ESG Under a Trump Administration

For ESG and responsible investment professionals working in the U.S., the past few years have been marked by increasing politicisation. With Donald Trump’s recent election victory, supported by vocal ESG critics like Ron DeSantis, Vivek Ramaswamy and Elon Musk, the future of ESG (“Environmental, Social, and Governance”) and responsible investment in the U.S. is poised to face significant changes.

Amid this uncertainty, a useful starting point for grasping what may lie ahead is looking at a report titled “The Failure of ESG: An Examination of Environmental, Social and Governance Factors in the American Boardroom and Needed Reforms”, published 1st August 2024 and written by the “Republican Environmental, Social, and Governance (ESG) Working Group”.

This piece delves into the report’s key points, providing a sense of what may occur over the next four years with a Republican administration. This is not meant to be a prediction, but rather it aims to provide insights into likely activity.

The SEC

The report takes a strong stance against what it sees as overreach by regulatory agencies, particularly the SEC. It argues that the SEC’s Climate Disclosure Rule, which mandates that public companies report on the climate-related risks they face, plans to address those risks and greenhouse gas emissions, is excessive and ineffective. The report also claims that the rule is costly and does not align with the SEC’s core mission of protecting investors through material disclosures. Additionally, the report criticises the SEC’s efforts to introduce more extensive disclosures on workforce management, again viewing these as exceeding the scope of material relevance.

Therefore, regulations like the Climate Disclosure Rule could be further watered down or even repealed. It is worth noting that the SEC voluntarily stayed its Climate Disclosure Rule a month after it was announced due to legal challenges which are currently active in the U.S. Court of Appeals for the Eighth Circuit. Notably, the SEC recently disbanded its Climate and ESG Task Force within the Division of Enforcement, which many interpreted as a quiet shift away from ESG focused enforcement.

ESG Ratings

The report also addresses the inconsistencies and opacity within ESG ratings, their perceived inaccuracy as well as their impact on U.S. public markets, through their use by institutional investors as a means of creating ESG-focused financial products. However, the criticism of ESG ratings is not limited to this report and is somewhat aligned with how other countries, such as Japan and India, are beginning to view them.

Therefore, it is reasonable to expect the U.S. to also consider some form of regulation around increased transparency and consistency within ESG rating products.

Proxy Voting

The report singles out the U.S. proxy voting system as overly politicised and dominated by activist shareholders pushing agendas that may not align with long-term shareholder value. It criticises the low thresholds that allow ESG-focused proposals to be resubmitted repeatedly, even after being rejected by shareholders. Furthermore, the report addresses the influential role of proxy advisory firms like Glass Lewis and ISS, estimated to collectively control 97%¹ of the market. It argues that these firms prioritise ESG issues over financial performance and recommends that they be required to publish annual reports detailing their recommendations, the proposals they reviewed, and the financial rationale behind their advice.

Although some proxy advisory firms are now offering “ESG-sceptic” voting options, seen as a means of satisfying their “anti-ESG” client base, there is a possibility that more substantial reforms will be pursued.

CSRD and CSDDD

It is well known that the European Union is pushing sustainability through regulations like the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD). However, the report argues that these rules impose excessive compliance costs on U.S. companies operating in Europe, which may not align with American business priorities, putting them at a disadvantage. This stance suggests that the U.S. may pursue legislative action to limit the reach of these EU regulations on American businesses, setting up potential tensions between U.S. and EU regulatory approaches.

This could, in turn, actually impact how these regulations are perceived and implemented within the EU itself. There is a shifting mood in the EU around sustainability, especially related to the productiveness and efficacy of their sustainable finance regulations. Mario Draghi (President of the European Central Bank), in his report “The Future of European Competitiveness”, described the level of sustainable finance regulation as a burden on European competitiveness. This is something that will likely become even more apparent if U.S. firms are exempt from compliance.

Congress and the Courts

Finally, the report outlines three primary pathways to actively counteract the perceived overreach of ESG: Courts, Legislative Action and Congressional Oversight, all of which will likely see increased activity under the upcoming administration.

Courts: The judiciary is positioned as a key check on ESG regulations. Ongoing legal challenges, including cases against the SEC’s climate disclosure rules, may limit agency authority. Additionally, the report references ExxonMobil’s recent lawsuit, whereby activist shareholders agreed to withdraw their climate proposals—highlighting the courts’ role in curbing what the report views as activist-driven ESG influence.

It is worth noting that a number of anti-ESG laws have faced legal challenges themselves with courts in Missouri and Oklahoma stopping the introduction of such legislation.

