1 Legal and enforcement framework
1.1 What regulatory regimes and codes of practice primarily govern environmental, social and governance (ESG) regulation and implementation in your jurisdiction?
The United States has a federal system of government, which means that laws and regulations can be made at the federal level for nationwide coverage, or by states and local governments for more site-specific coverage. Currently, no comprehensive federal or state framework exists that regulates ESG; instead, a patchwork of federal and state laws and practices govern ESG activities and, in some cases, require disclosure of ESG risks and risk mitigation:
- The US Securities and Exchange Commission (SEC), which regulates the sale and distribution of securities in the United States, requires public companies to disclose 'material' financial risks. The SEC has issued guidance confirming that ESG risks – including climate change, human capital, and cybersecurity issues – may trigger these disclosure obligations. Reporting companies may have liability if the disclosures they make are considered misleading. In March 2022, the SEC proposed comprehensive rules governing disclosure of public companies' climate change risks and greenhouse gas (GHG) emissions ('proposed SEC rules') aligned with existing disclosure frameworks that would require registrants, among other things, to measure and manage GHG emissions from operations, value chains and mitigation actions. As of the date of publication, the proposed SEC rules remain subject to public comment and have not been finalised.
- The Federal Trade Commission (FTC) prohibits deceptive marketing, including marketing related to companies' ESG initiatives.
- The Financial Stability Oversight Council, composed of the heads of the top US financial agencies, has identified climate change as a threat to US financial stability and recommended steps for an orderly transition to a net-zero economy.
State and local governments also drive ESG risk management, disclosure and enforcement, using state consumer protection laws and specific ESG-related disclosure requirements for organisations registered or doing business in their jurisdictions. For example:
- California's Unfair Competition Law protects the public against false advertising of environmental impact claims by limiting the circumstances in which an organisation can claim that its products are 'biodegradable', 'compostable', or 'sustainably sourced'; and
- Illinois' Business Corporation Act requires public corporations headquartered in Illinois to include diversity information about their boards of directors and policies and practices for promoting board diversity in annual public reports.
State laws regulating the creation and structure of corporations, partnerships and other business entities and a corporation's governance choices also affect a corporate entity's ESG obligations and duties. For example, under Delaware law (and other US states) and the well-established business judgement rule, the board of a traditional Delaware corporation has a duty to advance stockholder value. While a Delaware corporation board can consider various interests and constituencies, the board's decisions must ultimately tie to promoting and protecting stockholder value. Alternatively, eligible public or private companies may also voluntarily seek certified B Corp status. Certified B Corp corporations must measure their ESG performance through impact assessments, which include measuring their impact on employees, consumers, community and governance. The ESG reports are then assessed against a third-party standard.
1.2 Is the ESG framework in your jurisdiction primarily based on hard (mandatory) law and regulation or soft (eg, 'comply or explain') codes of governance?
To date, federal ESG-related laws in the United States tend to be 'soft', in the form of guidelines, principles or 'comply or explain' regulations, setting a framework for organisations to disclose certain ESG-related benchmarks or explain why the organisation cannot achieve them. Soft law often requires identification of ESG risks but does not prescribe the management or mitigation of them. Laws setting forth specific disclosure requirements and/or penalties for not meeting mandates are more common at the state level. If and when the proposed SEC rules are finalised and promulgated (see question 1.1), public companies will be subject to 'hard' (or mandatory) disclosure obligations under federal securities law.
In addition, federal and state laws govern organisational conduct related to more specific ESG risk factors. These laws may set standards and/or require the collection of data relevant to organisations' ESG metrics. For example:
- federal environmental laws, such as the Clean Air Act, limit organisations' air emissions and mandate the collection of certain emissions data (including reporting of GHGs) along with other laws that regulate impacts to soil, water, and more;
- the Occupational Health and Safety Act governs worker safety;
- the Gramm-Leach-Bliley Act requires consumer financial services entities to disclose their data-sharing practices;
- the Sherman Antitrust Act prohibits anti-competitive conduct;
- the Foreign Corrupt Practices Act prohibits payment of bribes to foreign officials; and
- the Dodd-Frank Act requires companies to disclose whether they use 'conflict minerals' – tin, tungsten, tantalum and gold – and whether these minerals originate in the Democratic Republic of the Congo or an adjoining country.
In 2010, the SEC issued guidance regarding how the SEC's existing principles-based, materiality-focused disclosure requirements apply to climate change matters ('2010 Climate Change Guidance'). Since the 2010 guidance was issued, many public companies routinely disclose at least some climate-related information in SEC filings. Public companies could soon be required to disclose specifics under the SEC's recently proposed climate-related disclosure requirements discussed in more detail in question 1.1.
Mandatory laws related to ESG in the United States are constantly changing and subject to court challenges. For example, California passed a law in 2020 intended to diversify corporate leadership in the state. The law required publicly held companies headquartered in the state to include LGBT+ individuals and people of colour on their boards. The law was overturned in 2022 as unconstitutional. A similar California law requiring a minimum number of women on every public company's board was overturned a few weeks later.
Many private organisations voluntarily disclose ESG-related risks through soft codes of governance and frameworks such as those created by:
- the Global Reporting Initiative;
- the Value Reporting Foundation; and
- the Task Force on Climate-Related Financial Disclosures.
