Written by Enayat Kapadia
If you were to conduct a survey and ask people what the biggest issue facing the world is today, one of the most common answers would be climate change. Indeed, in a University of Bath study which surveyed 10,000 people aged 16-25, 75% of respondents saw the future as ”frightening” with respect to climate change, and 65% believed that governments were failing to protect their citizens from the effects of climate change.  Despite the level of concern, addressing climate change has proved to be a difficult task; not one country scored in the “very high” category of the 2020 Climate Protection Index, indicating that every nation is falling short in the efforts necessary to “avoid dangerous climate change.” 
One of the biggest contributing factors to this can be found by examining the sources of global emissions. The CDP’s 2017 Carbon Majors report found that over 70% of greenhouse gas emissions since 1988 have come from only 100 companies, many of which are well-established, investor-backed oil and gas giants like ExxonMobil and British Petroleum.  At first glance, this would seem to imply that investors don’t pay much attention to the environmental effects of the companies they put their money in; however, while that sentiment may have had some validity in the past, a new focus in business known as “ESG” is turning it on its head.
ESG, or environmental, social, and governance, refers to the environmental impacts of a firm’s operations (environmental), the diversity and inclusiveness of the firm (social), and the methods used to select the board of directors and oversee the firm (governance).  While this may sound qualitative and theoretical in nature, it has become a numbers-driven process in the world of investing. Analysts have begun to put out scores for various companies assessing their ESG performance which are becoming an increasingly important part of investment decisions that direct the flow of large sums of money.  For example, in 2020 alone, $51 billion flowed into sustainable US mutual funds, which was 10 times the amount invested in 2018.  In conjunction with the increasing scientific focus on climate change, this explains why the SEC is working on rolling out a “climate-disclosure regulation” proposal in the near future, something which already has White House support and is available for public comment. 
Considering the amount of emissions corporations produce, many see this as a good thing; indeed, the SEC’s comment request saw three out of every four remarks speak favorably about theoretical disclosure requirements.  Unfortunately, the reality of the situation is much different—while it wouldn't be too difficult to argue that we have a robust technical understanding of anthropogenic climate change and a desire to respond to it, we must also acknowledge that this doesn’t imply a readiness for ESG disclosure requirements.
To begin, there are several technical questions surrounding ESG disclosure that must be explored before any requirements can be implemented. Most pressingly, no one really agrees on what ESG means beyond the general qualitative description which was provided above. A Wall Street Journal analysis of quantitative ESG scores issued to 1,500 companies by three separate rating firms found that 942 companies received different grades from different raters.  Additionally, almost a third of companies that were marked as “ESG leaders” by one firm were also marked as “ESG laggards” by a different firm.  The reason for this? Each rater emphasized different ESG components; for example, when rating Chevron Corp, one rater more heavily emphasized social issues like diversity while another focused on Chevron’s heavy investment in fossil fuels, leading the former to tab them as an “excellent” ESG performer while the latter declared them a “severe risk” as an ESG investment. 
This issue may seem irrelevant to evaluating the merits of ESG disclosure requirements- after all, it doesn’t seem ridiculous to suggest that people should have the data even if there’s no consistent way for them to evaluate it. The problem with this line of thinking is that it views ESG requirements solely as a means to provide information to the investor rather than as a tool for directing capital towards socially and environmentally responsible companies. A 2021 PRI study that examined the effect of ESG disclosure requirements in other countries from 2004 to 2016 found that “ESG disagreement is most pronounced for firms with high levels of ESG disclosure” as more data means more opportunity for ambiguity in evaluation.  Thus, if the SEC were to follow through with their planned disclosure requirements, the already high levels of confusion professional analysts have when evaluating companies would be made even worse, creating an environment where it is virtually impossible for investors to know if they are making a sustainable investment, and if so, in what kind of sustainability.
Narrowing the focus to the environmental component of ESG reveals another issue: there is widespread disagreement on how to define and quantify emissions. For context, there are three kinds of emissions: those resulting from company operations (scope 1), those from energy bought by the firm (scope 2), and those produced by the employees, suppliers, and customers of a firm (scope 3).  Unsurprisingly, scope 3 emissions are exceedingly difficult to quantify given the sheer number of variables involved in such a calculation. Consider a car-door maker trying to report their scope 3 emissions; they would not only have to track upstream emissions from mining operations and raw materials transportation, but also downstream emissions generated by car manufacturers and consumers who use the finished cars.  As if the errors in the process weren’t enough, the SEC is not even sure whether companies should include scope 3 emissions in their calculations in the first place. In a speech earlier this month, SEC Chairman Gary Gensler asked his staff to determine whether companies should have to disclose scope 3 emissions “’and if so, how and under what circumstances.’”  If companies are having a hard enough time calculating scope 3 emissions as it is, and the SEC has no guidance for them on either what the expectations are or how they should go about it, why is discussion of a regulation around it even on the table? One option may be to exclude scope 3 emissions from a potential disclosure requirement, but, given that they make up 65-95% of a company’s total emissions, such a decision would be misleading and harmful to investors trying to make environmentally-focused investments. 
