Securities Law and Climate Change

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    Introduction

    The convergence of climate change and financial regulations has become a pivotal concern, with profound implications for both the financial sector and regulatory frameworks. As climate change influences economies and societies, stakeholders are compelled to incorporate climate-related considerations into financial decisions. The U.S. commitment to reduce greenhouse gas emissions adds complexity to achieving ambitious goals. The Financial Stability Oversight Council (FSOC) recognized climate change as a risk to financial stability, prompting member agencies to enhance climate risk disclosures. The rise of ESG investments has shifted corporate priorities, aligning sustainability with success. The U.S. Department of Labor’s (DOL) rule emphasizes considering ESG factors within fiduciary duties. The SEC proposes climate-related disclosure rules, underlining climate’s financial significance. ESG factors fuse with green finance and sustainable investments, channeling funds towards responsible impact. Overall, climate change’s intersection with finance redefines risk assessment, transparency, and long-term growth in a dynamic landscape.

    • Growing Recognition of Climate-Financial Interplay: Climate change is recognized as a significant threat to financial stability, prompting businesses, investors, and regulatory bodies to integrate climate-related considerations into financial decision-making.
    • Challenges in Pursuing Climate Goals: The US commitment to reduce greenhouse gas emissions entails complex challenges including technological shifts, energy infrastructure revamping, economic impacts on carbon-dependent sectors, innovation, political/social dynamics, equity concerns, and international collaboration.
    • ESG Integration as Corporate Priority: Increasing investment in ESG factors has shifted corporate priorities. Businesses acknowledge the link between ESG and long-term success, integrating ESG considerations into objectives for resilience and impact.
    • US Department of Labor’s Final Rule: The DOL’s final rule emphasizes ESG and climate considerations in fiduciary duty. Investment managers must justify ESG relevance, tailor investment funds, align with prudent investment standards, and clearly outline ESG alignment within governance documents.
    • SEC’s Climate Disclosure Requirements: The SEC underscores climate change’s financial significance, urging companies to disclose material climate-related risks that could impact financial status and performance. Proposed rules seek standardized climate-related disclosures, encompassing governance, risk impacts, business strategies, and financial metrics.
    • ESG in Green Finance and Sustainable Investments: ESG integration in sustainable finance drives responsible investment decisions. Green financing mechanisms, like green bonds, fund projects addressing environmental challenges, aligning financial growth with societal and environmental wellbeing.
    • Factors Guiding ESG Investment: ESG-oriented investment factors include environmental impacts (e.g., sustainability, emissions), social considerations (e.g., labor practices, community relations), and governance aspects (e.g., transparency, ethics). Investors assess ethical screens, risk management, innovation potential, and long-term sustainability.
    Key legislation

    US Department of Labor’s ‘Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights’ rule

    Securities and Exchange Commission (SEC)’s rules on ‘The Enhancement and Standardization of Climate-Related Disclosures for Investors’

    General Impacts

    The intersection of climate change and finance/securities law has emerged as a critical and complex area of concern in recent years. As the repercussions of climate change continue to exert substantial influence on our environment, societies, and economies, there is a growing recognition of the profound impact this phenomenon can have on the financial sector and the regulatory frameworks that govern it. In response to the escalating risks posed by climate change, businesses, investors, and regulatory bodies are grappling with the need to integrate climate-related considerations into financial decision-making processes.[1] This dynamic interplay between climate change and financial law raises intricate questions about risk assessment, disclosure obligations, investment strategies, and the overall stability of financial markets.

    The United States has made a commitment to lowering U.S. greenhouse gas (GHG) emissions by 50-52 percent from 2005 levels by 2030 and set a goal of a net-zero emissions economy by 2050.[2] While being ambitious in pursuit of this goal, the process is accompanied by substantial challenges. These challenges encompass intricate technological transitions, the revamping of energy infrastructure, potential economic impacts on carbon-dependent sectors, the need for significant innovation and investment, navigating political and social complexities, ensuring equitable distribution of benefits, and fostering international cooperation. Successfully overcoming these obstacles will demand a combination of strategic policymaking, technological advancements, societal consensus, and a resilient approach to unforeseen difficulties.