Certain non-governmental entities also have adopted codes of governance, taking a 'soft' approach to mandating ESG disclosures and, at times, creating initiatives for their members. For example, in 2021 the Nasdaq stock exchange adopted rules requiring certain listed companies to disclose information showing that they had two diverse directors on their board of directors. Even if the disclosure is voluntary, once made, it may nonetheless be considered a securities disclosure and companies may face liability under applicable securities law.
1.3 Which bodies are responsible for implementing and enforcing the rules and codes that make up the ESG framework? What powers do they have?
As discussed in question 1.1, US regulation of ESG is a patchwork of federal and state laws, and therefore enforcement can be inconsistent.
The SEC, sometimes in conjunction with the US Department of Justice, may enforce mandatory disclosure of 'material' ESG-related risks by public companies. In 2021, the SEC announced the creation of a Climate and ESG Task Force to develop initiatives to identify ESG-related misconduct by public companies. To date, the taskforce has sent letters to public companies that failed to disclose certain climate change risks and advised them to disclose material risks related to climate change. The SEC also sanctions companies under its purview for inadequate cybersecurity practices – for example, eight firms were sanctioned in 2021 for cybersecurity failures that exposed thousands of individuals to identity theft risk.
The FTC enforces its regulations against false or misleading environmental marketing claims and has taken enforcement action against businesses for making those allegedly misleading claims. At the state level, many states have enacted consumer protection laws that include private rights of action, allowing consumers to file lawsuits against businesses that make false or misleading marketing statements, such as statements relating to ESG risks and initiatives.
Some state attorneys general enforce laws prohibiting misleading or fraudulent marketing practices, including with respect to ESG practices and public disclosures.
Private citizens and non-governmental entities have indirect enforcement roles. Shareholders can sue public companies under federal securities regulations for misleading ESG risk disclosures and for breaching fiduciary duties relating to ESG risk management. In 2021, the Nasdaq Stock Market instituted 'comply or explain' board-level diversity rules for Nasdaq-listed companies that will phase in over several years.
1.4 What is the regulators' general approach to ESG and the enforcement of the ESG framework in your jurisdiction?
As the use of ESG-related disclosures becomes an increasingly common global investment and corporate priority, regulators are engaging with public companies on these issues and initiating securities law and state law derivative actions based on ESG claims.
In the second half of 2021, the SEC began sending comment letters to public companies relating to their climate change-related disclosures, including to companies outside of energy-intensive industry sectors. The SEC letters request information on:
- material climate change transition risks;
- purchases or sales of carbon offsets;
- material pending or existing climate-related legislation or regulation;
- effects of climate change on operations and results; and
- why certain ESG-related information disclosed in corporate reports is not also included in SEC filings.
In the first few months of 2022, the SEC brought a case it described as its first major ESG enforcement action. The SEC charged a public company with securities fraud. The SEC alleged that the company made false and misleading statements in its ESG disclosures.
As discussed in question 1.3, federal agencies and state governments continue to bring claims relating to 'green' advertising or marketing. While the FTC is one of the main agencies regulating marketing claims through its authority under the FTC Act, other agencies also have authority to protect consumers against deceptive, unfair or unsubstantiated marketing, including the US Department of Agriculture, which governs claims that a product is 'organic', given that the FTC's Green Guides do not currently address 'organic' claims.
1.5 What private sector initiatives have been launched in your jurisdiction to complement the ESG framework?
The private sector has a lead role in ESG risk disclosure and mitigation efforts in the United States. Large institutional investors evaluate ESG risks in making investment decisions. Investor demand led fund managers to cultivate and market 'sustainable' financial products, which include organisations that were selected – in whole or in part – based on ESG criteria. Several US financial institutions joined a global coalition of members of the Glasgow Financial Alliance for Net Zero (GFANZ), which pledged in conjunction with the 2021 United National Climate Change Conference to align their investment activities to achieve net-zero emissions by 2050. Members formed the GFANZ at the United Nations Conference of the Parties in Glasgow in November 2021 by pledging to accelerate decarbonisation of the global economy in an effort to meet the goals of the 2015 Paris Agreement.
Shareholder activists have used the failure to identify or achieve ESG strategies as grounds for action if an organisation's failure to address ESG concerns adversely affected its long-term prospects. For example, in 2021, 0.02% shareholder Engine No 1 (with backing from ExxonMobil's three largest shareholders) secured three seats on ExxonMobil's board by promising to push ExxonMobil beyond crude oil, among other ESG-related goals.
Other notable private-sector commitments to ESG goals include the following:
- The Business Roundtable Statement on the Purpose of a Corporation, signed by 181 CEOs, emphasises the importance of:
- investing in employees;
- dealing ethically with suppliers;
- supporting communities in which they operate; and
- delivering value to customers and shareholders;
- More than 200 businesses joined Amazon's Climate Pledge, which includes commitments to regular reporting of greenhouse emissions, decarbonisation strategies and offsetting remaining emissions; and
- More than 30 major technology companies have signed on to the US IP Alliance's Increasing Diversity in Innovation Pledge, which commits to increasing inventor diversity.
Certain states require registered attorneys to take diversity and inclusion continuing education courses during each two-year reporting period.
2 Scope of application
2.1 Which entities are captured by the rules and codes that make up the principal elements of the ESG framework in your jurisdiction?
