Economy and Society: SEC planning largest regulatory push in decades

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C., and around the world

SEC planning largest regulatory push in decades says CNBC

According to a report from CNBC, the Securities and Exchange Commission (SEC) has a full agenda for 2022, with Chairman Gary Gensler planning to introduce the greatest number of rules and rules changes in decades. On February 9, the network reported the following:

“Securities and Exchange Commission Chair Gary Gensler has kicked off an ambitious regulatory agenda — and his agency is pushing forward with key measures focused on hedge funds and private equity.

The federal agency is meeting on Wednesday to consider three new rules: more disclosure from hedge funds and private equity funds, more disclosure regarding cybersecurity risks and attacks, and shortening the date on which stock transactions must be settled, a fallout from the GameStop saga. 

There are more than 50 proposed rules that Gensler is considering this spring, one of the largest regulatory pushes by the SEC in decades….

Surveying the more than 50 rules that are currently proposed or being finalized by the SEC, Shane Swanson, senior analyst at Coalition Greenwich, expressed amazement at their breadth.

“This is an aggressive agenda from the SEC,” he told me.

Swanson noted a common thread: “The broad theme is more disclosure and more reporting — it’s driving across all these issues.”

He also noted that part of the aggressive agenda — such as the focus on payment for order flow and shortening the settlement cycle — is a result of the GameStop controversy, and that it is understandable for Gensler to want to move on these issues while they are still fresh in the public mind.

“They have a lot of ideas that have been kicked around for a while, and in particular they want to act while there is focus on some of these issues [because of GameStop], like moving the settlement cycle,” Swanson said. 

“So there’s a bit of ‘let’s make things happen’ while they still have the public’s attention,” he added.”

Pushback against private company disclosure rules

In a recent cover story, Inc. magazine wrote of the concerns opponents of proposed SEC rules have about disclosure mandates for private companies:

“The Securities and Exchange Commission is pushing for more transparency — and though it’s mostly setting its sights on hedge funds and private equity shops, other public and private companies won’t necessarily be exempt. It’s is an initiative that the agency has been vocal about for some time.

SEC Commissioner Allison Herren Lee last October aired concerns over the lack of financial transparency at unicorns (companies with valuations of at least $1 billion), not to mention decacorns ($10 billion) and hectocorns ($100 billion). 

Estimates from CB Insights, a research and analytics firm, suggests that there are upwards of 1,000 unicorns around the world today. That’s up significantly from the 39 unicorns that Lee estimated were extant in 2013. 

Many of the requirements the SEC is pushing target large, private companies, hedge funds, or private equity shops. But that doesn’t mean small and mid-size businesses are unaffected here — especially considering that private companies are increasingly on the agency’s radar. 

Widespread transparency precedents could gain traction if the agency has its way. And in some instances, measures the agency is weighing for large companies could trickle down to small ones….

Congress never empowered the SEC to mandate disclosures based on a company’s valuation, according to Alex Platt, a law professor at the University of Kansas who specializes in financial and securities regulation. Instead, the SEC looks to another figure: the holders of record, or the registered owner of a security. Right now the disclosure threshold is 2,000 shareholders or 500 individuals who are not accredited investors. Accredited investors can include high-wealth individuals, those with various financial professional licenses, and different cohorts of institutional investors, Platt says. 

Beyond that cap, the company is required to go public and make the disclosures required of public companies. Platt explains that if a venture capital fund invests in a start-up, the fund is counted as “one” holder of record. But Platt says that the agency might be looking to propose a change to how that number is calculated.

The SEC is also considering regulation around the environment. Climate change is a key focus for the Biden administration, especially in reducing greenhouse gas (GHG) emissions. Since coming into office, Biden’s eyed the goal of reaching net zero emissions in the United States by 2050.

And as environmental, social and corporate governance (ESG) criteria become increasingly adopted, more companies are shouldering their own environmental responsibilities by cutting down on emissions.

Emission admissions could fall under three different “scopes.” Scope 1 pertains to a company’s direct GHG emissions while scope 2 includes a company’s indirect emissions, the latter usually associated with electricity or heating and cooling. 

Scope 3 emissions are those that are linked to entities that are not directly owned by a company, such as a third-party supplier. It’s also the scope that’s most likely to cause businesses more grievances: according to the Environmental Protection Agency, scope 3 emissions usually make up the largest portion of a company’s total emissions…. 

Any new SEC rules in this area are expected to affect all companies that make public statements about greenhouse gas emissions, according to David Slovick, a partner at the Indianapolis-based law firm, Barnes & Thornburg.

In Slovick’s view, there’s still the question of whether the SEC will give smaller companies a break on what they have to disclose, since their contributions to climate change pale in comparison to that of larger companies.

“That said, small and mid-sized companies will still be impacted disproportionately, both because they may not have the financial wherewithal to quantify the impact of climate change on their businesses, and because smaller companies typically have fewer resources to dedicate to preparing their public disclosures in the first place,” Slovick says.”

ESG rules are on the agenda in the European Union 

While the SEC continues to work through its own rules-making process, the European Union is moving forward on new ESG efforts. Indeed, the EU looks to be as busy as the SEC in the coming months:

“The year 2021 was a prolific one for environmental, social and governance (ESG) in the EU. The year 2022 looks just as productive for the EU legislature. 

Companies must comply with increasing obligations related to ESG. They must also do their best to meet requirements to have their businesses qualify as sustainable and to be noticed by investors on the EU market. 

Many legislative initiatives are also in the EU pipeline to ensure effective protection of human rights and the environment, involving potential further obligations for companies as well as their supply chains….

