When the U.S. Securities and Exchange Commission released their 2024 examination priorities, many were surprised that environmental, social, and governance did not make the list for the first time since added in 2021. This could be a signal of a shifting of priorities away from the ESG movement, or it could be a temporary pause in anticipation of new ESG regulations.
ESG is a type of investing where non-financial factors are considered as part of the decision-making process. As the name implies, those factors are divided into three categories: environmental, social, and governance. The environmental category receives most of the focus as part of the broader push for sustainability and the Paris Accord’s net zero goals. That is also the are where we have seen the most regulatory development.
In June, the International Sustainability Standards Board, a subset of the International Financial Reporting Standards Foundation, released their sustainable disclosure standards to be used as part of corporate financial reports. On July 31, the European Commission adopted the European Sustainability Reporting Standards for use by companies in the European Union. The ESRS follows the ESG template, incorporating the ISSB standards for reporting under the environmental category.
While the IFRS sets the international standard for financial reporting, the U.S. uses the Generally Accepted Accounting Principles set by the SEC. In March 2022, the SEC began the rulemaking process to develop Climate Related Disclosure Standards for publicly traded companies. In the wake of political pushback, and questions over their legal authority to take action, there has been a continued delay in the release of the final rule. A final announcement was anticipated for October 2023, but no action has occurred.
However, the SEC has taken a number of ESG related actions in the interim. On September 23, the SEC announced a $25 million settlement with DWS, a Deutsche Bank subsidiary, for misstatements regarding ESG investments and greenwashing. This followed a new rule announced on September 20 that amended the Investment Company Act “Names Rule” to include ESG and sustainable funds. The rule requires that ESG funds’ investments must be in 80% alignment with the stated goals of the fund, a move that could be problematic for the viability of ESG funds.
With the ESG related action, it was notable that the SEC Division of Examinations’ 2024 examination priorities did not include either ESG or sustainability as a focus.
“The Division conducts examinations and inspections of SEC-registered investment advisers, investment companies, broker-dealers, transfer agents, municipal advisors, securities-based swap dealers, clearing agencies, and other self-regulatory organizations. The Division prioritizes examinations of certain practices, products, and services that it believes present potentially heightened risks to investors or the integrity of the U.S. capital markets.”
Examinations are, in essence, narrow audits of the investment industry that include “analysis of an entity’s history, operations, services, products offered, and other risk factors.” The SEC began releasing examination priorities in 2011 as a guide for where the Division would focus for the upcoming fiscal year. ESG first appeared as a priority in 2021, and continued until removed in the recently released 2024 report.
This omission was originally noted by Bloomberg Law, and quickly caught the attention of the ESG industry, with mixed reactions. Some were quick to dismiss the change, noting that the priorities are not exclusive with examiners frequently looking at other areas as well.
However, the sudden removal of ESG as a priority does signal a shift. ESG has faced considerable pushback in the U.S., and is starting to experience it in the EU. The SEC backing off ESG as an examination priority could be a signal of a broader issue with ESG within the Commission. Paired with the delayed climate disclosure rule, and rumors it will be significantly scaled back, ESG proponents are rightfully alarmed. Whether this is a true change of priorities, or a simple realignment to allow the new rules to take shape, will only be revealed in the actions of the SEC over the next year.