While not exhaustive, the following categories of entities are captured by ESG-related rules and codes in the United States:
- Public companies: Publicly traded companies must comply with the US Securities and Exchange Commission's (SEC) prohibition on materially misleading ESG-related disclosures in their public filings. Public companies also must consider accounting standards issued by the Financial Accounting Standards Board (the independent financial accounting standard-setter) that relate to ESG issues for audited financial statements. In addition, as discussed in question 1, the proposed SEC rules remain subject to public comment and have not been finalised.
- Industry-specific entities: Entities operating in certain industries are subject to ESG-related mandates. For example, the energy industry is encountering significant ESG-related legislation (both carbon reduction targets and reporting requirements), leading some power producers to consider early closure of coal-powered generating facilities and wider adoption of renewable energy resources, such as wind and solar. Several states have established integrated resource planning processes for electric utilities, requiring utilities to address and disclose common risks, such as those posed by environmental and carbon dioxide reduction regulations. ESG rules and codes are also prominent in the garment, mining, pharmaceutical, shipping and utility industries.
- Companies making public ESG-related statements: Public and private companies engaged in interstate commerce can face federal regulatory enforcement for fraudulent or deceptive marketing statements related to ESG initiatives, such as environmental marketing that violates the Federal Trade Commission's Green Guides. Similarly, businesses are subject to state-level consumer protection law enforcement. Some states' consumer protection laws allow private rights of action and/or apply to not-for-profit organisations.
- Investment advisers, investment companies and private funds: In an April 2021 risk alert, the SEC highlighted deficiencies in ESG-related claims and practices among investment advisers, investment companies and private funds. Specifically, the SEC brought attention to:
- potentially misleading statements about ESG investing processes;
- adherence to ESG investing policies and global ESG frameworks; and
- weak documentation of ESG-related investment decisions and compliance programmes that did not guard against inaccurate ESG-related disclosures and marketing.
- Employers with 100 or more employees: Businesses that employ 100 or more people report demographic workforce data under the US Equal Employment Opportunity Commission laws. New state-level laws also require organisations to report human capital data. For example, starting in 2022, private sector employers with more than 100 employees in Illinois must:
- certify compliance with equal pay laws;
- disclose workforce demographic and pay information; and
- apply for an equal pay registration certificate.
- Large greenhouse gas (GHG) emission sources subject to the Greenhouse Gas Reporting Rule: Manufacturers of all types, suppliers of fossil fuels or industrial gas, carbon dioxide injection sites and facilities that emit at least 25,000 metric tons of GHGs per year must submit annual reports to EPA.
2.2 How are entities in your jurisdiction that are not subject to specific rules or codes implementing ESG?
Organisations not subject to specific rules or codes are implementing ESG practices by:
- benchmarking against ESG standards and codes of practice;
- engaging with ESG ratings agencies, such as Bloomberg ESG Scores, EcoVadis Ratings and Sustainalytics ESG Risk Ratings;
- making procurement decisions based on ESG factors;
- seeking merger partners or targets with mature ESG programmes that can:
- attract and retain diverse talent;
- engender customer loyalty; and
- help to minimise reputational risks;
- deploying greentech and bluetech solutions;
- promoting community engagement;
- adopting transparent and human-centric data practices that engender consumer and employee trust;
- using machine-learning tools and other algorithmic decision-making technology responsibly;
- implementing cyber and data hygiene programs and associated technology investments; and
- conforming to ESG standards in their customers' industries.
These ESG practice initiatives respond to demands for action on ESG issues from customers, consumers, employees, shareholders, investors and other stakeholders. Many US organisations issue sustainability reports outlining their responses and undertakings with respect to ESG metrics (as discussed further in response to question 3.2).
2.3 What are the principal ESG issues in your jurisdiction that are either part of the ESG framework or part of the implementation of ESG?
The ESG issues in the United States vary by (among other factors) stakeholder group, community, geography, political affiliation and industry, as well as among US financial market participants. Key ESG issues shaping the U.S. regulatory landscape include the following
- E – Environmental:
- climate change and increased frequency of extreme weather events such as wildfires, tornadoes and droughts
- management of emerging chemicals and forever chemicals;
- net-zero carbon goals and energy transitions from fossil fuels to cleaner energy sources, such as nuclear, wind and solar;
- conflict minerals; and
- recycling, reuse and the circular economy, such as product takeback programmes.
- S – Social:
- racial injustice;
- diversity, equity and inclusion in the workforce and boards of directors;
- human rights including privacy rights;
- equal pay;
- sexual harassment and the #MeToo movement;
- forced labour; and
- COVID-19-related risks, including talent exiting the workforce, cyber risks arising from remote working and workplace safety.
- G – Governance
- community relations;
- supply chain transparency and security;
- import/export compliance and trade regulation;
- anti-bribery and corruption;
- political contributions and lobbying;
- cybersecurity, data hygiene, and data breach risks;
- executive compensation tied to reaching ESG goals;
- management of business ethics; and
- ESG due diligence in corporate transactions.
3 Disclosure and transparency
3.1 What primary disclosure obligations relating to ESG apply in your jurisdiction?
US Securities and Exchange Commission (SEC) securities disclosure: Entities subject to the SEC's jurisdiction file periodic disclosures that cover material financial and other risks, including ESG-related risks, if they are reasonably likely to have a material effect on the entity's financial condition or results of operation, such as:
- environmental risks and the impacts on costs of compliance;
- climate change impact;
- companies that have enacted diversity policies relating to the nomination of directors to explain how diversity characteristics are considered; and
- environmental regulations and litigation.