At the end of 2021, two European Commission (Commission) delegated acts were published in the EU Official Journal, allowing the EU Taxonomy Regulation to apply from 1 January 2022….

The first delegated act sets the technical screening criteria (TSC) to establish whether an economic activity contributes substantially to climate change mitigation and adaptation. Climate change mitigation and adaptation are two of the six objectives established in the EU Taxonomy Regulation, the main EU instrument to channel investors’ money toward sustainable activities and achieve the bloc’s climate goals. 

Therefore, since 1 January 2022, companies carrying out one of the activities listed in this delegated act are able to use the TSC to determine and report/disclose whether their activities are eligible and aligned with the EU Taxonomy as regards the objectives of climate change adaptation and mitigation (provided that such activities do not harm any of the other EU Taxonomy objectives). 

The second delegated act relates to the companies’ obligations to disclose how and to what extent their activities are associated with environmentally sustainable economic activities (Article 8 of the EU Taxonomy Regulation). The Article 8 delegated act provides for a simplified disclosure regime during a transitory period covering the year 2022. Thus, companies must report only on certain elements (regarding taxonomy eligibility) from 1 January 2022….

On 2 February 2022, the Commission presented its Complementary Delegated Act (CDA) on climate change mitigation and adaptation covering certain nuclear and gas activities.

Nuclear and gas related activities must meet the TSC set out in the CDA to be considered as contributing to climate change mitigation and climate change adaptation. Thus, upon the fulfillment of certain conditions, these activities could be included in the EU Taxonomy. The CDA also introduces specific disclosure requirements for businesses active in the gas and nuclear energy sectors to provide full transparency to investors. 

However, the CDA remains subject to the approval of the European Parliament (Parliament) and the Council of the European Union (Council). They will have four months from the Commission’s formal adoption to scrutinize the CDA and possibly reject it….

Increasing disclosure obligations apply to financial market participants and companies in the EU. 

The Sustainable Finance Disclosure Regulation (SFDR) provides for disclosure obligations that apply to financial advisors and financial market participants (fund managers’ insurance undertakings, investment firms and credit institutions providing portfolio management services).

Level 1 disclosures have applied since March 2021 (i.e., the disclosure of information about the financial market participants’ policies on the identification and prioritization of principal adverse sustainability impacts). 

Level 2 disclosures are more detailed disclosure requirements that were supposed to apply from 1 January 2022. However, the Commission has delayed the application of the Level 2 disclosure obligations because it has not been able to adopt the relevant regulatory technical standards (RTS). The draft RTS was submitted to the Commission by the European Supervisory Authorities in two tranches in February 2021 and October 2021, which, according to the Commission, did not leave enough time for a proper review. The Commission has therefore announced that the application of the Level 2 disclosures is postponed until 1 January 2023. 

However, financial market participants should already prepare for such disclosures, including by collecting all the relevant data.”

The EU is aiming to exempt companies from antitrust concerns, if the perceived good that they do outweighs the perceived harm they may cause:

“At the end of last year, the Commission published a communication titled “A Competition Policy Fit for New Challenges.” In its communication, the Commission acknowledges that companies should be allowed to cooperate to pursue genuinely green initiatives jointly. Thus, agreements restricting competition could be exempted if they brought benefits for customers that outweigh the harm caused—for instance, replacing non-sustainable products with sustainable ones and thus improving their longevity and increasing the value that consumers attribute to that product. Many issues remain, however—notably, the vexing questions of whether, how fast and under what conditions EU antitrust enforcers will be prepared to approve collective agreements that benefit the environment as a whole and that do not generate specific improvements for the customer class impacted by the agreement.”

On Wall Street and in the private sector

ESG off to a rocky start

According to Barron’s, ESG funds are off to a rocky start this year, trailing the markets, both domestically and globally:

“Funds that incorporate environmental, social, and corporate governance factors into their investment decisions, or ESG, have had a rocky start to the year.

Among the 170 funds with ESG mandates that focus on U.S. stocks, 40—less than a quarter—have outperformed the S&P 500‘s loss so far this year as of Friday, according to data from an investment research and analytics firm Morningstar. Forty-nine funds outperformed the index in all of 2021 and 73 in 2020. Only two sustainable funds have generated positive returns year to date.

The weakness goes beyond U.S. stocks. A recent analysis from Morningstar suggests that 34% of the firm’s ESG indexes, which include equities and bonds in various regions, outperformed their non-ESG equivalents in January. That’s lower than 2021’s outperformance rate of 57% and 2020’s 75%.”

Off to a rocky start, ESG continues to attract investors

Reuters notes the struggle to keep up with the market but also reports that the underperforming sector nevertheless continues to attract investors:

“Investors continued to flock to environmental, social and corporate governance (ESG) stock funds in January despite a slide in Big Tech hitting the funds’ performance, and as the market braces for more growth wobbles in the year ahead….

Data shared with Reuters by funds network Calastone, which tracks the trading of units in UK-domiciled funds, shows globally focused ESG stock funds took in a net $622.28 million from Jan. 1 to Feb. 3, compared with $543.56 million flowing to non-ESG stock funds.

Money kept flowing even though January was the worst month in over three years for the technology-heavy Nasdaq index and its tech constituents, favoured by ESG funds for their low emissions and high scores from ESG data providers….

The 10 biggest actively managed ESG funds tracked by Morningstar reported an average 9.2% loss in January, much steeper than the 5.3% drop in both the S&P500 and MSCI World indices.”