The Evolving Regulatory Landscape of ESG

By Tahmina Day

With ESG issues dominating the headlines of major news outlets lately, it is easy to assume that ESG is a new phenomenon. But it is not.

In fact, banks have been practicing three dimensions of ESG—shorthand for environmental, social responsibility and corporate governance factors—in one way or another for decades, with corporate governance being the most formalized and structured component. What is new is that ESG regulatory developments are now rapidly unfolding.

While there is currently no formal, centralized ESG regulatory framework in the United States, there are advocates on both sides of ESG regulation. Some claim that the lack of harmonized approach toward ESG taxonomy and disclosure metrics create widely inconsistent approaches and make it hard to establish benchmarks. Others prefer to leave those matters to the discretion of companies and industries, citing potential regulatory burden and the need for flexibility. Regardless of which school of thought you may find attractive, it is important to stay in line with the latest ESG developments and understand potential implications for banks.

Following is a summary of the latest developments by key regulatory players that might influence banks and highlight emerging themes to help banks navigate the fast-evolving ESG landscape.

The Biden administration

Since the new administration stepped into the office, we have seen accelerated attention toward ESG. One of the more significant actions taken by the federal government is the Executive Order on Climate-Related Financial Risk signed by President Biden on May 20. Among other provisions, it includes:

  • The acknowledgment of the presence of risk imposed by climate change to the stability of the financial system of the country. The executive order also articulates the administration’s policy “to advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk … including both physical and transition risks … ”
  • A directive to develop the government-wide “Climate-Related Financial Risk Strategy” within 120 days.
  • A directive to the secretary of the treasury to engage the Financial Stability Oversight Council’s members to consider the assessment of climate-related financial risk. The executive order further mandates within 180 days to issue a report on the integration of consideration of climate-related financial risk in policies and programs.

Securities and Exchange Commission

As mandated, the SEC is playing a central role in setting a regulatory stage for public companies’ disclosures and has recently reaffirmed its resolve in advancing ESG disclosures. Most recently, the SEC has introduced a myriad of actions to advance the ESG agenda. Below is quick look at some of them and their progression line.

One of the most notable past publications by SEC with regard to climate risk is its Commission Guidance Regarding Disclosure Related to Climate Change that was issued as an interpretive release in February 2010. In February of this year, the SEC’s then-Acting Chairwoman Allison Herren Lee directed the “Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings.” The SEC staff was directed to assess how public companies address the 2010 guidance and comply with disclosure requirements outlined in the securities laws. Drawing on the results of the assessment and the latest advancements in this field, the staff will update the guidance.

Following these directives, in March, Herren Lee made a statement reinforcing the commission’s intent to revisit the climate disclosure directives and rules, and welcomed public comments on this subject including requirements in Regulation S-K and Regulation S-X and potential new commission disclosure requirements. As a response to this statement, SEC has received more than 550 comment letters with many responses supporting mandatory climate disclosure rules.

Furthermore, in March the SEC also communicated its 2021 examination priorities highlighting amplified focus on climate and ESG risk as an effort to integrate ESG factors into the overall regulatory perspective.

Following the 2021 examination priorities’ statement, on March 4 came an announcement on establishing a climate and ESG task force within the Division of Enforcement. Kelly Gibson, the acting deputy director of enforcement, was tapped to lead the task force of 22 members. According to SEC, “the Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct.” For a glimpse into what can be a subject of concern, banks might want to refer to a risk alert published by the SEC’s Division of Examination in April. While the risk alert is not a rule, regulation or a statement of the SEC, it provides valuable insights into internal control weaknesses as well as effective practices related to ESG investing that were derived from examinations of investment advisers and funds.

SEC Chairman Gary Gensler has made multiple comments on the agency’s resolve to advance the ESG agenda. In recent remarks, Gensler pointed out that that he “asked SEC staff to develop a mandatory climate risk disclosure rule proposal for the commission’s consideration by the end of the year.”

Office of the Comptroller of the Currency

In a similar ESG-enhancement spirit, on July 27, OCC announced the appointment of Darrin Benhart as climate change risk officer. In the same statement, OCC also said it had joined the Network of Central Banks and Supervisors for Greening the Financial System. The announcement elaborated on the OCC’s intended two-pronged approach that includes learning from others, and establishment of a sound climate risk-management practices, especially at larger banks.

The chosen approach was further emphasized by Michael Hsu, the acting comptroller of the currency, in his testimony before the Senate Banking Committee on August 3. Hsu pointed out that while the challenge is straightforward and identified as banks’ exposure to physical and transition risks associated with climate change, crafting a solution will not be an easy task.

Stock exchanges

Stock exchanges play a vital role in reinforcing good practice and disclosure requirements through their listing rules for publicly traded companies. Both the New York Stock Exchange and the Nasdaq Stock Market have been offering their members a plethora of ESG resources and voluntary guidance. NYSE’s ESG guidance aims at helping companies to tell the ESG story and make further progress on their ESG journey. Nasdaq’s ESG Reporting Guide 2.0 serves as an ESG support resource to companies.

In December 2020, Nasdaq took a step toward advancing board diversity in support of corporate governance, one of the ESG factors. Nasdaq filed proposed rule changes with SEC to adopt listing rules related to board diversity that were approved by SEC on August 6. The approved rule changes include:

  • The board diversity proposal would require Nasdaq-listed companies, subject to certain exceptions, to have, or explain why it does not have, at least one director who self-identifies as female and at least one director who self-identifies as an underrepresented minority or LGBTQ+ (with all terms defined in the approval order).
  • The Board Recruiting Service proposal that will provide certain listed companies free access, for a limited time, to a board recruitment service with access “to a network of board-ready diverse candidates.” The intention behind this offer is to help companies to achieve compliance with the Board Diversity Proposal.

Still many unknowns

The latest wave of actions, orders and statements make a sound case for an evolving ESG regulatory environment. It is yet to be seen how a series of SEC and other agencies’ initiatives directed toward ESG will materialize. However, the accelerated interest in regulatory ESG enhancement and intent to take actions were stated loud and clear. Two of the major emerging themes of the latest developments are ESG disclosure rules, and following examination and enforcement.

Additional efforts are underway. Kevin Stiroh, former head of the Federal Reserve Bank of New York’s supervision group, is heading the Fed’s recently formed Supervision Climate Committee, a system-wide group bringing together senior staff across the Federal Reserve Board and Reserve Banks. The committee “will further build the Federal Reserve’s capacity to understand the potential implications of climate change for financial institutions, infrastructure, and markets,” the Fed noted in a press release.

And the White House last week issued a 40-page report titled “A Roadmap to Build a Climate-Resilient Economy.” It lays out in broad terms the Biden administration’s view that the health of the U.S. economy is intrinsically linked to climate change and that climate change poses a systemic risk to both the economy and the financial system.

As we all closely monitor next developments, what can banks do to put themselves in a better position and prepare for potential regulatory changes? For banks that have not yet formalized their ESG approach and practices, the good place to start is to have a company-wide discussion. Understanding what constitutes ESG and most prominent global frameworks will be time well invested to raise awareness and prepare for what will follow. For larger banks that have already advanced in the ESG experiences and disclosures, reassessing current practices will help to evaluate existing control environment to be ready for forthcoming regulatory changes.

Tahmina Day is VP and enterprise risk program manager for one of the largest community banks in Florida. For more than a decade, she served as a corporate governance officer of the International Finance Corporation ESG Group. Most recently, Tahmina served in governance, risk and compliance leadership roles at CIT Group, Inc. and Fannie Mae. She can be reached at [email protected] and LinkedIn.