    In its 2021 Report on Climate-Related Financial Risk (“2021 FSOC Report”),[3] the Financial Stability Oversight Council (FSOC) provided an initial evaluation of the threats posed by climate change as an emerging and increasing threat to financial stability. The report highlighted the initiatives undertaken by its member agencies to incorporate climate-related financial risks into their regulatory endeavors and enhance the disclosure of climate risks and other pertinent information. The 2021 FSOC Report suggested that member agencies should review existing mandates and explore the potential for updating relevant regulations. This would serve to enhance the assessment and mitigation of financial risks associated with climate change, while simultaneously fostering the “consistent, comparable, and decision-useful disclosures allow[ing] investors and financial institutions to take climate-related financial risks into account in their investment and lending decisions”.[4]

    Pursuing ESG Factors as a Fiduciary Duty

    The substantial influx of investments focused on ESG factors has catalyzed a significant shift in corporate priorities. Companies are increasingly recognizing that integrating ESG considerations into their objectives is not only aligned with responsible business practices but also essential for long-term success. This evolving landscape underscores the close connection of financial performance and sustainable practices, prompting companies to embrace ESG factors as an integral part of their strategic goals, fostering a more resilient and impactful business ecosystem.

    In 2020, a record $51.1 billion in additional funds was invested in ESG funds, approximately 10 times as much as during 2018.[5] Consequently, the huge volume of investments in ESG oriented vehicles has anchored the era “of a long but rapidly accelerating transition – one that will unfold over many years and reshape asset prices of every type”.[6]

    The US Department of Labor (DOL) issued the final rule on November 22, 2022, amending the “Investment Duties” regulation (“Final Rule”), which aims to provide clarity regarding the application of fiduciary responsibility duties outlined in the Employee Retirement Income Security Act of 1974 (ERISA). This includes the selection of plan investments that consider factors such as climate change and other ESG considerations. The main takeaways from the Final Rule are as follows:

    • Investment managers seeking involvement with ERISA funds should also incorporate explanations in their promotional materials justifying the relevance of climate and other ESG factors in risk-return evaluations. Concurrently, these discussions should be balanced with potential disclosures mandated by newly introduced SEC regulations (as explored below).[7]
    • Fund managers possess increased leeway to tailor investment funds to participant preferences and emphasize ESG attributes. However, fiduciaries must still prove that the fund aligns with prudent investment standards based on economic viability and risk-return considerations.[8]
    • Fiduciaries bear an obligation to clearly outline how ESG factors align with their fiduciary obligations within their internal corporate governance documents and external disclosures.[9]

    While the prevailing perspective often regards ESG factors in corporate management as supplementary considerations and not the primary one,[10] the emphasis placed by US federal agencies on disclosure and compliance requirements suggests a shifting landscape.[11] These requirements underscore the growing significance of ESG factors in the broader corporate framework. Despite the prevailing notion that ESG might be ancillary, the increasing focus on disclosure and compliance signifies a recognition of ESG’s material impact on business operations and its role in aligning companies with responsible and sustainable practice.

    However, it is important to acknowledge that the acceptance and emphasis on ESG factors are met with resistance in numerous states. Prominent example is the recent ban enacted by the Florida governor’s office (Florida’s State Board of Administration) prohibiting state-run fund managers from taking environmental, social or governance (ESG) factors into consideration when making investments.

    SEC Disclosure Requirements

    The U.S. Securities and Exchange Commission (SEC) underscores the importance of climate change as a financial consideration and urges companies to disclose relevant information. This includes material climate-related risks, both physical and transitional, that could affect a company’s financial status and performance. The rationale behind the SEC urging companies to disclose climate change-related information stems from the understanding that climate change presents both risks and opportunities that can significantly impact a company’s financial performance, operations, and long-term sustainability. By providing transparent and comprehensive climate-related disclosures, companies allow investors to make informed decisions that take into account these potential risks and opportunities.

    From a risk perspective, climate change can lead to physical risks (such as extreme weather events disrupting operations or damaging assets) and transition risks (such as changing regulations affecting business models or shifts in consumer preferences). These risks have the potential to affect a company’s financial condition and performance, which is why they are considered material information for investors.

    On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) proposed to enact rules requiring climate-related disclosures for companies (the “Climate Release”).[12] The proposed rules aim to establish a framework for standardized and enhanced climate-related disclosures in registration statements and periodic reports. Furthermore, the proposed rules align with established climate disclosure frameworks such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.[13] This alignment enhances consistency across disclosures and facilitates comparability among companies.