Legislative Action: The report outlines several proposed bills by the House Financial Services Committee, including:

• H.R. 4767: Protecting Americans’ Retirement Savings from Politics Act — This bill aims to reform the proxy voting system, restrict the influence of proxy advisory firms, and limit activist-driven proposals that the Committee views as irrelevant to financial performance. It consolidates various earlier proposals focused on safeguarding retirement savings from perceived politically driven ESG agendas.
• H.R. 4790: Prioritizing Economic Growth Over Woke Policies Act — This act seeks to establish uniform disclosure requirements and prevent regulators from imposing non-material ESG disclosures that lack direct financial relevance.
• H.J.Res. 127 Providing for Congressional Disapproval of the Climate Disclosure Rule — This resolution provides for Congressional disapproval of the SEC's Climate Disclosure Rule, arguing that it exceeds the SEC's statutory authority and imposes undue compliance burdens on companies.
• H.R. 4655: Businesses Over Activists Act — This act is designed to protect companies from activist shareholder proposals. It would prohibit the SEC from compelling the inclusion or discussion of shareholder proposals and clarify that the agency does not have the authority to override state regulation of shareholder proposals or proxy materials. Again, this gives companies more ability to reject ESG-related shareholder proposals.

Congressional Oversight: The report details the House Financial Services Committee’s ongoing scrutiny and actions targeting the SEC. It highlights the committee’s current efforts to oversee “the ability of asset managers to fulfil their fiduciary responsibilities to prioritise financial returns and act in the shareholder’s best interest”, as well as requesting further information around how Glass Lewis and ISS operate in relation to how ESG factors inform their voting recommendations.

What Now and What to Do?

Although it’s very early days, and any long-term actions will ultimately depend on forthcoming policy announcements, the key message for companies and investors in this evolving landscape is unmistakable: financial materiality.

Although the report is highly critical of ESG factors, it does focus on the concept of materiality with 52 references to “material” and “materiality”. While it continues to propagate the view that ESG investing consistently prioritises values over value, one thing is clear—ESG reporting from corporates or ESG considerations within investment activities must be firmly anchored in financial materiality, risk mitigation and value creation, which includes an amount of judgement and will not be uniformly applied.

One practical step to ensure your responsible investment efforts are explicitly aligned with financial materiality is to break down the integration ESG information into its individual sustainability topics. The more specific you can be about each underlying topic’s relevance to your business or your investment, the stronger your case for financial materiality becomes. For instance, a real estate fund stating that “ESG impacts real estate” is less persuasive than one detailing how the increase in specific extreme weather events is directly affecting its portfolio.

Therefore, for asset managers and corporates, it’s time to go back to basics. Start by revisiting your approach towards ESG and responsible investment. Consider whether your approach is sufficiently grounded in financial materiality, directly contributes to long-term value creation, risk mitigation, and that evidence of this contribution is being sufficiently documented. In this new environment, a basic approach to responsible investment, with little consideration of financial materiality, is no longer viable.

However, most of NorthPeak Advisory’s asset manager clients have a global client base, often with diverging expectations around the consideration of ESG factors and responsible investment. As such, they cannot implement an investment approach that is everything for everyone, whilst investment processes also need to be grounded in what is practical to implement.

Assessing material information, including relevant ESG topics, that are likely to have an impact on the financial performance of an asset is fundamental to any robust investment process. Investors will need to adapt to the different directions that countries are taking as it relates to mandatory sustainability reporting and the availability of information that can be used within investment processes. For example, the focus on climate-related risks and opportunities is here to stay in Europe and other regions like Australia and may well remain for many U.S. investors. However, the ability for managers to be able to assess and report on this topic for certain U.S. investments will likely remain difficult.

At NorthPeak Advisory, we have always believed in the premise of financial materiality, but also understand the need that end investors have for ESG reporting and transparency flowing through the investment value chain. While the incoming administration in the U.S. may make that task more challenging, we feel that the investment community will continue to adapt to meet the demands of end investors and their beneficiaries.

NorthPeak Advisory works closely with clients, many of whom are simultaneously exposed to “pro” and “anti-ESG” clients with designing and implementing Responsible Investment processes that are practical, value add, and in line with investor expectations.

For further information on how NorthPeak Advisory can help you navigate upcoming ESG, Responsible Investment and Corporate Sustainability trends, both in the U.S., and beyond, please reach out to info@northpeakadvisory.com.

References

¹ Glassman, James K. and Verret, J.W., “How to Fix Our Broken Proxy Advisory System,” (April 2013), Mercatus Center. Available at: https://www.mercatus.org/system/files/Glassman_ProxyAdvisorySystem_04152013.pdf