From candy makers to missile manufacturers, CFOs of numerous companies have spent years trying to attract equity capital by adopting environmental, social, and governance (ESG) best practices. According to Morningstar data, by one measure their efforts have paid off—global investment in so-called sustainable mutual funds and exchange-traded funds has more than tripled since 2018, reaching $2.47 trillion.

Today, ESG is facing a hostile redefinition. Critics call it "woke capitalism," an agenda imposed on American businesses by a "climate cartel" of shareholder activists, asset managers, and politicians.

"ESG is a harmful strategy because it allows the left to achieve goals it could never reach at the ballot box or in free market competition," former Vice President Mike Pence said in May. He joined a diverse camp of opponents including Berkshire Hathaway Vice Chairman Charlie Munger and Tesla CEO Elon Musk.

According to lawyers and former regulators, CFOs should not expect this wave of opposition to stop a proposed rule by the U.S. Securities and Exchange Commission (SEC)—a rule aimed at more closely aligning securities law with climate activism and the corporate world's push toward ESG disclosure.

According to the Governance and Accountability Institute, 92% of S&P 500 companies already publish ESG reports. In response to investor pressure, thousands of companies worldwide have committed to reporting greenhouse gas (GHG) emissions.

"The largest institutions have made commitments, and they are not going to back down," said Elizabeth Saunders, a partner at Clermont Partners. "That ship has sailed."

CFO Dive, data source: Morningstar Direct

The lawyers and former regulators said the SEC will publish a rule by January next year requiring listed companies to provide detailed disclosures on carbon emissions and climate risks. The SEC is reviewing more than 14,000 public comments on the proposed rule, but any revisions to its 490-page draft are likely to retain the most stringent and costly requirements for measuring and reporting climate risk.

"If I were the CFO of a public company, I would fully expect these rules to take effect," said Kai Liekefett, a partner at Sidley Austin and co-chair of its shareholder activism practice. "You need to be prepared—you cannot expect Santa Claus to bring you gifts."

The SEC currently does not require companies to report climate risks or explain how they report them. Instead, the agency relies on "interpretive guidance" issued in 2010, advising companies on how to disclose the impacts of climate change based on existing or new legislation, regulations, and global agreements.

Under the new climate risk rule, the SEC aims to require companies to describe in their 10-K filings their strategies for mitigating climate risks, including plans developed to achieve targets they have set for curbing such risks. Companies would also need to disclose their GHG emissions data (from their own facilities or through energy purchases) and obtain independent assurance on that data.

SEC Chair Gary Gensler said clear, uniform disclosure of climate change costs would benefit both companies and investors. Companies would gain deeper insight into potential costs and opportunities, while investors would be better able to assess risks at specific companies and compare risk levels across industries.

"If information is consistent and comparable, it helps both issuers and investors, and can lower the cost of risk premiums, which are part of the cost of capital," Gensler said at a Harvard University forum on September 15.

The Measurement Challenge

According to the lawyers and former regulators, the current patchwork of methods for measuring how well companies adhere to ESG principles is causing confusion among investors, as well as some CFOs and their executive colleagues.

"It is a complete mess," Liekefett said in an interview, adding that ESG rating firms will need several more years to reach consensus on unified measurement standards.

Researchers at the MIT Sloan School of Management, in a study titled "Aggregate Confusion," noted that more than 100 companies worldwide specializing in ESG performance ratings often give the same company different rankings.

Moreover, when measuring and reporting carbon emissions and other ESG factors, CFOs currently must choose from dozens of inconsistent frameworks. The clutter of measurement systems also creates confusion and allows some companies to "greenwash"—that is, exaggerate their progress in adhering to ESG principles.

"In my view, these metrics and measurement systems are still in their infancy in some respects," said Brad Smith, president of Microsoft, adding that they are insufficient to assess whether 3,470 companies worldwide are delivering on their promises to improve environmental impact. "Unless there is accountability, the public—whether shareholders, customers, or community members—has no fundamental reason to believe what companies say," Smith said at the Harvard forum.

Gensler told the Harvard forum that global regulators are gradually converging on common standards for reporting climate risk. The SEC's disclosure rule, like mandates adopted in Europe and elsewhere, draws on the guidance of the Task Force on Climate-related Financial Disclosures (TCFD), he said in a recorded interview. "We are all trying to build on that."

