In late June, the US Department of Labor (DOL) proposed a new rule that would significantly curtail responsible investments made by pension funds. If passed, pension fund administrators would be required to prove that financial returns are not at risk in order to pursue ESG (environmental, social and governance)-based investments. As a result, incorporating risks such as climate change impact into investment strategies would be more difficult. While the DOL expressed skepticism, the SEC’s response was more agnostic. At a recent conference, senior SEC official Elad Roisman called for better 'green' labelling and noted his reservations about requiring companies to disclose ESG information for regulators and investors.
The move by the DOL and the lack of action from US regulators - coupled with lessons learned from the pandemic - have triggered investors to become activists for climate action. Last week, a coalition of trade bodies that include financial institutions such as the US’s largest pension funds wrote to the Federal Reserve, CFTC, SEC, and various government bodies urging action by integrating climate change as a systemic risk into their mandates through a series of recommendations. The signatories include investors managing nearly $1tn in assets, as well as several US senators. Investors are concerned that if regulators do not act immediately, climate change can have a disastrous impact on asset valuations and the macroeconomic stability of the US.
Investor activism globally
The lack of regulation related to climate action in the US is in sharp contrast to the UK and EU, where investors actively shape policy for climate change through lobbying efforts to Parliament, joint coalitions, and open discussions with regulators.
In the UK, the Bank of England announced plans in December 2019 to conduct mandatory stress tests of the resilience of major banks and insurers on a range of climate scenarios, one being rising sea levels.
The European Union provided guidance on sustainable finance and clarity through a taxonomy.
Central banks of the UK, EU, and various other nations have identified the Recommendations of the Taskforce for Climate-related Financial Disclosures (TCFD) as useful guidance. We are also seeing increasing pressure from regulators and investors to adopt TCFD and embed climate risk for all listed companies.
More recently, as the Covid-19 pandemic exposed the impact of systemic issues, international governments weaved environmental reforms into economic stimulus packages. The Canadian government for example requires large businesses (revenues over $300m) requesting loans to publish annual climate disclosure reports on risks and sustainability goals. European Commission President Ursula von der Leyen announced the Green Deal strategy (which seeks net zero emissions by 2050) and includes plans that drive private investment and create jobs for environmentally-friendly initiatives. Similarly, in the UK, a package of green stimulus-measures were released after business leaders called on Boris Johnson to align climate goals to economic recovery plans while rebuilding the economy.
Three considerations for US businesses
Over the past years, investor activism has been a driver for climate change action around the world. Many businesses across sectors and regions have already started their journey towards reducing climate change risk, and embrace opportunities through innovation and competitive advantage – even where governments and regulators have not yet taken action.
In the current political climate, it is difficult to assess how US policymakers will proceed – but this should not be discouraging or prohibiting to businesses because we believe the climate-change movement will be led by investors in the US as witnessed in the European market.
US businesses should be considering three points to prepare themselves as the pressure on climate action increases from investors
- Investor-activism will lead climate change – Like in international markets, US investors will continue to advocate for greater transparency on climate risks and impacts through disclosures and reporting. Investment managers and businesses will need to address this by rethinking current risk management frameworks and internal operations.
- Analysis of investment data will be critical – With increased pressure from investors, and the possibilities of rule-changes, investment managers will need to understand and document investment criteria thoroughly to uphold their fiduciary responsibilities. Existing methods will require enhancement when it comes to selecting and monitoring investments to show consistency with the investor’s objectives. Leading businesses are those leveraging climate risk data and insight at the heart of their strategy whilst ensuring Revenue growth for investors.
- Leverage existing frameworks – Whilst there is no US-specific regulation in place, businesses should build on existing frameworks such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD). Since its inception, companies around the globe have been leveraging the TCFD’s guidance on climate change strategy and disclosures. Specifically, previously complex methods such as scenario analysis tools and data analytics have progressed to help leaders better understand the impact of climate-related risks to their business.
We encourage US businesses and market participants to take the lead and focus on integrating climate change risk into their strategies. Climate action and sustainability will provide a holistic assessment of a business’s long-term prospects and ability to generate financial returns by capturing emerging risks and new opportunities – which will benefits investors, regulators, engage employees and benefit society overall. Investors are becoming increasingly aware of this and are starting to hold businesses accountable.
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