State and federal employment reporting: Federal regulations require organizations to disclose workforce demographic data and some states are now requiring more detailed reporting.
- Large private employers with 100 or more employees and federal contractors with 50 or more employees meeting certain other criteria must annually file with the Equal Employment Opportunity Commission an EEO-1 Component 1 report providing demographic workforce data, including data by race/ethnicity, sex,and job categories (42 USC § 2000e-8(c); 29 CFR § 1602.7; 41 CFR § 60-1.7(a); 41 CFR § 60-1.7(a)).
- Some states require private employers to file similar reports with their respective state agencies that disclose pay data in addition to demographic workforce data. For example,
- beginning in March 2021, California employers with 100 or more employees must annually file a pay data report including pay and hours-worked data by establishment, job category, sex, race and ethnicity (Cal Gov't Code § 12999); and
- beginning in March 2022, Illinois employers with 100 or more employees must biannually report pay data, submit equal pay registration certificates and certify compliance with the state's equal pay laws (820 ILCS § 112/11).
Federal greenhouse gas (GHG) reporting: Large industrial sources of GHGs, fuel and industrial gas suppliers, and carbon dioxide injection sites must report emissions under the Greenhouse Gas Reporting Program.
State and federal environmental reporting: Federal regulations and virtually all states require certain sources to report emissions – whether methane from landfills, spills of hazardous materials, industrial air pollutants or pollutants discharged in wastewater. Environmental reporting regulations vary by industry and by state.
Some states further require public agencies that manage government funds to consider ESG factors when investing public money – for example, on behalf of state pension funds; and companies seeking investment from those agencies may need to comply with such state agency-specific disclosure obligations. Other states require the disclosure of board diversity or human capital metrics, as described, respectively, in questions 1.1 and 2.1.
3.2 What voluntary ESG disclosures are also commonly made in your jurisdiction?
Many organisations now prepare and make publicly available fairly extensive sustainability reports regarding their organisations. Voluntary disclosures range from thorough reports published in accordance with – or at least influenced by – recognised ESG reporting frameworks, including GHG Protocol Standards, Task Force on Climate-Related Financial Disclosures Recommendations, and Global Reporting Initiative Standards, to sustainability or corporate responsibility reports that showcase important ESG achievements. Voluntary reports can be a significant source of comprehensive ESG information for the public and are generally published on organisations' websites. Some voluntary disclosure metrics are qualitative and some are quantitative, but they tend to focus on the following areas:
- Environmental-focused disclosures include:
- waste management;
- net-zero goals in line with the Paris Agreement;
- product sustainability, ingredients and components; and
- water, land, air and natural resource use.
- Social-focused disclosures include:
- data privacy and protection policies;
- diversity, equity and inclusion in the workforce;
- human rights and labour conditions throughout the supply chain;
- anti-slavery commitments;
- product safety;
- worker health and safety programmes during the COVID-19 pandemic and beyond;
- community impact; and
- use of conflict minerals.
- Governance-focused disclosures include:
- board diversity;
- business ethics;
- business risks and strategies;
- executive compensation tied to ESG goals; and
- political spending.
The information that organisations voluntarily disclose is often driven by:
- their largest ESG risks;
- market demands on their industry; and/or
- a desire to highlight important accomplishments.
Although these disclosures are voluntary, once made, they may be subject to similar levels of scrutiny as SEC disclosures, and, accordingly, care should be taken to ensure that such voluntary disclosures are accurate and not misleading.
3.3 What role is played in this regard by (a) the board and (b) other corporate bodies and/or officers?
Most US corporations have a single board that oversees the operations of the organisation and establishes its priorities. In some cases, a board may have committees – for example, an audit committee or disclosure committee – that will be required to finally approve the organisation's ESG-related disclosure. Day-to-day operations are carried out by management under the board's supervision.
While still an emerging trend, some corporations are creating new officer positions with titles such as 'chief sustainability officer' or 'chief diversity and inclusion officer'. These officers often report directly to the board or senior management. These new officer roles have significant authority to implement and direct many of the organisation's ESG-related policies and practices.
Even where an organisation has an ESG-focused officer, ESG responsibility is often spread throughout the organisation based on job function. For example:
- environmental compliance and policy may rest with the legal department or plant managers;
- diversity and inclusion may rest with human resources; and
- cybersecurity may rest with information technology.
Because much of ESG relates to understanding and managing risk, this may often be the most efficient approach for the organisation.
3.4 What best practices should be considered in relation to ESG reporting and disclosure?
Best practices for ESG reporting and disclosure include the following:
- Provide specific and accurate disclosure;
- Avoid greenwashing and other misleading practices;
- Conduct stakeholder outreach and incorporate the feedback into ESG policies and practices;
- Determine whether a third-party assurance or audit will help to validate the authenticity of disclosures so they are considered 'investor grade' information;
- Consider performing ESG data gathering under the advice of, and in conjunction with, counsel to keep sensitive information privileged;
- Adequately budget for ESG disclosure, benchmarking, implementation and oversight; and
- Report on ESG efforts in a timely, consistent, reliable and verifiable manner, regardless of whether reporting is voluntary or required.
4 Strategy and governance
4.1 How is ESG strategy typically designed and implemented in companies in your jurisdiction?
Organisations typically begin developing their ESG strategies by identifying the ESG issues that both are risks and add value to their long-term organisational sustainability. Organisations accomplish ESG issue identification by conducting an ESG risk assessment. These assessments can have different starting points. Some organisations identify material ESG issues based on how their activities are changing the world, while others identify how changes in the world are impacting their long-term financial outlook.