    Overall, the Climate Release requires the disclosure of following information in public offerings and periodic filings: (1) the registrant’s governance of climate-related risks and relevant risk management processes; (2) how any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term; (3) how any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook; and (4) the impact of climate-related events (severe weather events and other natural conditions and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.[14] The SEC’s proposed rule changes introduce several significant requirements for companies to disclose climate-related information to investors, which include:[15]

    • Climate-Related Risks Disclosure: The proposed rules mandate that companies disclose information about climate-related risks that have the potential to materially impact their financial condition, business operations, or results. These disclosures should encompass the company’s risk management processes and strategies related to climate risks.[16]
    • Impact on Business and Financial Statements: Companies are required to detail the tangible effects of identified climate-related risks on their business strategies, models, and financial statements. This disclosure should span various timeframes—short, medium, and long-term—to provide a comprehensive view.[17]
    • Climate-Related Financial Metrics: A notable addition is the introduction of climate-related financial statement metrics. These metrics, to be included in the audited financial statements, aim to enhance transparency regarding the financial implications of climate-related risks.[18]
    • Greenhouse Gas Emissions Disclosure: The proposed rules necessitate the disclosure of greenhouse gas emissions. This includes direct emissions (Scope 1), emissions from purchased energy (Scope 2), and, if relevant, emissions from the company’s value chain (Scope 3).[19]
    • Disclosures for Scenario Analysis and Targets: Companies already engaged in scenario analysis, transition planning, or those with climate-related targets must provide additional disclosures. This requirement aims to offer insight into companies’ proactive climate risk management practices.[20]
    • Attestation Report for Emissions Disclosures: Companies classified as accelerated filers and large accelerated filers are required to include an independent attestation report covering Scope 1 and 2 emissions disclosures. The phased approach intends to bolster the reliability of emissions-related disclosures.[21]
    • Compliance Phase-In Period: The proposed rules include a phase-in period tailored to companies’ filer status. Furthermore, a separate phase-in period is allotted for Scope 3 emissions disclosure.[22]

    Companies are advised to discuss climate impacts within their Management Discussion and Analysis (MD&A) sections, highlight pending climate-related legal proceedings, and detail the influence of climate change on their business operations, supply chains, and market dynamics. The level of disclosure varies based on factors like industry and materiality, allowing companies to provide investors with comprehensive insight into the potential impact of climate change on their operations and financial health.

    Integration of ESG in Green Finance and Sustainable Investments

    In today’s evolving financial landscape, the fusion of ESG factors with sustainable investment and green financing has become a driving force behind responsible and impactful financial decisions. ESG considerations guide the integration of ethical, environmental, and governance principles into investment strategies, ensuring that financial success aligns with broader societal and environmental well-being.[23] Concurrently, green financing mechanisms, epitomized by instruments like green bonds, channel investment toward projects that offer tangible solutions to pressing environmental challenges. This interconnected approach underscores the pivotal role of finance in fostering positive change, underscoring the profound potential to simultaneously achieve financial growth and contribute to a more sustainable world. According to certain calculations, the volume of funds allocated to sustainable investing has surpassed a value of $35 trillion.[24] In 2020, the Forum for Sustainable and Responsible Investment classified 1,741 funds as ESG funds, marking a significant increase from the 55 funds identified in 1995.[25] Notably, a growing number of funds have adopted names reflecting a commitment to socially responsible investment practices, with nearly 400 funds estimated by the S.E.C. to have embraced this approach.[26] Asset managers globally are expected to increase their ESG-related assets under management (AuM) to US$33.9tn by 2026, from US$18.4tn in 2021.[27]

    ESG financing is a unique and attractive investment for Companies, this distinguishing factor has caused the volume of ESG oriented investment to skyrocket. ESG-oriented investments consider environmental factors like sustainability and emissions, social aspects such as labor practices and community relations, and governance considerations like transparency and ethical leadership.[28] Investors also consider ethical screens, stakeholder engagement, risk management, innovation potential, and long-term sustainability. This approach emphasizes aligning financial success with positive societal and environmental impact while assessing companies’ responsible practices and their potential for growth in emerging markets.[29]

    In its Investor Bulletin dated February 26, 2021, the SEC delineated key criteria guiding fund decisions regarding portfolio composition and the selection of specific securities for investment choices. Notably, certain factors hold substantial importance and are carefully evaluated.[30] These pivotal elements receive considerable emphasis and deliberation in the decision-making process;

    • Environmental component – focuses on a company’s impact on the environment—for example, its energy use or pollution output. It also might focus on the risks and opportunities associated with the impacts of climate change on the company, its business and its industry.[31]
    • Social component – focuses on the company’s relationship with people and society—for example, issues that impact diversity and inclusion, human rights, specific faith-based issues, the health and safety of employees, customers, and consumers locally and/or globally, or whether the company invests in its community, as well as how such issues are addressed by other companies in a supply chain.[32]
    • Governance component – focuses on issues such as how the company is run—for example, transparency and reporting, ethics, compliance, shareholder rights, and the composition and role of the board of directors.[33]