The TCFD describes 11 categories of disclosure across four areas: governance, strategy, risk management, and metrics and targets. It does not delve into how to measure climate risk. The SEC also encourages the use of the Greenhouse Gas Protocol, a set of standards for accounting for and reporting GHG emissions.

Widespread Backlash

Critics say the cost of the upcoming rule far outweighs any benefits. SEC Commissioner Hester Peirce, before casting the sole dissenting vote in a 3-to-1 commission vote, said the regulation would accelerate the growth of the "climate industrial complex." "We are laying the cornerstone here for a new disclosure framework that will ultimately rival our existing securities disclosure framework in scale and cost, and may surpass it in complexity," she said. "We are not the Securities and Environment Commission—at least not yet."

According to lawyers and former regulators, criticism of the SEC's draft rule echoes many points in the broader ESG backlash and highlights the rule's vulnerability to delay.

"Everyone is preparing for the 'extra war' after the SEC issues its final rule," said David Brown, a partner at Alston & Bird.

The SEC estimates that complying with GHG emissions disclosure requirements would cost a small company an additional $420,000 per year, while a large company would need an additional budget of $530,000. "The SEC has severely underestimated the amount of money needed to comply with this rule," Brown said in an interview. He predicted that eventually a judge will tell the agency, "'Your economic analysis is flawed—go back and redesign it.'"

Brown said CFOs will need to hire accountants, data analysts, and other sustainability experts, and pay external auditors and consultants for independent reviews of SEC filings. Additionally, measuring Scope 3 GHG emissions from upstream and downstream contractors will be challenging and costly. "The Big Four accounting firms are hiring tens of thousands of people to get ahead, and the scarcity of talent will naturally drive up costs," Brown said. "The Sarbanes-Oxley Act was once called the 'Auditor Full Employment Act,'" he said. "This is the 'ESG Consultant Full Employment Act.'"

While imposing heavy compliance costs on companies, the SEC is also overstepping its congressionally authorized mandate, Pennsylvania Republican Senator Pat Toomey, the ranking member of the Senate Banking Committee, told Gensler at a committee hearing on September 15. "The SEC is wading into controversial public policy debates far beyond its mission and expertise, and it is doing so without legal authorization," Toomey said. "The impact of compliance costs on investors will be more significant than the (climate risk) information itself."

He said the SEC's ultimate purpose is to cut off investment in fossil fuel producers by "providing data to climate activists to launch political pressure campaigns against companies, often to the detriment of shareholder interests." "The SEC will have to explain itself to the courts." Congressional reaction to the proposed rule has largely split along party lines.

"The SEC's work on climate risk disclosure is an important example of improving market understanding of risk and providing transparency and comparability—clarity and uniformity are key," Ohio Democratic Senator Sherrod Brown, chairman of the Banking Committee, said at the hearing. "If only some companies provide disclosures, and in a haphazard manner, that benefits no one."

Supreme Court 'Ammunition'

Opponents of the SEC rule have found "ammunition" in a Supreme Court ruling in June that limited the Environmental Protection Agency's (EPA) authority to restrict power plant emissions under the Clean Air Act. In the 6-to-3 ruling in West Virginia v. EPA, the Court invoked the "major questions doctrine," holding that federal agencies need congressional direction before enacting regulations with significant economic or political impact.

Saunders predicted in an interview that this doctrine "will be the threshold question determining whether the SEC can survive challenges," and "everything else becomes secondary."

Critics also argue that the disclosures required by the SEC rule are not material to investors' decision-making and risk management efforts. Gensler defended the proposed regulation, noting that investors holding $130 trillion in assets globally are urging unified and consistent disclosure on climate risk. "I do not think any court today would rule that climate risk is not material to certain companies now," Saunders said.

Nevertheless, several states, including Florida, Oklahoma, Texas, and West Virginia, have said asset managers like BlackRock are pushing an ESG agenda at the expense of investor returns. They argue ESG principles are irrelevant to investment decisions and have barred some asset managers that use ESG benchmarks from managing state pension funds.

Louisiana State Treasurer John Schroder notified BlackRock CEO Larry Fink in an October 5 letter that the state would withdraw $794 billion in pension fund money from BlackRock funds due to the asset manager's use of ESG criteria. "Your overtly anti-fossil fuel policies will destroy Louisiana's economy," Schroder said. "In my view, your support for ESG investing is not in the best economic interests and values of Louisiana."

BlackRock has pushed back against claims that it dictates to companies how to address carbon emissions, saying such decisions should be the responsibility of company management teams and boards.