ESG reporting standards and frameworks can help companies understand how to collect and use data in order to characterise their ESG risks and opportunities. Common standards and frameworks used by US companies include:
- the Sustainability Accounting Standards Board Standards (a programme of the Value Reporting Foundation);
- the Task Force on Climate-Related Financial Disclosures Recommendations;
- the Climate Disclosure Standards Board Framework;
- the Global Reporting Initiative Standards; and
- the Integrated Reporting Framework (formerly the International Integrated Reporting Council, now a programme of the Value Reporting Foundation).
After identifying and collecting the data needed to identify ESG risks and opportunities, organisations can benchmark their ESG profiles relative to their peers and develop ESG goals and the metrics to report on progress towards those goals. Based on these data, organisations may choose to adjust strategies for ESG and/or publicise their ESG achievements, goals and milestones.
4.2 What role is played in this regard by (a) the board and (b) other corporate bodies and/or officers?
A corporate board may take responsibility for assessing the relevance of ESG issues to the organisation's purpose and assigning resources that commensurately reflect the complexity, magnitude and centrality of those issues. US boards have signalled the priority of ESG issues to the organisation's vision and purpose by:
- nominating and selecting directors that have ESG experience;
- expanding the responsibilities of an existing committee to include particular ESG areas of focus and altering those committee's charters to reflect those responsibilities – for example, by:
- explicitly housing shareholder engagement or board diversity in a nominating and governance committee;
- establishing ESG accountability incentives through a compensation committee; and
- integrating ESG disclosure into an audit committee's role; and
- ensuring that a dedicated board committee has authority to integrate ESG into the overall enterprise.
Senior management, in partnership with the board, is typically responsible for developing and executing an ESG strategy that is linked to the organisation's purpose and vision and embedded throughout the organisation's core operations. Among the actions that senior management at US organisations have taken to design and implement a cohesive ESG strategy are:
- embedding ESG into each business unit's risk management, performance management and strategic planning;
- creating cross-enterprise steering committees that evaluate existing ESG strategy and advise the board on changes;
- setting up structures to compare how ESG initiatives are implemented across business units and controls to approve ESG disclosures; and
- developing personnel and teams with specific responsibility for monitoring and managing ESG matters generally, including benchmarking, best practices and reporting.
4.3 What mechanisms are typically utilised to monitor the implementation of ESG strategy in your jurisdiction?
Monitoring ESG implementation and performance is challenging because the ESG performance measures are not standardised. Organisations monitoring ESG priorities may use leading global standards and frameworks as their bases for monitoring and reporting on performance; but unless all their peers use the same standards, comparing ESG performance across organisations can be difficult.
Some organisations monitor their own implementation of ESG strategy and others seek third-party support to monitor quality of ESG disclosure to stakeholders and investors. Third-party assurance and attestation can be provided by an organisation's financial statement auditor or independent consultant, who can also provide insights on how organisations can evolve their focus on ESG to meet the increasing demands of investors and other stakeholders. In addition, consultancies affiliated with investment research firms, as well as some rating agencies, have introduced ESG ratings.
4.4 What role is played in this regard by (a) the board and (b) other corporate bodies and/or officers?
The board ultimately oversees enterprise risk management, which includes risks and opportunities that arise from the ongoing implementation of an ESG strategy. Significantly, the board must approve the organisation's financial statements, including levels of reserves for risks, including ESG risks. The board may monitor progress towards the most significant ESG goals at the level of the full board and board committees may oversee progress towards each of the particular aspects of the ESG strategy within its purview.
Senior management are typically responsible for implementing board ESG initiatives and ensuring that the board has the right data and information to monitor organisation progress on its ESG.
4.5 How is executive compensation typically aligned with ESG strategy in your jurisdiction?
While not a universal practice, US organisations may align ESG achievements with executive compensation by, for example, linking annual or short-term bonus payments to achieving ESG metrics or goals, such as:
- increasing the percentage of women and minorities in various executive and leadership positions;
- reducing their carbon footprint reduction; and
- supporting human rights.
Examples from recent shareholder proxy meeting statements of S&P 500 companies include:
- 15% of short-term incentives tied to 'human capital metrics', including the percentage of underrepresented groups in senior management; and
- 20% of annual incentive compensation determined by non-financial metrics, of which:
- 5% was determined by the number of fatal or serious injuries;
- 5% was determined by carbon dioxide emissions reduction; and
- 10% was determined by the percentage of women in the global workforce.
Less commonly, long-term incentives and stock options are tied to ESG metrics, such as an energy company determining 10% of long-term incentives based on the amount of 'clean' energy produced.
Some organisations that do link ESG-related metrics to executive compensation may do so on the grounds that it is intended to enhance governance and reduce the risk of serious misconduct, reputational damage, and harm to shareholder value.
The US Securities and Exchange Commission (SEC) recently solicited public comment on proposed rules for SEC-regulated entities to report to investors how executive pay relates to financial performance – a metric known as total shareholder return. The SEC noted that it is considering also letting organisations include ESG statistics, as long as they are tied to executive compensation.