    In recent years, there has been a notable increase in the incorporation of ESG covenants and objectives in financing agreements between companies and lenders, investors, or financial institutions.[34] ESG covenants are provisions within these agreements that require the borrower to meet specific ESG-related criteria or targets, while ESG objectives refer to the broader goals that the borrower aims to achieve regarding environmental, social, and governance considerations. As ESG considerations gain prominence, companies and financial partners are recognizing the importance of aligning financial agreements with ESG goals to enhance long-term value and mitigate risks.

    Future Trends

    The world of securities law and financial regulation is undergoing a profound transformation in response to the pressing issue of climate change. As the consequences of a warming planet become increasingly evident, a growing consensus among governments, regulators, and financial institutions is pushing for significant changes in the way we approach climate-related concerns within the financial sector.[35]

    A prominent trend emerging on this front is the development of stricter disclosure requirements. Regulators are recognizing the imperative of transparency when it comes to assessing climate risks and opportunities. Companies are being urged to disclose information not only on their carbon emissions but also on how climate change could impact their financial performance. This entails divulging their strategies for mitigating these risks and adapting to a changing climate. Such disclosures enable investors to make more informed decisions and facilitate the allocation of capital to businesses that are better prepared for the challenges ahead.

    Another critical trend is the advent of climate stress testing. Financial regulators are taking proactive measures to assess the resilience of financial institutions and markets to the shocks and disruptions caused by climate change. These stress tests evaluate the potential impacts of various climate scenarios on a firm’s assets, liabilities, and overall stability. By subjecting financial entities to these assessments, regulators aim to ensure that they are adequately prepared for the financial implications of climate change.

    Furthermore, the promotion of green finance initiatives is gaining momentum. Governments and regulators are actively incentivizing investments in environmentally sustainable projects and technologies. This encouragement extends to the issuance of green bonds, green loans, and other sustainable financial products, all of which channel capital towards endeavors that contribute positively to the environment while yielding financial returns.

    Lastly, carbon pricing mechanisms are being explored and implemented in some jurisdictions. These mechanisms impose a cost on carbon emissions, incentivizing companies to reduce their carbon footprint. Such pricing schemes not only serve as a financial deterrent for carbon-intensive activities but also provide an economic incentive for transitioning to cleaner and more sustainable practices.

    The world of securities law and financial regulation is evolving to meet the challenges posed by climate change. Stricter disclosure requirements, climate stress testing, green finance initiatives, and carbon pricing mechanisms are among the notable trends that signal a proactive response to climate-related risks and opportunities within the financial sector. These developments are not only reshaping the way businesses operate but also aligning financial markets with the urgent need for climate action on a global scale.


    [1] See e.g. Pierpaolo Grippa et al, ‘IMF: Climate Change and Financial Risk‘(IMF Finance and Development, December 2019) <https://www.imf.org/en/Publications/fandd/issues/2019/12/climate-change-central-banks-and-financial-risk-grippa> accessed 23 April 2024.

    [2] See President Biden’s Action to Tackle the Climate Crisis. Available at:<https://www.whitehouse.gov/climate/>accessed 23 April 2024.

    [3]Report on Climate-Related Financial Risk 2021‘ (Financial Stability Oversight Council (FSOC), 21 October 2021) < https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf> accessed 23 April 2024.

    [4] Ibid, p. 3.

    [5] Marcel Kahan and Edward Rock, ‘The Emergence of Welfarist Corporate Governance‘ (Law Working Paper N 683/2023, February 2023), p. 24.

    [6] See Lary Fink’s 2021 Letter to CEOs. Available at: <https://www.blackrock.com/corporate/investor-relations/2021-larry-fink-ceo-letter> accessed 23 April 2024.

    [7]SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosure for Investors‘ (Press Release No. 2024-31, 06 March 2024) <https://www.sec.gov/news/press-release/2024-31> accessed 23 April 2024.

    [8] Ibid.

