Despite the ESG backlash that dominated US headlines in 2023, we still see a strong level of investor interest in two perennial responsible investing mega-themes: climate and diversity.
Let’s review what has happened recently and look ahead at what investors might expect in the near term.
Climate rules remain a flashpoint
Last year was a busy time for regulators who set out to create standards for disclosing climate risks. Regardless of jurisdiction, we have seen quite a bit of public debate over whether regulators should mandate Scope 3 emissions disclosures.1 Not only are these much harder to measure than Scopes 1 and 2, but they can also lead to double-counting when considered at a portfolio level.
In the US, all eyes are on the widely anticipated finalizing of the SEC’s climate rules. The SEC has confirmed that its efforts to require companies to disclose their emissions in a standardized and comparable manner should culminate in April 2024. That aligns with the predictions we made in September 2023.
With the proposed rules attracting a record 16,000+ public comments, the SEC has taken longer than originally anticipated to sift through these views, while navigating a spicy hot political environment. The current sticking point seems to be whether the final rules will ultimately require issuers to disclose Scope 3 emissions.2
In the meantime, California forged ahead with its own climate disclosure that might end up being more influential than the SEC’s potential future rules. California’s Climate Corporate Data Accountability Act mandates Scope 3 emissions disclosure for over 5,000 public and private companies that do business in the world’s fifth largest economy by GDP. Passed in October 2023, this legislation makes California the first state to enact mandatory climate emissions disclosure rules, which could go into effect as early as 2026.
What’s next in 2024? With the presidential election heating up, climate will continue to be a flashpoint in a divisive US political environment. We expect the SEC to follow California’s lead and finalize climate rules in the spring that would give US companies a better sense of what disclosure requirements will look like in the coming years.
Meet financial and ESG goals
Diversity efforts face headwinds
Diversity initiatives in the US, whether at the board or workforce level, have ramped up over the past couple of decades. But their progress might be slowing down in the wake of the US Supreme Court’s July 2023 ruling against colleges’ ability to use affirmative action in the college admission process.
Although this ruling doesn’t technically apply outside higher education, flurries of lawsuits targeting Diversity Equity and Inclusion (DEI) initiatives at law firms and corporations have been filed since then. Furthermore, 13 Republican attorneys general sent a letter to Microsoft and other Fortune 100 companies threatening them with “serious legal consequences” if they relied on race-based employment preferences.
While companies are not openly changing their DEI approaches, we wouldn’t be surprised to see them mute their efforts in the short to medium term.
Similarly, a 2018 California law requiring a minimum number of directors from under-represented groups (and the disclosure of racial, ethnic and sexual orientation of corporate directors) at companies headquartered in the state was deemed unconstitutional in 2022. That was a setback for diversity advocates, who could point to the law’s significant impact on the percentage of women on California company boards, which had more than doubled from 16% in 2018 to 33% in 2022.
By contrast, a 2020 Nasdaq diversity rule had been challenged but was upheld in October 2023. While the Supreme Court and California rulings may have a chilling effect on diversity efforts, the Nasdaq rule is expected to increase boardroom diversity in terms of racial/ethnic, gender and sexual orientation characteristics.
Starting this month, Nasdaq requires that companies listed on its exchange have at least one director who identifies as female, LGBTQ+ or a member of an underrepresented racial or ethnic minority—or explain why they do not. By 2026, companies will need to explain why they don’t have two such directors.
What’s next in 2024? After years of progress, diversity efforts ran into headwinds in 2023. We believe that the controversies and attacks against these initiatives are not over and might even intensify as we proceed into an election year.3
The bottom line
The two most prominent ESG mega themes, climate and diversity, have been a political battleground for the past couple of years. As we proceed into the 2024 US presidential election cycle, we expect that incorporating financially material ESG metrics into investment decisions will continue to be a rather sensitive endeavor for investors.
1 “Scope 1, 2 and 3 emissions: What you need to know,” Deloitte.com, accessed January 2024. Scope 1, 2 and 3 categorize the different kinds of carbon emissions a company creates by its own operations and in its wider value chain. Scope 1 covers the Green House Gas (GHG) emissions that a company makes directly. Scope 2 emissions are made indirectly, for example, energy or electricity produced for heating and cooling buildings. Scope 3 includes all the emissions produced up and down a company’s value chain, whether bought from suppliers or sold to customers.
2 “SEC Chair Gensler says Scope 3 emissions flap delays final climate risk rule” by Jim Tyson, Utilitydive.com, September 14, 2023.
3 “DEI backlash hits corporate America” by Emily Peck, Axios.com, November 27, 2023.