4.6 What best practices should be considered in relation to the design and implementation of ESG strategy?
ESG strategies are necessarily specific to the organisation that is adopting them. The following elements are considered best practices when designing and implementing an ESG strategy:
- Use commonly accepted ESG standards or frameworks to guide data collection and harmonise internal reporting with external disclosures;
- Solicit input from across the enterprise – the board, senior management and legal counsel – to develop an ESG strategy that proactively anticipates and manages ESG risk and identifies potential opportunities;
- Integrate ESG strategy at the level of each business unit and across all business functions;
- Consider competitors' ESG strategies, how rating agencies or reporting frameworks are scoring competitors and what information competitors are disclosing;
- For private organisations, consider the needs and obligations of their public partners;
- Frequently review strategies, update goals and engage stakeholders to ensure that the ESG strategy remains visibly central to the organisation's purpose;
- Engage employees in developing programmes to meet ESG objectives; and
- Provide high-quality, consistent, reliable disclosure.
5.1 What is the general approach of lenders towards ESG in your jurisdiction? What internal and external information regarding a prospective borrower will they typically consider in this regard?
Like other sectors of the US economy, lenders face increasing public pressure to address ESG concerns, such as by increasing lending for sustainable energy or for projects that promote social growth. Lenders have moved forward cautiously with their efforts to balance their traditional financial mandates with new ESG factors while lacking longitudinal data and amid an evolving regulatory framework. Notably, promoting social benefit has long been a general requirement for public finance, principally through the awarding of tax-exempt status.
ESG-linked lending and the factors that lenders consider in ESG-linked lending vary based on each lender's own priorities and values. Nonetheless, industry groups have promulgated screening tools to assist both borrowers and lenders in determining the most useful factors. For example, the Loan Syndications & Trading Association (LTSA) has published an ESG Diligence Questionnaire that is designed for a borrower to complete along with other diligence materials.
The LTSA questionnaire, which is representative of other ESG diligence screening tools (eg, the guide published by the UK Loan Market Association (LMA)), focuses on the following key issues:
- ESG governance – a borrower's policies, oversight and integration of ESG principles;
- whether a borrower adheres to an ESG framework, such as:
- the Carbon Disclosure Project;
- the Value Reporting Foundation (formerly the Sustainability Accounting Standards Board);
- the UN Global Compact Principles;
- the UN Sustainable Development Goals; or
- the Ceres Roadmap for Sustainability;
- direct and indirect greenhouse gas emissions and other 'E' factors, such as supply chain origins; and
- other financially material 'S' and 'G' business risks and opportunities, citing the Materiality Map of the Value Reporting Foundation Revenue sources from activities that may present ESG-related risks.
The Sustainability-Linked Loan Principles (SLLPs), discussed in question 5.3, recommend that prospective borrowers disclose specific information to lenders for their consideration such as:
- their sustainability and business strategy;
- the rationale for selecting its key performance indicators (KPIs);
- the motivation for its sustainability performance targets (SPTs); and
- sustainability standards or certifications to which they must or would like to conform.
5.2 Are bonds/loans that are marketed as green bonds/loans, social bonds/loans, sustainability bonds/loans or similar a feature of the markets in your jurisdiction?
Green bonds – which are bonds intended to provide capital for and investment in environmentally beneficial projects – sustainability-linked bonds (SLBs) and sustainability-linked loans (SLLs) are all features of the US markets. Currently, the United States is the largest source of green bonds and US bond rating agencies are starting to undertake green bond ratings. SLBs are expected to become the fastest-growing segment of the ESG-linked lending market in 2022. As in other areas of ESG, the COVID-19 pandemic and increased focus on issues of social justice, carbon emissions and sustainability have driven the market for ESG-linked lending.
The LTSA published Green Loan Principles (GLPs) which offer a high-level framework of market standards and guidelines. The GLPs are voluntary recommended guidelines for market participants to use on a deal-by-deal basis to promote integrity in the development of the green loan market. Nonetheless, anecdotally, many financings labelled 'green' are not and, conversely, financings not labelled green have environmental benefits. For example, building 100 houses with renewable materials may be labelled green; but building an 100-unit apartment building with standard construction materials may not be considered green even though an 100-unit apartment building is arguably greener per person than 100 separate homes. The 'green' label also typically does not consider the environmental costs borne by the local community and other externalities.
5.3 What key developments have taken place in the structuring of these instruments in your jurisdiction?
As in other areas of ESG in the United States, no standard classification system or regulatory framework applies to green bonds, SLLs and SLBs. However, as in other areas of ESG, key voluntary frameworks offer some structure:
- For SLLs, the SLLPs – first published in 2019 and updated most recently in March 2022 and developed through a collaboration among the LTSA, the LMA and the Asia Pacific Loan Market Association – provide key factors for the evaluation of environmentally and socially sustainable lending activity in the United States.
- For SLBs, the Sustainability-Linked Bond Principles (SLBPs), published by the International Capital Market Association (ICMA) in 2020, represent an influential framework used in the United States (and other) markets to promote recommended structuring features, disclosure and reporting factors for all types of issuers and instruments.
- Supplementing the SLLPs is the Guidance for External Reviews, which was issued in March 2022 and is based on the ICMA 2021 Guidelines for Green, Social, Sustainability and Sustainability-Linked Bonds External Reviews. The Guidance for External Reviews aims to promote best practice for external reviewers, including for the organisation, content and disclosure of evaluations.
