The Future of ESG Legislation
Add bookmark
As sustainability becomes a key metric for stakeholders and corporations globally, companies must consider the future of ESG legislation. The current trends have far-reaching implications for investment opportunities and compliance efforts.
The Current State of ESG Legislation
Environmental, social and governance (ESG) legislation has experienced growing attention in recent years. As of 2023, various governments and regulatory bodies have authorized different acts to expand corporate regulations. The broadened global standards often offer incentives, but may also carry additional compliance requirements or tax implications.
Despite legal pushback and some investment hesitancy, the sustainability market is growing. In fact, the total market value of ESG funds is projected to grow exponentially, to reach an estimated $33.9 trillion by 2026. In its current state, ESG remains a critical market driver and an essential element for stakeholders, investors, companies, and regulators to consider.
ESG Legislation Trends
Globally the trend in ESG legislation is for a strengthening of environment regulations, especially as they pertain to carbon emissions and transparency.
In Europe, much of the legislation focuses on restricting companies' potential emissions, employing higher corporate tax rates and forcing disclosure of environmental impacts.
For instance, the European Union (EU) Carbon Border Adjustment Mechanism — provisionally agreed upon in 2022 — would impose a carbon tax on businesses importing steel, aluminum, electricity, hydrogen, iron, cement, fertilizers or hydrogen. Importers must purchase certificates to make up for the embedded carbon dioxide emissions of the goods. The mechanism was recently passed (May 2023) and will enter into force in 2026 after a transitional period that begins later this year.
Government agencies in the U.S. and Canada have moved forward with tightening standards. In May 2023, the U.S. Securities and Exchange Commission announced proposals to force funds using ESG wording in their names to invest 80% of their assets in ways aligning with the language and disclose their impacts, metrics, and progress. If they have specific words in their name, they must comply and invest accordingly or face disciplinary action.
The EU has typically focused on creating similar legislation. Adopted in 2022, the Corporate Sustainability Reporting Directive forces almost 50,000 companies in the EU to disclose their environmental impact. It’s an expansion of a previous directive, increasing the number of businesses that must comply and requiring more detailed reporting. The move is in response to insufficient reporting, as the European Commission felt more explicit requirements and standardization were necessary.
While not every enacted legislation is restrictive, a growing number of entities seek to hold organizations to a higher standard. Sectors like manufacturing and transportation significantly impact the environment, so their behavior is often restricted. Most official bodies focus on strengthening past actions or enforcing compliance in specific situations as of now, but that could change with heightened visibility in the future.
What Are the Incentives?
Although organizations face challenges due to increasing restrictions or requirements, many agencies offer benefits in exchange for compliance. For example, the U.S. passed the CHIPS and Science Act in 2022 to incentivize domestic manufacturing because most companies typically outsource for affordability. The desired outcome is a more sustainable production process and the bonus is local labor is more cost-effective for the country.
While incentives or remuneration for organizational ESG metrics in the United Kingdom aren’t required by law, many will likely do more than they’re obligated to because a future return on investment is connected to achieving ESG goals. In addition, some entities may offer compensation even though they’re not required to because it can encourage compliance and visibility.
Restrictions Lawmakers Face
Although there is growing support for ESG regulations broadly, there has also been a growing backlash against it. Officials in the United States enacted 39 anti-ESG bills in 2022 with the number set to grow this year (the number already totals 99 bills halfway through 2023). Although sustainability is attractive to many consumers and investors, certain political bodies have retaliated against such efforts.
For example, Florida’s chief financial officer announced the move to stop BlackRock Incorporated from managing nearly $600 million in investments and freeze over $1.4 billion worth of securities to punish it for its ESG investing practices. Despite the company being the largest asset manager in the world, it was still significantly affected by the changes in legislation.
The pushback primarily comes as an ideological response to the increase in global environmental policies. For instance, a minimum of seven states in the U.S. have enacted laws or regulations banning or restricting public entities from investing state funds with ESG considerations in mind as of March 2023. The attempts at restriction limit the financial flexibility of some investors.
The Potential Outcome of ESG Legislation
Recent sociopolitical factors also affect the path of ESG legislation and investment. For instance, organizations in shipping and manufacturing have been primarily influenced by Russia’s invasion of Ukraine. In particular, it may hasten the transition to clean energy in the EU and investments in alternative fossil fuels by complicating transport and production of fossil fuels and making cleaner alternatives more economic. In addition, dozens of large businesses pulled out of Russia within days despite it affecting their revenue.
The war also affected the global energy crisis since it significantly hindered the conventional transport and manufacturing of fuel. Multiple countries looked to clean power in response; the IEA estimates that 90% of global energy expansion will come from renewables by 2025. Companies in related sectors must watch for these situations, as they have the potential to alter opportunities for investment strategies.
While most organizations don’t appreciate excess scrutiny or increased regulations, ESG legislation can also provide an opportunity. Consumers and regulators often consider compliance beneficial, which could be fundamental for growth. It also levels the playing field between market participants.
Many also provide specific incentives like tax breaks or investment credits. For example, the U.S. Inflation Reduction Act of 2022 offers advanced manufacturing production credit and energy-efficient commercial building deduction to promote sustainability in business. While compliance expansion may seem like a hindrance, it has the potential to be advantageous. If organizations carefully prioritize their investments and strategies to align with regulation, they can drive growth.
To do so, however, they must fully understand the scope of applicable laws. Entities operating globally or in areas with varying requirements must follow all relevant regulations. Impact disclosure, updated tax rates and investment restrictions will likely be most important, but it depends on the industry. The potential outcome of ESG legislation lies in how they change their investment strategies in response to proposals and upcoming changes.
The Future Impact of ESG Legislation
Industries should monitor ESG legislation to determine its relevance and potential impact. While proposals will affect particular sectors over others, the investment opportunities and regulatory implications will remain the same for most.