Before either of these technical concerns can be addressed though, there are a number of legal issues the SEC must also consider before it makes its proposal. To make sense of these issues, it is important to understand the basis of the SEC’s legal authority to regulate disclosures by companies. Section 13(a) of the Securities and Exchange Act only requires the disclosure of “necessary and appropriate information,” while Rule 10b-5 of the act says disclosure requirements must be for “material” information, that is for information that an investor would see as important when deciding on an investment.  Consequently, the SEC would have to articulate its reasoning for how ESG data are material to the decisions made by investors. While it may not be intuitively difficult to come up with such an explanation, SEC Commissioner Elad L. Roisman pointed out in a speech earlier this year that any suggestion of a climate change “goal” would go expressly against this principle of materiality.  Comments hinting at challenges to the requirement based on such an idea have already been made by West Virginia Attorney General Patrick Morrisey, who called the proposal an attempt by the SEC “to expand its congressional mandate into unrelated social manners.”  Unfortunately, regulation with a climate change goal would be much more effective at encouraging sustainable investment than a regulation without such a goal; as such, it may best be left to agencies like the EPA or Congress who aren’t constrained by the materiality principle. 
Another potential legal challenge comes from the Constitution, as some opponents have already suggested that ESG disclosure requirements violate the First Amendment’s compelled speech doctrine. The doctrine prevents the government from forcing people to speak or not speak in a certain way; critics argue that the proposed regulation would violate it since it may force companies to make comments about business operations that are detrimental or subjective.  There is legal precedent for this type of challenge to disclosure as well. In National Association of Manufacturers v. SEC, the US Court of Appeals for the District of Columbia struck down the requirement to disclose conflict minerals in the Dodd-Frank Act based on the compelled speech doctrine.  While the decision wasn’t unanimous, it does at least provide precedent which suggests the SEC would be fighting an uphill battle against challengers in court. 
However, it should be noted that all these issues currently complicating the SEC’s proposal are not an inherent indictment of the desirability of more uniformity and accountability in ESG disclosure. As mentioned above, three out of every four companies which have commented so far have been in favor of standardized disclosure, and there is no reason to think that consumers would be upset with more information.  The problem is the timing––we currently don’t know enough about what ESG is or how to disclose it to design effective regulations around either of those things. As Roisman said in his speech, “SEC rule-writing is slow by design… we want to feel confident that [new rules] will be relevant for many years to come since the Commission normally does not revisit them for some time.”  Climate change is an issue which is not going away any time soon; thus, it seems worth it to put off disclosure requirements by a few years if it means we can get it right and harness them as an asset in the effort to save the planet.
 Robby Berman, Eco-anxiety: 75% of young people say ‘the future is frightening’, Mᴇᴅɪᴄᴀʟ Nᴇᴡs Tᴏᴅᴀʏ (Sep. 28, 2021), https://www.medicalnewstoday.com/articles/eco-anxiety-75-of-young-people-say-the-future-is-frightening.
 Jeannette Cwienk, How Successful are Intentional Climate Efforts?, Dᴇᴜᴛsᴄʜᴇ Wᴇʟʟᴇ (Sept. 24, 2020), https://www.dw.com/en/climate-emissions-paris-agreement/a-55044341.
 Tess Riley, Just 100 Companies Responsible For 71% of Global Emissions, Study Says, Tʜᴇ Gᴜᴀʀᴅɪᴀɴ (Jul. 10, 2017), https://www.theguardian.com/sustainable-business/2017/jul/10/100-fossil-fuel-companies-investors-responsible-71-global-emissions-cdp-study-climate-change.
 ESG Board Governance, Dɪʟɪɢᴇɴᴛ, https://www.diligent.com/insights/esg/.
 Dane Christensen et al., ESG Rating Disagreements: Why is Corporate Virtue so Subjective, Pʀɪɴᴄɪᴘʟᴇs ғᴏʀ Rᴇsᴘᴏɴsɪʙʟᴇ Iɴᴠᴇsᴛᴍᴇɴᴛ (May 7, 2021), https://www.unpri.org/pri-blog/esg-rating-disagreements-why-is-corporate-virtue-so-subjective/7633.article.
 ESG Board Governance, supra note 4.
 Robert S. Kaplan & Karthik Ramanna, Accounting for Climate Change, Hᴀʀᴠᴀʀᴅ Bᴜsɪɴᴇss Rᴇᴠɪᴇᴡ (Nov. 2021), https://hbr.org/2021/11/accounting-for-climate-change.
 ESG Board Governance, supra note 4.
 Eric Rosenbaum, Climate Experts Are Worried About the Toughest Carbon Emissions for Companies to Capture, CNBC: ESG: Iᴍᴘᴀᴄᴛ (Aug. 18, 2021, 6:19 PM), https://www.cnbc.com/2021/08/18/apple-amazon-exxon-and-the-toughest-carbon-emissions-to-capture.html.
 Jonathan D. Brightbill & Jennifer Roualet, Evaluating Challenges to SEC’s ESG Disclosure Proposal, Wɪɴsᴛᴏɴ & Sᴛʀᴀᴡɴ LLP (Aug. 25, 2021), https://www.winston.com/en/winston-and-the-legal-environment/evaluating-challenges-to-secs-esg-disclosure-proposal.html?utm_source=Mondaq&utm_medium=syndication&utm_campaign=LinkedIn-integration.
 Elad L. Roisman, Chairman, U.S. Securities and Exchange Comm’n, Can the SEC Make ESG Rules That are Sustainable? (June 22, 2021), https://www.sec.gov/news/speech/can-the-sec-make-esg-rules-that-are-sustainable.
 Brightbill & Roualet, supra note 17.
 Roisman, supra note 18.
 Brightbill & Roualet, supra note 17.
 Jean Eaglesham & Shane Shifflett, How Much Carbon Comes From a Liter of Coke? Companies Grapple With Climate Change Math, Wᴀʟʟ Sᴛʀᴇᴇᴛ Jᴏᴜʀɴᴀʟ (Aug. 10, 2021, 11:12 AM), https://www.wsj.com/articles/climate-change-accounting-for-companies-looms-with-all-its-complexities-116286083
 Roisman, supra note 18.