The SLBPs and SLLPs are based on five core performance-based components:
- selection of KPIs;
- calibration of SPTs;
- bond or loan characteristics (eg, the margin under the relevant loan agreement may be reduced where the borrower satisfies a pre-determined SPT as measured by the pre-determined KPIs or vice versa);
- reporting with an emphasis on transparency (eg, information sufficient to allow lenders to monitor the performance of the SPTs and to determine that the SPTs remain ambitious and relevant to the borrower's business); and
5.4 What best practices should be considered in relation to ESG in the financing context?
The lack of uniform guidance in the industry makes developing clear ESG policies and practices a key best practice for both lenders and borrowers. These ESG policies and practices must include controls that help to ensure that information related to a project and its outcomes does not constitute greenwashing or otherwise result in misleading, inaccurate or inflated claims about social and environmental risks associated with proposed projects. Designating a person or group with expertise and responsibility for understanding sustainable business practices is also considered a best – if not necessary – practice.
For borrowers, developing policies and practices that include realistic and achievable metrics is particularly key. For lenders, transaction documents should clearly define what constitutes an ESG breach in each deal.
6 ESG activism
6.1 What role do institutional investors and other activist shareholders play in shaping ESG in your jurisdiction?
The lines between activist investors and institutional investors are blurring with respect to ESG issues.
Institutional investors are starting to view ESG criteria as linked with business resilience, competitive strength and financial performance. Institutional investors are developing ESG-themed investment products which they are marketing to investors looking for sustainable investments. In addition, institutional investors such as pension funds are applying ESG criteria when making investment decisions for their own accounts. It is expected that this attention from significant investors will influence corporate decision-makers and boards to take ESG into consideration when determining organisational strategy.
Historically, activist campaigns were focused on mergers and acquisitions and the return of capital to shareholders. In recent years, activism has become more accepted and traditional institutional investors appear more willing to support activist campaigns. Increasingly, activist investors are focused on ESG metrics and goals as a basis for their campaigns.
As activist investors use ESG criteria to launch campaigns with the support of traditional investors, boards and corporate management are expected to focus attention on their ESG policies and performance as a defensive strategy or strategy to attract investment.
6.2 How do activist shareholders typically seek to exert influence on corporations in your jurisdiction in relation to ESG?
Shareholders can file proposals and resolutions during proxy season (the time when large public companies hold their annual shareholder meetings – most typically, in the spring). For ESG-focused activist shareholders, those proposals aim to commence a dialogue on ESG issues and, in some cases, to change organisational policies and practices. To date, the majority of these proposals have related to climate change and carbon emissions disclosures and initiatives.
ESG-focused shareholders can exert influence via shareholder lawsuits, which challenge not only the accuracy of an organisation's ESG disclosures and statements but also, in some cases, the adequacy of actions taken by the company to mitigate ESG risks. Climate change and other significant environmental events have largely been the focus of shareholder litigation to date.
Activist shareholders can use ESG criteria as a basis for challenging corporate board slates and seek to elect as directors people who are more open to ESG criteria.
6.3 Which areas of ESG are shareholders currently focused on?
Shareholders appear primarily focused on:
- climate change policies, carbon emissions and other sustainability issues, such as water use and waste reduction;
- commitment to equity, diversity and inclusion;
- policies relating to supply chain and human capital issues; and
- the impact of consumer products on public health.
6.4 Have there been any high-profile instances of ESG activism in recent years?
ESG activism has been increasing, particularly around issues of diversity, carbon emissions and sustainability. The National Law Review reported that the 2021 proxy season included at least 34 ESG proposals that garnered more than 80% of shareholder votes on topics including climate change, diversity and political spending. In addition, 12 environmental proposals passed in 2021, up from five in 2020 and none in 2019.
Asset manager BlackRock continues to be among the leaders on high-profile ESG reporting and disclosure issues. It announced in early 2021 that it would ask the organisations in which it invests to disclose a business plan for compatibility with a net-zero economy.
Other visible examples of ESG activism in 2021 included:
- the replacement of three ExxonMobil board members with nominees supported by ESG-focused investment firm Engine No 1; and
- hedge fund Impactive Capital's work with Asbury Automotive Group's management to alleviate labour shortages through a strategy to increase the number of women mechanics in its workforce.
6.5 Is ESG activism increasing or decreasing in your jurisdiction? How and why?
ESG activism is increasing. The US Securities and Exchange Commission (SEC) appears to be facilitating this trend. In November 2021, the SEC changed the proxy voting rules effective 31 August 2022, enabling proxy shareholders to vote for their preferred combination of board candidates, similar to voting in person by putting dissident and registrant candidates on the same ballot rather than allowing the organisation to propose a full slate for the ballot. The SEC lauded the rule change as "an important aspect of shareholder democracy" ("SEC Adopts New Rules for Universal Proxy Cards in Contested Director Elections", 17 November 2021, SEC Press Release 2021-235). The proposed new SEC rules, if enacted (see question 1.1), may provide activists with additional information to aid in their challenges to public companies' ESG risks and policies. ESG activism is also increasing through shareholder litigation focused on ESG issues.
7 Other stakeholders and rights holders
7.1 What role do stakeholders or rights holders (eg, employees, pensioners, creditors, customers, suppliers, and Indigenous communities) play in shaping ESG in your jurisdiction? What influence can they exert on a company?
Stakeholders have played and will continue to play a critical role in shaping ESG in the United States. As noted in question 1, the Business Roundtable Statement on the Purpose of a Corporation reflects a commitment by participating CEOs to lead their organisations for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders.
