and investment firms quantify and disclose climate risks — and the costs associated with them — is a bold step that could make ESG (environmental, social and governance) data as commonplace in corporate financial reports as sales and profit figures.
“The recent change in administration in Washington has contributed to a renewed sense of urgency around environmental issues,” said Leahruth Jemilo, head of the ESG advisory practice at Corbin Advisors.
The Treasury Department is reportedly adding a “climate czar,” the Wall Street Journal reported earlier this month. At the New York Times DealBook virtual conference on Monday, Treasury Secretary Janet Yellen floated an idea of what a framework for evaluating climate risk might look like, saying that banks and insurers could be subject to climate stress tests.
Although they would not limit companies’ ability to pay out dividends or impose new capital requirements, Yellen said they could still be an effective risk-discovery and -mitigation tool. She clarified that implementation and oversight would fall under the purview of the Federal Reserve and other banking regulators, not the Treasury, although she said the Treasury could “facilitate” the process.
Yellen also seemed to dismiss the idea that voluntary oversight measures on the part of the financial services industry would suffice, saying, “It certainly requires policy.”
The Securities and Exchange Commission already has created a new, climate-focused senior policy adviser position, and the Federal Reserve in December joined the Network of Central Banks and Supervisors for Greening the Financial System, a consortium of more than 80 countries.
Ben Koltun, director of research at consulting firm Beacon Policy Advisors, said these announcements are a signal to investors, executives and policymakers. “It does speak to the whole-government approach the Biden administration is taking with climate change,” he said.
Climate activists such as environmental nonprofit group Ceres want Gary Gensler, the former Commodity Futures Trading Commission chair who is Biden’s nominee to lead the SEC, to mandate that public companies disclose their exposure to climate risks and the potential costs that could be incurred, on top of documenting metrics such as greenhouse gas emissions, water usage and plastic consumption.
Failing to do so could constitute securities fraud. It might sound drastic, but advocates of this expanded regulatory scope say climate change is a crisis of such monumental significance that using financial regulations as a lever to advance environmental policy is less extreme than it sounds.
Advocates say climate change is a crisis of such monumental significance that using financial regulations as a lever to advance environmental policy is less extreme than it sounds.
“I think it is justified to some extent. While climate change is a real risk and crisis, we still don't have a clear regulatory guideline to handle what that means, what that entails for corporations,” Koltun said.
Some Congressional Republicans have warned that using a regulatory infrastructure intended for banking and markets to accomplish climate policy goals could produce unintended consequences, such as inhibiting access to capital markets by companies involved in fossil fuel production. “There's a concern that there isn’t a clear framework and it could lead to concerns of regulatory overreach,” Koltun said.
Centralizing the federal government’s approach to climate change could help mitigate those concerns, Koltun said. The alternative — multiple agencies working with different, sometimes overlapping rules — could overwhelm smaller companies’ bandwidth for regulatory compliance management and erode support from the business community. “The regulatory process is already pretty cumbersome,” he said. “The benefit is you have a hub for organizing this… It creates a better workflow and it creates a more seamless messaging process to voters and companies.”
For regulatory agencies like the SEC, getting the broad contours in place will be only the first step: Crafting detailed standards for how companies must define and quantify their exposure to risks related to climate change will be the heavy lift.
Even defining what a “green” or investment incorporates or entails will be a challenge. Some institutions that have marketed funds as sustainable have faced investor blowback when investments in companies like fossil fuel producers — historically not a sector that has been viewed were publicized. According to Jemilo at Corbin, 48 percent of institutional investors say their biggest challenge regarding ESG disclosures is the lack of a uniform standard for measuring and reporting that information.
“This renewed emphasis on [environmental disclosure] will only further drive home the need for companies to decide on a framework or standard to use in measuring and reporting on ESG efforts,” she said.
By framing climate change mitigation as a driver of job growth, rather than just environmental stewardship, Biden has built support for this push from some unlikely allies. The U.S. Chamber of Commerce has endorsed Washington’s holistic approach to fighting climate change, saying in a statement: “The impacts of climate change are far reaching and it will take smart policies across a wide spectrum of issues to achieve meaningful global emissions reductions while also supporting economic growth and job creation.”
“This policy is as much about jobs and job creation as it is about clean energy,” Koltun said. “You want to get as big a coalition as possible… That’s the political tightrope they have to walk — they want to focus on the climate crisis, but their concern is building the economy.”
Dan North, chief economist for North America at Euler Hermes, said companies are coming around to the realization that regulation to mitigate climate change is inevitable, and market pros have largely priced in these expenses as a cost of doing business. “We’re going to be having more regulation. That’s where this is going, and anytime there’s more regulation, there’s a cost to businesses,” he said.
Some aren’t waiting for the regulators. Major corporate entities such as Amazon, Microsoft and Morgan Stanley have pledged to achieve carbon neutrality and set target dates for reaching zero-emission status. Millennials, who make up a growing share of the workforce and are moving into leadership roles, are cognizant of the costs of continued climate inaction and bringing those values into boardrooms and onto trading desks. An increasing number of retail investors also are voting with their dollars. Morningstar data shows that sustainable fund balances are up 67 percent year over year, and currently total nearly $1.7 trillion.
“Companies that incorporate meaningful ESG into their business strategy are better positioned for long-term value creation,” Jemilo said. “Those that are taking ESG seriously — not greenwashing — will be better able to target specific investors and open doors to additional capital.”
“It’s very popular with investors,” North said. “They've gone away from the Milton Friedman model that return to investors is everything. ESG is important, as well.”