ESG Investing Is About to Get Easier. Here’s Why.

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Interest in sustainable and ethical investing is on the rise. A recent Gallup poll found that almost half of investors are interested in sustainable investing, with nearly 10% already doing so.

Many investing platforms offer environmental, social and governance (ESG) investing options, while research firms like Morningstar offer sustainability ratings. But as we’ve covered before at Investor Junkie, knowing if the companies you invest in are actually sustainable isn’t always easy.

The U.S. Securities and Exchange Commission (SEC) is trying to change that.

Earlier this year the regulator released a proposal for their highly anticipated climate-related disclosure rules. If adopted, the rules would have a massive impact on companies and investors alike. Here’s what you should know about the proposed changes.

The Short Version

  • A proposed SEC rule would require companies to report a number of climate-related disclosures, including their greenhouse gas emissions.
  • If adopted, the rules would make it easier for investors to find out which companies are combating emissions and are more in line with ESG investing.
  • However, some lawmakers and officials think the SEC is going too far and overstepping the regulator's authority, while some companies say the proposed third-party reporting requirements are too difficult to compile.

What Are the Proposed SEC Climate-Related Disclosure Rules?

The proposed rules require a minimum amount of disclosures from companies on their greenhouse gas emissions both from their operations and the energy they consume (you can read the full 490-page proposal here).

It would also require companies to obtain independent certification of the emissions. And in some cases, companies would have to report greenhouse gas emissions of their supply chains and consumers, known as Scope 3.

Carbon offsets would also have to be disclosed. Companies would need to describe any climate-related risks they face and how they're mitigating those risks. And they may be other climate-related disclosure rules. For example, corporations may need to report any transition plans to deal with global warming or the impact of physical risks (like hurricanes or flooding) on the company's bottom line.

Lastly, any climate targets or commitments made by companies would also need to be disclosed, as well as plans to achieve those goals.

It’s important to note that the rules are not yet adopted and likely won’t be for some time. Public comment just closed yesterday, May 31, 2022. Now the SEC will take feedback into account and propose a final rule. Once adopted, there would be a phase-in time period, with larger companies expected to start reporting in 2024 and smaller ones in 2026.

Why Is the SEC Proposing These Climate Disclosures?

“Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies. And investors need reliable information about climate risks to make informed investment decisions.”

The SEC’s role is to protect investors and require companies to disclose risks and any other information they consider material to the firm. Investors use these reports on the financial health and governance of a company to make financial decisions.

SEC officials claim they are responding to investor demand to streamline ESG disclosures. While many companies do release emission data, there is no consensus on the type and frequency of data that needs to be released.

“Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies,” SEC Chair Gary Gensler said in a press release. “And investors need reliable information about climate risks to make informed investment decisions.”

The proposals align with a reporting regime known as the Task Force on Climate-Related Financial Disclosure, a voluntary effort that asks corporations to report their greenhouse gas emissions and how they manage climate change risk.

Many scientists believe that human-caused climate change has led to hotter summers and more extreme weather conditions across the globe, with the last seven years being the hottest years on record. Inclement weather can impact the supply chains of companies, as well as lead to credit risk, insurance risk, and other related financial risks.

Are There Any Downsides to the Proposed Rule?

“According to finance company MSCI, only 15% of companies disclose any part of their Scope 3 emissions.”

Not everyone is happy about the proposed rules. Republican SEC commissioner Hester Peirce voted against the proposal, which passed in a 3-1 vote. She thinks the proposed rules place the interest of environmental activists ahead of shareholders.

″[The proposal] forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial performance,” Peirce said in a statement of response to the proposed climate change disclosures.

Other lawmakers claim the SEC is going beyond its mandate to protect investors by requiring disclosures related to a company's financial performance. And West Virginia’s attorney general has threatened to sue the SEC over the proposed plans.

Some companies and lobbyists are against requiring Scope 3 disclosures as they claim the information is outside of their control and difficult to compile, let alone estimate. According to finance company MSCI, only 15% of companies disclose any part of their Scope 3 emissions.

The proposed rules could also cause increased costs to companies, especially for companies that aren’t already gathering ESG data.

The SEC estimates that for larger companies, costs could run up to $640,000 in the first year and $530,000 in subsequent years. For smaller companies, they expect the first year to cost $490,000 and $420,000 in annual costs after the first year.

What Does the SEC’s Climate Change Disclosures Mean for Investors?

According to data from Statista, 63% of Americans are worried about global warming. For investors who want to make sure they're investing in companies that are lessening their greenhouse gas emissions, the SEC’s proposed rules are groundbreaking.

The rules won’t just help individual investors looking at specific companies. It will also help asset and fund managers who pick stocks and bonds to put into exchange traded funds, pensions, and institutional portfolios.

With the disclosures, they can decide to limit exposure to companies with climate change risks. In turn, this could indirectly impact millions of investors who hold funds in ETFs and pension funds. Large shareholders could leverage their stake in companies to persuade management to do more if they feel the corporations aren’t addressing climate risk.

The SEC climate change disclosure rules allow the entire industry to be more aware of what they are investing in. ESG investing won’t have to be limited to a few carefully selected funds here and there. Sustainability could become another risk criteria portfolio managers take into account, like credit or economic risk.

In other words, ESG investing could become mainstream.

The Bottom Line: ESG Investing Is About to Get Easier

It’s likely some government officials and lobbyists will push back on some of the current provisions. Regardless, the SEC has made it clear it thinks corporations need to be more transparent about their climate change risk.

While it will be a few years before the SEC’s climate-related disclosure rules are implemented, the impact it will have on investors is huge.

Climate change risk could become another common risk that investors will need to take into account when managing their portfolios. And for investors who already invest in ESG funds or are interested in sustainable investing, the new rules will make it even easier to make sure your investing portfolio isn’t contributing to climate change.

Ready to get a head start on ESG investing? Check out our guides here: 

Moriah Costa

Moriah Costa is a freelance financial journalist specializing in specializing in business and investigative reporting. Moriah obtained her Master's in Financial Journalism from City, University of London and holds a BA in Journalism from the Walter Cronkite School of Journalism and Mass Communication. Her work has appeared in Thomson Reuters, the Arizona Republic, Washington Business Journal, Benzinga, and more. When she isn't writing or reading the news, she makes art journals and travels around Europe.

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