ESG Hits a New Snag as Climate-Disclosure Rules Come Under Fire

After years of gaining momentum, ESG programs, socially responsible investing and climate-related regulation have encountered legitimate setbacks in the United States lately.

On Wall Street, ESG funds had a miserable year in 2022. New client investments from the U.S. fell a whopping 96% year-over-year to $3 billion, down from $70 billion in 2021. The start of 2023 hasn’t gone any better, as ESG exchange-traded funds saw outflows of $772 million in January. They had inflows of nearly $1 billion during the year-earlier period.

Does the conservative backlash against ESG investing have anything to do with the declines? Possibly, although Peter Krull, partner and director of sustainable investing at Earth Equity Advisors, suggested in an interview with Bloomberg that adjustments to portfolio allocations in an overheated sector has likely played a significant role in the fund outflows.

On Capitol Hill, though, there’s no denying that right wing interests are having success in blunting the impact of ESG on new legislation. The Republican takeover in the House of Representatives following last year’s elections has rendered any hope of passing climate-change legislation moot, for example. That has left the executive branch angling to impose tougher environmental regulations on businesses – another effort that is encountering renewed resistance.

The Securities and Exchange Commission had grand plans for the climate-disclosure rules scheduled to begin rolling out this year. However, after delaying the release of the final version of the requirements last year, the agency now appears likely to scale back their implementation in the face of renewed opposition from a variety of stakeholders. The Wall Street Journal broke the news last week that deliberations are heating up within the agency over some aspects of the forthcoming climate-disclosure rules, citing pushback from “investors, companies and lawmakers.” Naturally, critics of the new regulations are balking at total compliance costs estimated in the range of billions of dollars, and the movement to blunt the effects of the regulations has a powerful ally in the U.S. Chamber of Commerce.

Current reporting standards call for issuers to disclose any environmental costs or risks they deem material to investors. In essence, the SEC is proposing to eliminate the element of discretion and replace it with mandated reporting requirements. That offers room for compromise by raising the threshold at which the requirements kick in.

The proposal that seems to be creating the most consternation among opponents is a requirement that companies assess the line items on their financial statements to determine if climate-related costs equal at least 1% of each line-item total. If so, issuers would need to report those costs, a process that detractors argue would produce faulty disclosures. Even powerful investment firm BlackRock Inc. – a staunch supporter of the ESG movement – has spoken up against the proposal.

Raising that threshold seems like an easy way for the SEC to show its responsiveness to stakeholder concerns, a message that might play better in the courts than with business interests. But in the long run, the most important takeaway over the disclosure flap may be that ESG is broadly popular, so long as it doesn’t mean sacrificing too much.