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House Republicans escalate ESG battle to the national stage

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Key Republicans in the US House of Representatives have formed a working group to “combat the threat” of ESG proposals. It has escalated the debate to the national stage and could threaten to derail the Biden Administration’s sustainability policies.

  • The new initiative is primarily targeting the Securities and Exchange Commission’s (SEC) proposals on climate risk disclosures.
  • By gaining control of the House of Representatives in the recent midterm elections, the Republicans are in a favourable position to oppose the Biden Administration’s sustainability policies.
  • The working group intends to “rein in the SEC’s regulatory overreach”, which could leave the US lagging behind the rest of the world in setting mandatory ESG disclosure rules.

The Republican war against ESG in the US has escalated to the national stage, with members of the House of Representatives forming a working group to combat what they have called a ‘fascist strategy’ being used by the ‘woke left’ against free markets. Backed by the fossil fuel industry, their multi-pronged attack has targeted individual banks and financial institutions, proxy services the firms, the SEC and the Department of Labour (DoL). 

They claim that a pro-ESG stance does not serve investors as it prioritises environmental, social and governance issues over earning a financial return, and imposes diversity, inclusion and equity standards on firms that do not want them. 

What is the agenda of the Republican’s ESG Working Group?

The latest development in a series of anti-ESG actions by Republicans in the US is the formation of an ESG Working Group in the House of Representatives. The group’s stated aim is to protect the average retail investor from “far-left environmental, social, and governance proposals”, and ensure that “American capital markets remain the envy of the world”. 

Specifically, it seeks to curb the SEC’s regulations on mandatory ESG disclosures and to make materiality the standard of their disclosure regime. The SEC’s climate risk proposal, which was released for public comment in March 2022, has drawn criticism from Republicans because they claim the SEC is exceeding its authority, and that the required disclosures are not material to making financial and investment decisions.

“Last year, the Supreme Court ruled in West Virginia vs EPA that government bureaucracies cannot arbitrarily expand their own regulatory reach,” said Congressman Bill Huizenga. “The SEC’s climate disclosure rule is a prime example of this overreach- that would have a wide-ranging impact on hard working Americans across all walks of life. I look forward to leading our committee’s ESG working group, which will focus on promoting strong, vibrant capital markets, while defending the interests of all retail investors.”

Multiple studies have shown a positive correlation between financial performance and sustainability, however, and a materiality-based ESG score has been shown to be a better predictor of returns when compared to a standard ESG score. Using an ESG lens provides investors with the information they need to allocate capital most efficiently, in line with their own risk appetite and for the highest, most stable return on investment.

Working group members have direct influence over SEC, regulatory policy

The working group was announced by House Financial Services Committee chairman, Patrick McHenry of North Carolina, and will be led by Congressman Bill Huizenga, chairman of the Oversight and Investigations Subcommittee. It also includes seven other Republican members of Congress.

The House Financial Services Committee has jurisdiction over the economy, the banking system, housing, insurance, and securities and exchanges, giving it direct influence over the Securities and Exchange Commission. The role of the Oversight and Investigations Subcommittee is to ensure the efficiency, effectiveness, and accountability of the federal government and all its agencies. Of relevance to the anti-ESG debate is the subcommittee’s oversight of energy policy and regulatory affairs.

The national debate over ESG could escalate further, after all 49 of the Republicans in the Senate backed legislation to strike down a Department of Labour ruling to permit pension plan managers to include ESG factors in their investment decisions. 

This legislation’s chances of passing are helped by the fact that it also has the backing of a Democrat senator, Joe Manchin from West Virginia, which banned five major financial institutions from doing business in the state in July 2022, due to their plan to limit involvement with the fossil fuel industry.

Restricting banks from providing financial services could result in higher interest costs for the state, and result in a burden to taxpayers. According to research by economic and policy consultant firm Econsult Solutions, the potential cost to taxpayers in six states mulling over anti-ESG laws, which includes West Virginia, could be as high as $700 million in excess interest payments per year.

Many of the Biden administration’s sustainability plans and proposals could fall under the purview of the committees led by members of the Republican working group. As such, they could be jeopardised since the Republicans control the House of Representatives, after gaining a majority in the 2022 mid-term election.

Where does this leave ESG disclosure regulation in the US?

A big concern for fossil fuel companies is the requirement to disclose data on their greenhouse gas (GHG) emissions, including their Scope 3 emissions, which comprise their upstream, downstream and supply chain operations. A major difference in the development of standards between the US and other major jurisdictions such as Europe, which are considered to be more advanced in their disclosure regulation, is their approach to materiality.

In the US, the International Sustainability Standards Board, which was launched by the International Financial Reporting Standards (IFRS) Foundation, has been focused more on an enterprise value approach. Such an approach means that the IFRS sustainability reporting standards have focused more on the financial impact of climate, biodiversity and other risks on business operations, rather than looking at wider systemic risk. 

While there was a shift in October 2022 when the IFRS said that it would look at including Scope 3 emissions in its reporting standard, there is still quite a difference between the two approaches. According to the SEC, clear, uniform disclosures on the costs of climate change will benefit both companies and investors.

Companies will be able to assess the potential climate-related costs and opportunities while investors will be able to better gauge risks at specific companies and compare risk levels across industries. Reining in the SEC’s ability to mandate Scope 3 emissions disclosures will definitely put US businesses and investors at a relative disadvantage to their European counterparts.

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