On June 16, 2021, the U.S. House of Representatives passed legislation that would impose new ESG due diligence and disclosure requirements on publicly traded companies. H.R. 1187 – the ESG Disclosure Simplification Act of 2021 – would require publicly traded companies to disclose their commitments to ensuring that environmental, social (human rights), and good governance standards (ESG) are reflected in their operations, activities, and supply chains.
The Legislation’s Impact on ESG Due Diligence and Disclosure
Specifically, Section 3 of the Act would mandate that public companies listed with the U.S. Securities and Exchange Commission (SEC) disclose at their shareholder meetings “a clear description of the views of the [SEC-listed company] about the link between ESG metrics and the long-term business strategy” of the company; and “a description of any process” the company uses to “determine the impact of ESG metrics on the long-term business strategy” of the company. Subsequent rulemaking would also define the ESG metrics that are to be disclosed and set requirements for corporate disclosure of ESG metrics in audited financial statements.
H.R. 1187 would also establish the Sustainable Finance Advisory Committee, (SFAC) a permanent body that would have no more than 20 members and that would advise the SEC on ESG metrics, standards, and disclosure. Within 18 months after the SFAC’s first meeting, the body would be required to issue a report that identifies challenges and opportunities for investors associated with sustainable finance and recommend policy changes that facilitate the flow of capital towards sustainable investments, particularly environmentally sustainable investments.
Section 4 of the Act would require that the SFAC submit to the SEC recommendations regarding what ESG metrics the SEC should require companies to disclose. Additionally, the Act would allow the SEC to incorporate any internationally recognized, independent, and/or multi-stakeholder ESG disclosure standards in defining ESG metrics and the disclosure process.
The Act was drafted by the House Financial Services Committee. Since coming under Democratic control in 2019, the Committee has spearheaded a passel of legislative initiatives that are focused on increasing accountability and social responsibility within the corporate sector.
In championing the legislation, the Financial Services Committee noted that (1) the SEC does not currently require companies to disclose information related to their ESG commitments, nor does it require companies to adhere to standards for disclosing such information; (2) investors have reported that voluntary disclosures of ESG metrics are inadequate; (3) statutes and regulations requiring reporting and standardization of ESG disclosures are in the interest of investors; and (4) ESG standards are “material to investors,” meaning the SEC is obligated to establish standards for disclosure of such matters.
Towards a Mandatory ESG Standard
H.R. 1187 comes at a time when expectations for corporate social responsibility have become more fulsome and expansive. Shareholders and consumers alike expect companies to meaningfully fulfill their corporate responsibilities as prescribed by the U.N. Guiding Principles on Business and Human Rights (UNGPs). The UNGPs establish a strong expectation that companies will identify salient harms their activities might engender, remedy such harms when they occur, and make changes to their policies and operations that can help prevent future harms.
With the mainstreaming of ESG has come a clearer understanding that environmental sustainability is also a human right, and risks associated with climate change have the potential to severely undermine the enjoyment of rights. In principle, the standard that is emerging around ESG establishes a more nuanced and holistic corporate responsibility to prevent harms. At the same time, countries in which some of the largest multinational companies are domiciled are moving in the direction of making ESG due diligence and disclosure mandatory.
Leadership at the SEC recently signaled that the agency will make ESG reporting binding on SEC-listed companies. At a whole-of-government level, on May 20, 2021, President Biden issued an Executive Order to address predicted financial instability in the federal government as a result of climate change. This Executive Order showcases how the Biden Administration’s stance towards corporate ESG standards will differ dramatically from that of the previous administration.
While the Executive Order’s policy and regulatory scope is mainly limited to the federal government and its contracts, it has potentially significant implications for the private sector. The Executive Order expects companies to collaborate on efforts to ensure “economic opportunity, worker empowerment, and environmental mitigation, especially in disadvantaged communities and communities of color.” On the whole, the Executive Order is part of a growing trend in the Biden Administration of promoting corporate ESG standards and principles.
Internationally, the E.U Parliament earlier this year passed a landmark piece of legislation that paves the way for binding regulations setting a corporate duty of care centered around ESG due diligence and disclosure. The regulations, which will likely be promulgated by the European Commission later this year, will require both small and large companies operating in the European market to respect human rights, protect the environment, and comport with ethical business practices in their operations and supply chains, including through their direct commercial partnerships with other business entities and suppliers.
Positions on H.R. 1187 in Congress are currently divided on a party line basis; the vote on final passage in the House received no support from Republicans.
Senate Majority Leader Chuck Schumer (D-NY) will now consider whether to schedule H.R. 1187 for a vote in the Senate, aware that the bill will need support from 10 Republican Senators in order to pass in that chamber and become law. If Senate Republicans were to support the measure, they would likely first insist on changes to key provisions in the current text.
Regardless of the outcome, ESG due diligence and disclosure are fast becoming incumbent on companies active in both U.S. and international markets. Although H.R. 1187 may not become law, the Biden Administration has made ESG a greater focal point of its regulatory agenda, while Congress and international jurisdictions will likely advance other measures aimed at standardizing and mandating ESG.