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SEC’s Proposed Climate Rule Update Last month, the Securities and Exchange Commission (SEC) reopened the comment period for several proposed rules, including the Enhancement and Standardization of Climate-Related Disclosures for Investors rule and the Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices rule. This reopening of the comment period will require the SEC to also process and consider any additional comments received, which is likely to further delay the publishing of the final rules. Additionally, SEC Chairman Gary Gensler recently declined to commit publicly to rule finalization by the end of the year. While the delay may cause implementation to be pushed back, public companies will
still need to consider how their existing disclosure process and their potential future disclosure strategy might be affected and should continue to prepare for implementation of an emissions reporting requirement. For background, earlier this year, the SEC proposed three rules attempting to regulate how ESG-related factors are disclosed and how they are considered by funds and advisors. The first rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors, was published in the Federal Register in March 2022. That rule requires the disclosure of certain climate-related information in registration statements and annual reporting documents, such as (i) climate-related risks that are reasonably likely to have a material impact on the registrant’s business or financial status, (ii) registrants’ greenhouse gas emissions, and (iii) financial metrics connected to climate change. Following the initial proposal, two additional rules were subsequently promulgated in May 2022. The Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices rule sets forth additional requirements for disclosure of environmental, social, and governance investment practices, while the Investment Company Names rule addresses the naming of funds that are ESG-focused. According to their website, the SEC received a significant number of public comments on all three of the proposed rules. Given the reopening of the public comment period for the Enhancement and Standardization of Climate-Related Disclosures for Investors rule and the Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices rule, and the high amount of interest from stakeholders in each, more public comments are expected to be submitted on each rule. ESG Finance – ESG-Linked Lending While the lending market itself has continued to contract as 2022 has waned, ESG-linked lending (generally, in the form of sustainability linked loans) has continued to stay relevant by adapting market trends, demonstrating its resilience as a useful mechanism to borrowers and lenders alike. While we have seen ESG-linked loans continue to arise in deals throughout the market over the last few quarters, we have seen a shift in the method ESG-terms are implemented within debt facilities. While it was a common occurrence over the last year to see ESG-terms (such as key performance indicators and specific performance targets) negotiated and established as of the closing date of any facility, market forces have begun to punt these negotiations (and sustainability decisions)
to a later date. Instead, we are seeing what can be termed as “agreements to agree” arise at a growing rate throughout the market – beginning to appear at a greater clip than debt facilities which establish ESG goals/terms at closing. These “agreements to agree” come in a variety of forms and, similarly to sustainability linked lending as a whole, are customizable to many different borrower profiles. Generally, this approach clearly states that the borrowers, lenders, and agents agree to negotiate and implement ESG terms to a facility in the future. In some cases, these sections will lay out minimum and maximum ESG-adjustments which may be permitted (such as the minimum and maximum adjustments which may be made to a facility’s applicable rate, for example), while other instances will delineate the E, S, or G parameters to be utilized in the future. It will take time to see how these “agreements to agree” are ultimately negotiated and the terms eventually implemented, but it is a strong
sign that ESG and sustainability linked terms will continue to thrive even as the market itself slows. With an eye towards the regulatory front, efforts aimed at improving the opaque, random, and inefficient ESG-data reporting process have finally come to fruition. Recently, as of November 8th, the Loan Syndications and Trading Association (“LSTA”) announced their launch of the ESG Integrated Disclosure Project (the “ESG IDP”). The ESG IDP attempts to detail ESG information which should be specifically requested by lenders in the private loan market as part of a lender’s standard diligence and reporting materials. Think of the ESG IDP as a pre-determined ESG disclosure list, wherein a list of cultivated, specific sustainability related materials are highlighted for lenders to focus on and request. The cohort of organizations involved with the
development of the ESG IDP – the LSTA, the Association of Corporate Counsel and the U.N. Principles of Responsible Investment – hope that their standardized ESG diligence template will allow for lenders (and investors market-wide) to receive more consistent, comparable data to utilize while marking investment decisions. The ESG IDP addresses the interests and needs of all loan market stakeholders and represents one of the first industry-wide collaborative effort to harmonize ESG diligence and data reporting. The hope is that this harmony will address key challenges related to the reliability of ESG-reported data and metrics in both the private credit and syndicated loan markets. This collaborative effort has been long in the making, having been announced in the early spring of this year, but is not the only regulatory or reporting effort in the works. We will continue to report as the ESG IDP is utilized by lenders and borrowers, and as other regulatory and reporting efforts are announced in the ESG-market. ESG Finance - Swaps and Derivatives In October, a group of Senators submitted a letter in response to the Commodity Futures Trading Commission’s (“CFTC”) June 2022 Request For Information. The Senators were critical of the CFTC’s voluntary standards governing carbon offsets and recommended that the CFTC investigate the integrity of currently approved derivatives and their underlying carbon offsets, create a registration framework for offsets and related entities, create a working group to study carbon offsets and derivatives, and pursue cases of fraud. Relatedly, the Voluntary Carbon Credit (“VCC”) markets are a critical element towards supporting the transition to a low carbon economy, since VCC can offer an efficient and marketable product which should increase the financing of projects aimed at reducing carbon emissions or removing