Sustainable Finance Policy Cleaves Down the Atlantic

Unbeknownst to the market, the UK Department of Work and Pensions (DWP) had been working on and in late August released proposals to integrate climate risk analysis into the pension fund investment process. Once again, the boundaries of sustainable finance regulation are being redrawn in unanticipated ways. In this article, details of these new proposals are discussed against the broader transatlantic ESG regulatory dichotomy.

Globally, Moody’s noted earlier in the year that the sustainable finance landscape remains shaped by a fragmented tapestry of overlapping voluntary regimes that together inhibit further growth of the sector and, moreover, engender greenwashing. The EU is seeking to overcome these issues with a single ESG regulatory regime. Likewise, the UK is gradually moving in the same direction, but with a Brexit drag slowing the pace of progress. On the other side of the Atlantic, however, a not-so-tacit policy antithetical to ESG considerations and regulation is playing out as four recent developments demonstrate.

U.S. Policies Reject ESG Considerations

First, there is the decision by the U.S. administration to withdraw from the United Nations Paris Agreement in November 2019. Second, there is the SEC press release of May 2020, rejecting formal industry recommendations calling for ESG regulation. Interestingly, SEC Chair Jay Clayton concedes the importance of each ESG factor but rejects the recommendations due to conflation of the factors, despite the recent out-performance of ESG funds versus benchmarks.

Then there are the U.S. Department of Labor (DOL) proposals to prohibit ERISA pension plan fiduciaries from subordinating pecuniary factors to ESG considerations. This policy position has met with an unprecedented volume of responses, almost all of which are negative, and several of which note how the proposals are at odds with consensus (though not universal) jurisprudence that consideration of ESG factors is also a fundamental obligation of a fiduciary.

The negative industry response has not deterred the DOL from doubling down on the issue by further announcing at the end of August another blanket prohibition on ERISA plan fiduciaries. The proposed rule would restrict voting at company meetings on non-pecuniary (read "ESG") issues, thereby curbing the efforts of a key segment of institutional investors from holding corporates and their management bodies to account.

In parallel, the DOL has apparently been sending out waves of enforcement letters to employers asking for a slew of documents on their ESG funds as well as the names, addresses, and responsibilities of all persons responsible for investment decisions in such funds.

The UK Aligns Its Policies More Closely to the EU

Meanwhile, as EU and U.S. policy further bifurcates, the UK has avoided taking a firm stand on the topic of sustainability. The Financial Conduct Authority (FCA) has adopted a modest intermediate position between the EU and the U.S., whereas the Bank of England has adopted a marginally more progressive stance. However, as a whole, the UK government has until now largely sat on the fence, as typified by its non-committal approach to the EU Taxonomy Regulation in June 2020.

As such, it came as a surprise to many in the industry when the DWP announced on August 26 proposals to integrate environmental sustainability into the pension fund investment process. Specifically, the UK is proposing that large occupational pension schemes integrate climate-related governance, strategy, and risk management measures and metrics into their investment process from both an investment risk and opportunity perspective. Funds would also be required to report on the outcomes of measures taken pursuant to these processes in their annual reports and accounts in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations. Investors would in turn be notified of these disclosures in their annual benefit statements.

The proposals are relatively detailed and include other innovations such as calculating and disclosing the carbon footprint of pension schemes and assessing the sensitivity of their underlying assets and liabilities to different temperature scenarios, including Paris Agreement aligned targets. This move signals that the UK is finally climbing down from the fence and opting for a policy approach more closely aligned to the EU, but with a unique British twist: the UK is doing things its way. Nevertheless, a bright line has now been drawn down the Atlantic.

Conclusion

The sands of the ESG regulatory landscape will likely shift again in the short to medium term and one should not underestimate the capacity for Brexit and a potential change in incumbency in the White House to fundamentally re-sculpt the ESG landscape yet again. Ultimately, regulation of the sustainable finance sector is acutely sensitive to political developments and given the febrile nature of Western politics today, one should expect the unexpected.