SEC pressures won’t go away, ESG experts warn

Private funds' thinking has evolved from "risk management" to "value creation," PwC's Eric Janson says on RCW webinar

The SEC’s new public company ESG disclosure rules may or may not survive court challenges, but the regulatory pressures on firms won’t go away because they’re driven by investor demand, a panel of experts agreed at a 26 March webinar hosted by affiliate title Regulatory Compliance Watch.

“I think this isn’t just driven by lawmakers and regulators,” ILPA managing director Matt Schey said. “We see more and more LPs these days conducting climate risks assessments, thinking through their emissions, footprints, building out kind of their own ESG capabilities and expertise internally. I think that the booming popularity of ESG as an acronym the past few years has certainly resulted in a greater emphasis on climate, labor, supply chain-type issues.”

Whatever you think about the SEC’s latest efforts – federal courts have stayed implementation of the latest rules pending the myriad legal challenges they’re facing – they’re at least a stab at bringing the financial services industry “back to basics,” Schey said. “I think many of us would prefer to see this framed around the recognition and management of material risks, which can include environmental, social and governance risks as part of a broader diligence and company management process. It’s probably not at all about making [political] concessions as it is about being thorough and making smart business decisions.”

Schey spoke as one of three experts in a CLE/CPE webinar sponsored by RCW and affiliate title Private Funds CFO. He was joined by Eric Janson, who leads PwC’s private equity practice, and Debbie Franzese, a partner in and co-founder of Seward & Kissel’s ESG investment management practice.

‘Evolution in thinking’

Janson said it’s been striking to watch “the evolution in thinking” amongst private fund leaders on ESG, with or without regulators. If firms were initially thinking about ESG as a risk management question – “How do I avoid being sued?” or “How do I not get on the front page of the local city paper?” – they’re increasingly putting their “emphasis around, ‘How do I create value here?’” Janson said.

That doesn’t make the regulators irrelevant, Janson quickly added. California’s ESG law, for instance, requires large firms not only to disclose their Scope 1, 2 and 3 carbon emissions but to obtain some kind of third-party assurance by 2026. The EU’s CSDR requirements are every bit as stringent, and the thresholds even lower than California’s, Janson said. CSRD applies to companies doing business anywhere in the EU that have 250 employees and/or €50 million of revenue and/or €25 million of assets on the Continent, Janson said.

“The thresholds are relatively small,” he said. “So you start to think about the size of companies that will get pulled into this.”

New suite of questions

Companies that are subject to either California’s or Europe’s rules (or both) now find themselves having to answer a whole new suite of questions, Janson said. Firms “are having to do a level-set internally managing all of their stakeholders, from the financial folks, to the folks that sit in the sustainability business all the way up to the CEO, who is sometimes signing some of these representations. What data do we have? Where does it sit? How are we going to develop a process that has the appropriate governance around it to make sure we’re getting data fed up into these disclosures in a relatively efficient manner that can be trusted and then has an audit trail so that our external audit firm or outside provider can actually provide assurance on it?”

“I think that is where those are six month, one year, two-year type exercises to actually work through that in any sort of traditional corporate setting because of the nature of a lot of these disclosures I had mentioned before this isn’t like pulling off an amount that’s currently sitting on your balance sheet in some sub-general ledger account that’s subject to audit procedures,” Janson added.

More hedging?

Seward & Kissel’s Franzese reminded the audience that the SEC doesn’t necessarily need new rules to bring enforcement actions. Under the antifraud provisions of the securities laws, and in particular, under the substantiation requirements of the SEC’s marketing rules, fund managers have to think carefully about what they’re telling the public, and how they’re telling it.

“I think the Scope 3 emissions are probably the most difficult for people to really get comfortable with, particularly if you’re going to look for some kind of assurance from a third party,” she said. “I think in relation to the SEC materiality is something that companies have been thinking about in connection with their disclosures generally for a number of years, typically, the way it’s defined under the securities laws is information that a reasonable investor would consider important when making an investment decision, which is a relatively low bar.”

That’s especially true for firms and fund managers that have been aggressive in marketing their ESG products or thinking, Franzese said.

“And so I think that’s something that companies are going to have to grapple with if they’ve been maybe a little bit more forthcoming on some things,” she said. “It will be interesting to see now if they’re including some of this in kind of more mandated disclosures rather than voluntary. Does it provide for any kind of less certainty? Is there more maybe hedging than were included in other statements previously?”