carbon from the atmosphere. In December 2021, the International Swaps and Derivatives Association (ISDA) published a Whitepaper on the Legal Implications of Voluntary Carbon Credits (the “VCC Whitepaper”), which set out a roadmap for the development of contractual standards for VCC derivatives, with the expectation that such contractual standards should further promote safety, efficiency and liquidity in the market. ISDA has diligently been working on not only final definition set for VCCs, but also Forms of Confirmation. Final versions are expected to be published in the near future, which will be a relief for market participants currently trading on bespoke documents or document based on “draft” documents from ISDA. The CFTC’s initiative to improve the rules governing VCCs and ISDA’s market standard documentation should increase market participants willingness to transact and provide improved stability for the carbon offset market. Employee Matters - Diversity, Equity, and Inclusion (DEI) This year’s proxy season saw companies receiving far more proposals than ever, breaking 2021’s prior record. Social and political-related proposals remained the largest category of submissions, with around 81% growth in submissions relating to analyzing civil rights, human rights, and racial equity impacts. In the first half of 2022, for example, at least 30 companies received racial equity audit proposals, including banks, institutional investors, and companies in the retail/consumer products and technology sectors (compared to a dozen companies receiving such proposals in 2020/2021). The SEC rejected all no-action requests on these 2022 proposals, and more than half were withdrawn after companies agreed to conduct some form of the audit. The other proposals made it to a vote, with at least three passing following a vote. For civil rights audit proposals, the SEC similarly rejected all no-action requests, and at least four proposals passed after going to a vote. Given the likelihood of continued support for social proposals, and the increasing pressure from shareholders and consumers on DEI issues more generally, all companies should pay close attention to sentiments among shareholders and ready themselves for potential external engagement on DEI issues. Employee Matters – Equal Pay Transparency Laws Equal Pay Transparency (“EPT”) laws continue to gain traction nationwide as one of the leading tools to prevent pay gaps and create more fair and equitable compensation for all employees. Most recently, California has joined a growing number of states enacting pay transparency laws with the signing of Senate Bill 1162, which goes into effect January 2023. The California law imposes significant requirements on covered employers, including pay scale disclosures on job postings and pay data reporting requirements according to race, ethnicity, and gender within specified job categories. Requirements to publish pay scales on job postings have a direct impact on Permanent Labor Certification (“PERM”) recruitment activities. Current federal PERM regulations do not require inclusion of wage or wage range publications on most job postings, but local EPT laws may impose additional requirements. The exact nature of the EPT laws vary by jurisdiction with more states expected to enact their own EPT legislation in the near future. Employers are encouraged to take note of the requirements now in place, identify compensation ranges for any open positions if they do not already exist and proactively consider how to holistically approach their pay policy, given the momentum of this trend. In addition to California, states and localities with EPT laws include Colorado, Connecticut, Maryland, Nevada, New Jersey, Ohio, Rhode Island, and Washington along with New York City and Toledo. New York City's new Wage Transparency Law went into effect Nov. 1. The law makes it an unlawful discriminatory practice to post a job listing that does not include the position’s minimum and maximum salary or hourly wage. Human Rights - Foreign Labor and Supply Chains The International Labour Organization (“ILO”) recently released updated estimates of forced labor worldwide. According to the ILO, fifty million people experienced forced labor, including human trafficking and forced marriage in 2021. Of those estimates, twenty-eight million were subjected to forced labor including commercial sexual exploitation. Some U.S. companies are experiencing import disruptions due to heightened awareness around exploited labor in commercial supply chains, and U.S. Customs and Border Protection enforcement of the Uyghur Forced Labor Prevention Act. The Act became effective June 2022 and creates a rebuttable presumption that products, elements, or components linked to the Xinjiang region of China were made with forced labor and are prohibited from entry into the U.S. Companies are encouraged to be prepared to demonstrate supply chain tracing, due diligence, and management to ensure no linkage to Xingjiang labor programs or inputs. Human Rights Update – Data Privacy and Responsible Use of Technology Did you know that data privacy management and responsible use of artificial intelligence are matters of ESG? MVA lawyers Ed O’Keefe, Sarah Byrne, John Stoker, and Jules Carter recently co-authored “Can we keep up with the machines? Stronger and faster artificial intelligence systems require robust risk management practices.” The paper sets out the regulatory trends related to AI in compliance and risk management applications and the risks associated with inadequate data management, over-automation and other risk management oversight failures. The possible adverse outcomes were illustrated by a case study relating to the detection of money laundering associated with human trafficking. Other MVA ESG Updates - ESG Team Members Brendan Bailey, Jennifer Kim, Laura Truesdale and Sarah Byrne have completed Berkeley Law’s Sustainable Capitalism and ESG Program.
- Sarah Byrne served as a workshop facilitator at the Social Impact and ESG Summit hosted by the Pro Bono Institute in Washington, D.C.
- Attorney Barrett Morris will speak about ESG finance as a panelist at the Mecklenburg County Bar’s 20th Annual Banking and Finance Forum on November 18, 2022.
- Tracey Easton, the former General Counsel at the South Carolina State Housing Finance and Development
Authority, has joined MVA to advise clients on low-income housing tax credits and other financing opportunities within the affordable housing space. The development, finance and other support of affordable housing can be an impactful social goal for companies working in real estate.
We know that companies are looking to integrate ESG into both governance and operations. If your company is thinking critically about developing an ESG program and the legal and regulatory implications, please consider the multidisciplinary team at MVA as your advisors.
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