A California bill that would impose some of the widest ESG reporting requirements in the US has cleared its first hurdle, and it may force some tough business choices on private fund advisers.

The Climate Corporate Data Accountability Act passed the California Senate’s Environmental Quality Committee 15 March. It now heads to the judiciary committee for a second hearing. If passed as written, it would require all companies that do business in California but have at least $1 billion in total revenues anywhere, to track and report their Scope 1, 2 and 3 carbon emissions. It would cover nearly 5,400 companies – including private fund advisers and their portfolio companies.

A similar measure came to the California senate floor at the very end of the legislative session last year. It failed by one vote. Backers are confident this one will go through. It would be the broadest carbon reporting mandate in the US.

The SEC has proposed Scope 3 reporting requirements for public companies, but Commission chairman Gary Gensler has hinted lately they may not make it to a final rule. By year’s end, the Commission’s rule may be moot for any adviser with national or multinational ambitions: A bill similar to California’s has been introduced in New York. Rules like it are already in place in the EU, the world’s largest economy.

The minefield

A difficulty is that a handful of states have passed or are considering rules or laws that pressure fund advisers away from ESG or impact investing. The proposals vary, but by-and-large they boil down to saying that a fiduciary’s duty is to a client’s wallet, not to a client’s conscience.

“There are certain statements that you might want to make in California which would drive value, but it might conflict with Florida law,” said Giovanna Ferrari, a partner at and co-founder of Seyfarth, Shaw’s Impact and ESG Group. “Whether you favour ESG or impact investing or not, there will probably be a series of business risks that you’re going to be exposed to. And you’re probably going to have to make some tough business decisions. You may need to change the way you talk about climate. Or you may have to determine what the penalties are in the different states and whether you can take the risk of non-compliance. Or you may determine you can’t do business in some states.”

A decade ago, this kind of patchwork state regulation would cry out for federal pre-emption. Businesses value “regulatory certainty” above all, and divided states often pressure the feds to step in with one set of rules for everyone. The problem there, Ferrari said, is Washington is just as divided on the question as states are.

On 20 March, president Biden vetoed legislation that would have scotched Department of Labor rules allowing pension fiduciaries to use ESG factors in their investment advice. It was the first veto of his presidency.

Values (and valuation)

Scott Wiener

Backers of the California bill said they’re okay with the anxiety the legislation creates. Climate is a global emergency, they said, and more than that, there’s a lot of money in ESG and impact investing, and it should be subject to some basic standards and measurements. As they see it, the bill merely lines up investor demand with common-sense rules.

“This bill is just basic data transparency. That’s all it is,” bill sponsor Senator Scott Wiener, D-San Francisco, told RCW in an exclusive interview. “It doesn’t mandate anything – companies can still do business however they want, but they’ll need to disclose their carbon footprint. It’s a very reasonable thing to have this information for investors, for consumers.”

Advocates for broader ESG reporting requirements said their “anti-woke” foes confuse values with valuation.

“Without this kind of data, it’s much harder to value a security,” said Alexandria Fisher, sustainable finance manager at the Global Risk Institute in Toronto. “Maybe your portfolio company has terrific cashflows, but if your key warehouses are on flood plains how can I—or any other investor – evaluate your risk?”

Caught in the middle

Private fund advisers are caught in the middle, along several axes. At the top end of the market, companies such as BlackRock say ESG/impact is a risk/opportunity question and that government should intervene just enough so that investors are able to compare like with like.

For some smaller private funds – indeed, for many smaller businesses – regulatory costs are already oppressive. Imposing sweeping reporting requirements on such ephemeral topics such as “sustainability” or “ethics”, these critics said, bends the back of small businesses.

“There is no public database of emission factors used by companies to estimate [carbon] emissions,” 13 California trade associations, including its Chamber of Commerce and its Business Roundtable, said in an open letter shortly after Wiener re-introduced his bill earlier this year. “In fact, there are hundreds of possible sources, not all agreed-upon by business and academic leaders, and many have different levels of granularity and accuracy. As such, emissions disclosure, especially in Scope 3, will likely be incomplete, inaccurate and inconsistent, possibly leading to misleading results.”

‘A tough space’

Whatever private fund advisers think about ESG investing, these next few years may be difficult, Ferrari said. If you’re already a multinational, or you aspire to be a multinational, you’re already likely required to track and report your emissions. If you’re a multistate company, or aspire to be one, you’re going to want to talk to your firm’s counsel.

“We’re in a tough space,” she said. “It’s harder if you’re in a state where you’re not supposed to consider ESG risks. It’s a matter of communicating with your clients. And it means being able to talk to people of different political persuasions.”

For now, Ferrari said, it’s probably best to take “an even deeper dive into all your firm’s external communications, whether it’s with consumers, or regulators, or institutional investors”. From now on, when you talk about ESG, “couch it as a risk proposition”, she said.

California’s Judiciary Committee is scheduled to meet again 28 March.