The U.S. has lagged behind the European Union in codifying standards that measure the environmental, social, and governance (ESG) impact of businesses. Now with the comprehensive approach of the EU Corporate Sustainability Reporting Directive (CSRD), the regulatory gap in America is becoming glaringly clear, with some States even backtracking on previous ESG commitments. What does this mean for U.S.-based global companies with worldwide ESG compliance needs?
The CSRD, approved last year by the Council of the EU, requires more in-depth ESG reporting by more companies than any EU directive before. To increase corporate accountability, companies will be required to publish detailed information on the sustainability of their business model and how external functions such as climate change or human rights issues affect their activities.
At present, the U.S. doesn’t have a comparable federal law or framework regulating sustainability. Instead, it has inconsistent, isolated state-level legislation that governs corporate ESG activities or requires disclosure of ESG risks and risk mitigation.
The labyrinth of state laws makes corporate compliance confusing, complicated, and difficult to navigate. This can be particularly challenging for American companies with global operations that would need separate compliance programs for every country and every state in the U.S.
Ideally, a company should have a unified, consistent, and integrated ESG compliance program. In the face of fragmented regulations in the U.S., some companies might be tempted to take a wait-and-see attitude and either delay or de-prioritize their ESG efforts. On the contrary, there’s much to be gained by remaining vigilant and adaptable. But first, you need a better understanding of the ESG regulatory landscape in America.
Federal Laws Slowly Emerging
The Securities and Exchange Commission (SEC) and the Department of Labor (DOL) are among federal agencies with sustainability rules affecting corporates most. The SEC, which requires public companies to disclose material financial risks, has proposed a rule that will also require disclosure of climate change risks and greenhouse gas (GHG) emissions. Among other things, registrants will be required to disclose information about their direct GHG emissions and from upstream and downstream activities in their value chains.
The DOL, which has oversight of retirement plans, including pensions and 401(k) plans, has issued a rule allowing the consideration of ESG factors in the investment of retirement accounts and in the exercise of shareholder rights, such as proxy voting.
U.S. President Joe Biden’s administration has proposed a rule that would require major federal contractors to publicly disclose their GHG emissions and climate-related financial risks and to set science-based emissions reduction targets. Businesses receiving more than $50 million in annual federal contracts are considered major contractors.
ESG Regulations on State Level
States with ESG-related laws are important regulatory drivers. This is where most hurdles lie for global companies with compliance programs that are unable to adapt on a state level.
In the fight against human trafficking, all 50 states have laws in place that criminalize trafficking, according to the National Conference of State Legislatures.
According to the group, Washington became the first state in 2003 to criminalize human trafficking. Since then, every state has enacted laws establishing criminal penalties for traffickers seeking to profit from forced labor or sexual servitude. Some states have laws that specifically target businesses violating anti-trafficking laws. The laws in Hawaii, Minnesota, and Vermont include procedures for dissolution of the entities.
Individual states similarly drive regulatory compliance in other areas of ESG by implementing ESG risk management, disclosure, and enforcement rules through consumer protection laws and ESG-related disclosure requirements for companies doing business in their jurisdictions.
Some state consumer protection laws include private rights of action that allow consumers to file lawsuits against businesses that make false or misleading marketing statements regarding their ESG risks and initiatives.
Without a federal ESG framework, it’s no surprise that state legislations are diffused. Here are some of the states with pro-ESG laws or proposed legislations:
California: Lawmakers have introduced a bill (SB 253) that would require companies to track and disclose regularly their GHG emissions. Another proposed legislation (SB 261) would require affected companies to disclose climate-related financial risks and measures adopted to reduce disclosed risks. A third bill (SB 252) would prohibit the boards of the Public Employees’ Retirement System and the State Teachers’ Retirement System from making new investments or renewing existing investments in a fossil fuel company. Meanwhile, the state’s Unfair Competition Law protects the public against false advertising of environmental impact claims.
Illinois: The Illinois Sustainable Investing Act, in effect since 2020, requires state and local government entities managing public funds to integrate sustainability factors into investment decision making, investment analysis, portfolio construction, due diligence, and investment ownership. The Business Corporation Act mandates public corporations based in Illinois to include in their annual public reports information about their boards of directors and policies and practices for promoting board diversity.
Maryland: The State Retirement Pension System-Investment Climate Risk-Fiduciary Duties, effective since 2020, requires the state retirement and pension board to consider climate risks in its investment policy, to develop a process to regularly assess certain impacts of climate risk, and to report annually on climate risk levels across the portfolio, among other things.
New York: Lawmakers have proposed a bill (A 4123) that would require companies within the state with over $500 million revenue to annually disclose climate-related financial risks and measures to address such risks. Another bill (SB 897) would mandate businesses with over $1 billion revenue to report emissions annually to an emissions registry and to independently verify the disclosures. The state’s pending Fashion Sustainability and Social Accountability Act would require fashion retailers and manufacturers to disclose environmental and social diligence policies and establish a benefit fund for social justice communities.
Just as there are states with pro-ESG initiatives, there are others with proposed bills meant to restrict or oppose ESG activities. New Hampshire passed a law prohibiting ESG investment by the state treasurer and the retirement system, while Idaho prohibits state investment boards and other public entities from considering ESG characteristics in investment decisions. Likewise, North Dakota prohibits investment of state funds for the purpose of “social investment.”
There are states with laws that prohibit them from doing business with companies that boycott fossil fuel companies and other sectors deemed harmful by ESG advocates. Those states include Kentucky, Oklahoma, West Virginia, and Texas.
Need for Adaptability and Versatility
The intricate landscape of state-level lawmaking and the dynamic realm of ESG considerations poses a substantial challenge. This challenge is particularly pronounced for American companies operating on a global scale, as they must grapple with the demand for separate compliance programs across numerous countries and U.S. states. However, despite these complexities, it remains imperative for such companies to embrace a proactive approach, maintaining vigilance and showcasing adaptability within their regulatory compliance efforts. By doing so, companies can ensure adherence to an intricate web of regulations but also foster a reputation for responsible and sustainable practices in an increasingly interconnected world.
For those navigating similar waters, a robust platform and methodology are indispensable, capable of providing unwavering support for due diligence, sustainability reporting, and compliance obligations across diverse geographical jurisdictions. To be at the forefront of this endeavor, companies must either establish or transform their existing ESG reporting and compliance programs into inherently flexible and versatile tools for achieving success.