Among these stakeholders, employee stakeholders have exercised the most influence on ESG-related practices during the COVID-19 pandemic. According to the US Bureau of Labor Statistics, an average of 3.95 million workers quit their jobs each month during 2021 – the highest average on record. The reasons behind the phenomenon known as 'The Great Resignation' are varied – vaccine mandates, lagging sales, and low wages in hospitality and retail, as well as school and childcare closures. The Great Resignation has created a candidates' market, giving workers leverage to seek better opportunities and work/life balance. The competitive labour market has led employers to revisit their human capital management practices in an effort to attract and retain talent, including through organisation-led ESG-related initiatives focused on:
- enhanced diversity and inclusion;
- clear paths for advancement;
- workplace safety;
- pay equity; and
- greater flexibility (eg, remote work or a four-day week).
Customer stakeholders influence ESG by supporting businesses (eg, through purchase decisions) based on alignment with their ESG values, such as environmentally sensitive manufacturing processes and public commitments to equity. Supplier stakeholders are focused on labour practices and supply chain resilience, adopting the ESG practices of their customers.
Pensioner stakeholders exert pressure on organisations by adopting investment strategies based on ESG goals and investing or divesting accordingly. This approach influences organisations to implement ESG-aligned strategies themselves to remain (or become) viable investments.
Indigenous communities have objected to project development and decision making within their territories, both publicly and in court. By exerting pressure on organisations to, for example, reduce the impact of infrastructure and other projects on indigenous people and the resources on which they depend, indigenous communities are also shaping how businesses respond to climate change and how they impact diverse sets of stakeholders.
All of these stakeholders have effectively influenced the growth of ESG practices via:
- regulatory complaints;
- social media campaigns;
- purchase decisions; and
- for employees, job changes.
Further, organisations are increasingly driven to seek stakeholders' input to ensure they remain engaged and identify early on the ESG issues that are material to their stakeholders to mitigate legal, reputational, operational and political risks.
8 Trends and predictions
8.1 How would you describe the current ESG landscape and prevailing trends in your jurisdiction? Are any new developments anticipated in the next 12 months, including any proposed legislative reforms?
All signs indicate that ESG will stay in focus during the coming years with increased enforcement of existing laws, as well as new federal, state and local laws. In March 2022, in addition to the proposed US Securities and Exchange Commission (SEC) rules (see question 1.1), the SEC proposed another set of proposed rules relating to enhancing and standardising:
- cybersecurity risk disclosures;
- cybersecurity governance; and
- cybersecurity incident reporting.
The US Congress is also to revisit some of the proposed ESG disclosure and transparency laws, such as the Corporate Governance Improvement and Investor Protection Act (HR 1187). Federal agencies are enhancing their ESG-related commitments, such as the commitment from the General Services Administration (the centralised procurement agency for the US federal government) to 100% renewable electricity sources for the federally owned real estate portfolio by 2025 and the incorporation of green products and practices into the federal procurement supply chain.
State legislatures are also likely to extend their ESG-related laws. New York's pending Fashion Sustainability and Social Accountability Act (S7428/A8352) would require fashion retailers and manufacturers doing business in New York State to:
- comply with stringent supply chain mapping requirements; and
- disclose the environmental and social impacts of their activities.
In human capital, several states have considered, and a few have enacted, laws that require employers deploying automated decision-making technology to:
- screen job candidates and/or discipline or terminate employees;
- conduct bias audits; and
- obtain consent from affected individuals.
Other areas in focus for 2022 include:
- increasingly specific demands from stakeholders for:
- integration of ESG principles and practice into operations; and
- alignment of executive compensation to the achievement of ESG performance goals;
- continuing efforts to develop a universal, global ESG reporting framework from among the many laws and third-party disclosure standards and ratings for ESG performance; and
- expanding use of machine-learning tools that can more efficiently extract and find patterns among the data used for measuring ESG performance – both for the organisation's own analyses and for investors, regulators and other stakeholders seeking to understand a particular organisation's ESG posture.
9 Tips and traps
9.1 What are your top tips for effective ESG implementation in your jurisdiction and what potential sticking points would you highlight?
Effective ESG implementation requires a top-down and bottom-up approach:
- Top-down ESG implementation requires a demonstrable board commitment to, and competent leadership for, an ESG strategy, including short and long-term goal setting and associated financial and human capital resource commitment.
- Bottom-up ESG implementation means engaging both:
- employees and other stakeholders within the organisation who can help to identify gaps between ESG goals and current practices; and
- external stakeholders that can help an organisation refine and prioritise ESG goals.
The top-down, bottom-up approach requires that the organisation establish a process for managing the inevitable conflict of ESG priorities among the various internal and external stakeholders.
Once goals are set and resources allocated, effective ESG implementation requires careful consideration of the scope of an organisation's public ESG commitments. A key sticking point is over-promising – an organisation which makes ambitious ESG public commitments creates both legal and reputational risk of underperformance. The safer strategy – at least at the beginning of an organisation's ESG journey – is to under-promise and overperform on ESG commitments.
Relatedly, clear, accurate and transparent explanations about ESG commitments and detailed recordkeeping about progress measurements are also important risk management practices. For an organisation regulated by the US Securities and Exchange Commission, the analyses underpinning materiality determinations for ESG disclosures require thorough recordkeeping.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.