While 2022 threatened to become another lost year in the fight against climate change, it has turned out to be the most consequential year so far, in terms of US ESG regulatory developments. Not only has President Biden signed into law the Inflation Reduction Act but, earlier this year, the Securities and Exchange Commission (SEC) also proposed three new sets of rules to enhance climate-related disclosures. The former directs almost $370 billion of government funds to green investments and the latter provide investors with the transparency they need to identify truly green investments. Both are crucial for channelling the investments needed to meet the Paris agreement and prevent further climate catastrophe.
The Inflation Reduction Act
Whilst some experts are not convinced that the bill goes far enough, and critics have condemned the concessions made to pull senators Manchin and Sinema over the line, the bill is nevertheless the US’s most significant ESG regulatory effort yet. Indeed, it is projected to achieve about 80% of the reduction of carbon pollution needed for the US to reach its 2030 Paris agreement targets, alone, making it a meaningful down payment on the US’s climate obligations and boosting the US’s previously insufficient climate change response such that it is now well on its way to hitting its targets.
The bill aims to:
- reduce greenhouse gasses;
- soften the impact of the climate crisis, itself, and of the shift towards a cleaner system, ideally even leading to a positive impact, especially on vulnerable communities; and
- make the US an industrial leader in the clean technology revolution.
These goals are mutually supportive. For example, reducing carbon pollution naturally mitigates global warming and stimulating clean solar panel manufacturing in the coal belt can replace jobs.
The Inflation Reduction Act earmarks a total investment of $369 billion1 into energy security and climate change (exhibit 1). This is mostly split between four themes:
- $161bn for incentivising clean electricity through federal tax benefits for clean electricity projects;
- $100bn to make clean energy technologies more affordable and bring down energy bills, including benefits for retrofitting homes with better insolation, electrification of homes and tax credits for electric vehicles;
- $75bn for environmental conservation, financing projects to clean up pollution and creating a “green bank” through which communities can access low-cost capital to finance clean-up projects; and
- $37 billion to build clean manufacturing facilities that produce renewable energy technologies.
Exhibit 1: Climate-related spending of IRA
The climate-related spending under the Act is an important boost for climate investment, but is not enough to reach the 2030 Paris-aligned targets. Estimations of required annual global investment differ, but point to similar orders of magnitude, ranging from global $5 trillion2 to $5,7 trillion3 until 2030. This amounts to about 4.5 percent of global GDP. Global energy investments currently stand at around $2 trillion4. The US, with a GDP of roughly $20 trillion, would need $0.9 trillion of climate investments, so the majority will need to come from the private sector. This represents a significant opportunity for fund managers with strategies that can support these initiatives and also leads us neatly on to the second major development.
SEC’s proposed rules
The SEC has proposed several initiatives to enhance transparency and uniformity of climate-related disclosures for investors.
In March and May, the SEC proposed three new sets of rules that, when implemented, will require registrants to provide specific climate-related information: the Names Rule Proposal; the ESG Strategy Proposal; and the Climate Disclosures Proposal (exhibit 2). Each will provide investors with consistent, comparable, and reliable information, enabling them to compare ESG strategies across managers, and protect themselves from greenwashing. Enhancing transparency on the climate impact of investments is a crucial step and a prerequisite to ‘make finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development’, as agreed upon in the Paris agreement.
Exhibit 2: Proposed Rules by the SEC
With its proposals, the SEC is responding to a call from the market. There have been several investor initiatives stressing the need for improved climate disclosure and for mandatory disclosure requirements. Among these initiatives are the Global Investor Statement to Governments on Climate Change, the Net Zero Asset Managers Initiative and, most recently, the Glasgow Financial Alliance for Net Zero. The SEC is not the first to answer these calls: other jurisdictions have already started developing or revising their own mandatory climate-related disclosure regimes, including the European Union.
The Names Rule Proposal
The Names Rule Proposal applies to registered funds and is actually an amendment to the existing “Names Rule” in the Investment Company Act. This twenty-year-old rule requires investment companies whose names suggest a focus in a particular type of investment to actually direct 80 percent of the value of their assets to those investments. Fund names are an important marketing tool, and the rule effectively forbids putting this tool to use in a misleading way. The amended version would extend this requirement to funds whose names indicate that they incorporate environmental, social or governance factors.
To make sure that they abide to the new version of Names Rule, fund managers must take a critical look at the names of their products and revise these, or their underlying investment policy, should there be a mismatch.
The Climate Disclosures Proposal
The Climate Disclosures Proposal applies to public companies. It requires that companies incorporate climate-related disclosures in their registration statements and periodic reports. These include the “incoming” climate-related risks (risks that could pose a material threat on the business’s investments, operations, or financial condition), but also, the “outgoing” impact of the company on its environment, including greenhouse gas emission.
As this proposal applies to public companies, it requires no specific action from fund managers, in general, but those holding positions in public companies will want to ensure that these companies are in full compliance.
The ESG Strategy Proposal
Of the three SEC proposals, the ESG Strategy Proposal has the biggest ramifications for fund managers. If implemented, it requires them to update most of their written materials to include ESG-related disclosures.
The proposal follows the principles of the TCFD (the Task Force on Climate-related Financial Disclosures, a framework used widely by businesses to disclose climate-related risks and opportunities). The ESG Strategy Proposal classifies investment strategies into three levels: integration strategies; ESG-focused strategies; and impact strategies. There is also a fourth “No label” category. Depending on the type of strategy pursued, the proposal suggests varying disclosure requirements to advisors and registered funds in their registration statements, prospectuses, and annual reports.
Managers who have already streamlined their disclosure processes will be better prepared for when the rules come into effect, which could be as soon as 2023 (applying to 2024 SEC filings).
For more information on what these ESG regulatory developments mean for your firm and your portfolio, please contact Marieke Boudeling.
New York Times, What’s in the democrats’ Climate and Health Bill?
Financial Times, A guide to the US climate, health and tax package
Read the full text of its 700 pages, here