    [9] See ‘DOL Final Rule on ESG Factors to Take Effect February 1, 2023‘, (Latham & Watkins Client Alert Commentary, no. 3058, January 24, 2023). Available at: <https://www.lw.com/admin/upload/SiteAttachments/Alert%203058.pdf> accessed 23 April 2024. Interest in ESG-themed investments has surged in popularity in recent years. One 2020 survey showed that nearly 74% of global investors intend to increase their allocation to ESG-oriented ETFs. SeeJoseph A. Lifsics, ‘DOL Proposed Rule Urges Caution Regarding the Use of ESG Factors for ERISA Plans‘ (Mayer Brown Benefits & Compensation Blog, 29 June 2020). Available at: <https://www.usbenefits.law/2020/06/dol-proposed-rule-urges-caution-regarding-esg/> accessed 23 April 2024.

    [10] The doctrine of shareholder supremacy was addressed by Delaware Supreme Court Justice Leo Strine when he stated: “a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare”. See Leo E. Strine, Jr., ‘The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law’ (50 Wake Forest Law Review 761,768, 11 March 2015).

    [11] Rationale of such policy was addressed by Florida Gov. Ron DeSantis in the press release; “Today’s actions reinforce that ESG considerations will not be tolerated here in Florida, and I look forward to extending these protections during this legislative session”. Available at <https://thehill.com/policy/energy-environment/3816573-desantis-prohibits-florida-state-run-fund-managers-from-considering-esg-factors/> accessed 23 April 2024.

    [12]SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors‘ (Press Release No. 2022-46, 21 March 2022) <https://www.sec.gov/news/press-release/2022-46> accessed 23 April 2024.

    [13] See the TCFD Annex from October 2021 (which updates and supersedes an earlier 2017 Annex) recommending and discussing metrics to be used in disclosing greenhouse gas emissions using the three scope framework. Available at: <https://assets.bbhub.io/company/sites/60/2021/07/2021-TCFD-Implementing_Guidance.pdf> accessed 23 April 2024; see also the Corporate and Accounting Reporting Standard issued by the Greenhouse Gas Protocol in 2015, recommending the same three scope framework for Company disclosures to report greenhouse gas emissions. Available at: <https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf> accessed 23 April 2024.

    [14] SEC Press Release (21 March 2022).

    [15] See the SEC’s final rules (Final Rules) on climate risks effective on 28 May 2024. Available at: <https://www.sec.gov/files/rules/final/2024/33-11275.pdf> accessed 23 April 2024.

    [16] Final Rules, Items 1505 and 1506.

    [17] Final Rules, All Reg. S-K and S-X, Item 1502(d)(2), Item 1502(e)(2), Item 1504(c)(2).

    [18] Ibid.

    [19] Final Rules, Items 1505 and 1506.

    [20] Final Rules, Items 1500 and 1502(f).

    [21] Final Rules, Item 1506.

    [22] Final Rules, p. 35.

    [23] Riccardo Boffo & Robert Patalano, ‘ESG Investing: Practices, Progress and Challenges’ (OECD Paris, 2020) <https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf> accessed 23 April 2024.

    [24] Saijel Kishan, ‘There’s $35 Trillion Invested in Sustainability, but $25 Trillion of That Isn’t Doing Much‘ (Bloomberg, 18 August 2021) <https://www.bnnbloomberg.ca/there-s-35-trillion-invested-in-sustainability-but-25-trillion-of-that-isn-t-doing-much-1.1641418> accessed 23 April 2024.

    [25] See the executive summary of the US SIF foundation’s 2022 report on US sustainable and impact investing trends. Available at: <https://www.ussif.org/Files/Trends/2022/Trends%202022%20Executive%20Summary.pdf> accessed 23 April 2024.

    [26] https://www.sec.gov/rules/proposed/2022/ia-6034.pdf at 185 (33 open end funds, 21 closed end funds and 35 UITs).

    [27] ESG-focused institutional investment is predicted to soar to 84% to US$ 33.9 trillion in 2026, making up 21.5% of assets under management. See PwC’s 2023 report, available at: https://www.pwc.com/gx/en/issues/c-suite-insights/global-investor-survey.html> accessed 23 April 2024.

    [28] Boffo & Patalano (2020), pp 11-15.

    [29] Ibid.

    [30]Environmental, Social and Governance (ESG) Funds – Investor Bulletin‘ (SEC, 26 February 2021) <https://www.sec.gov/oiea/investor-alerts-and-bulletins/environmental-social-and-governance-esg-funds-investor-bulletin> accessed 23 April 2024.

    [31] Ibid.

    [32] Ibid.

    [33] Ibid.

    [34] Duffy et al, ‘2021: The Year of the Sustainability-Linked Loan’ (Butterworth’s Journal of International Banking and Financial Law, November 2021).

    [35] Boffo & Patalano (2020), pp. 11-15.