Advancing ESG Disclosure Policies: California Surpasses Federal Government
Why ESG and Why Now?
The rise of environmental, social and governance (“ESG”) factors is a reaction to the imperative for intervention amid a climate and social crisis. This is leading governments to increasingly rely upon disclosure regulations, justified by the need to enhance stakeholder engagement, risk management, brand reputation and long-termism. Such new ESG-oriented attention, nevertheless, may include additional duties in furtherance of interests beyond companies’ corporate purpose, moving in the direction of improving collective welfare.
The acronym, “ESG,” was first used in 2004 in the United Nation’s “Who Cares Wins” report. Since then, many more institutions – both public and private – have focused their attention on the relationship between ESG interests and private businesses, with regulators around the world (especially in the European Union and in certain individual European countries) introducing climate-related rules.
All the actions are based on the premise that disclosure policies are the best solution to address the environmental footprint of economic actors. However, such observation, although worthy of appreciation, seems to clash with the ultimate goal of a corporation (i.e., to increase its own value for its shareholders’ benefit). Consequently, the interrelation between sustainability factors and business activities has led to questions concerning the re-definition of the corporate purpose and the duties of directors.
Thus, such remarks are relevant when analyzing the new ESG reporting regime implemented in California, where state law appears to have taken the matter to the next step, advancing policies far more progressive than those of the federal government.
California’s ESG Regime: Notable Impacts of the New Legislation
On October 7, 2023, Governor Newsom signed SB 253 and SB 261 into law, making California the leading state in matters regarding climate-related disclosure. The two bills mainly focus on the duty for certain subjects that do business in the state to publish data on their environmental impacts and climate-related risks.
SB 253 defines a “reporting entity” as partnerships, corporations, limited liability companies or other business entities formed under the laws of California or any other U.S. state, the District of Columbia, or an act of Congress, doing business in California and with total annual revenues exceeding $1 billion. Starting in 2026, they will have to report annually to the California Air Resources Board (“CARB”) about their “Scope 1” and “Scope 2” greenhouse gas emissions. Additionally, beginning in 2027, these entities must also disclose their “Scope 3” emissions.
Scope 1 relates to direct gas emissions stemming from sources that a reporting entity owns or directly controls, including fuel combustion activities and regardless of location. Scope 2 concerns indirect greenhouse gas emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a reporting entity, regardless of location. Scope 3, on the other hand, aims to have reporting entities disclose emissions from sources that they do not own or directly control, and which may include purchased goods and services, business travels, employee commutes, and processing and use of sold products.
Under SB 261, “covered entities” are defined as corporations, partnerships, limited liability companies, or other business entities formed under the laws of California, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the United States with total annual revenues exceeding $500 million and that do business in California. They will be forced to disclose, on a biannual basis beginning January 2026, any “material risk of harm to immediate and long-term financial outcomes due to physical and transition risks,” such as risks to corporate operations, provision of goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health.
The Role of the Federal Government in the Context of ESG
Despite the ESG wave starting to spread globally a long time ago, the United States has so far been skeptical about regulating the matter. In fact, California is not the first institutional actor that has tried to implement ESG-related policies within the United States.
In March 2022, the Securities and Exchange Commission (“SEC”) released a proposed rule that would oblige registrants to disclose certain environmental data relating to their businesses in both their registration statements and periodic reports. In doing so, the SEC faced serious criticism stemming both from the private sector and academia, questioning in particular whether the SEC actually holds the power to regulate the matter. Indeed, granting significant authority to an empowered government agency is an unfavorable approach to addressing the issue, which would most likely face constitutional challenges.
One could then argue that the most appropriate solution is to allow states to take a stand on an issue that now involves the entire United States (and the rest of the world). However, it is important to note that state-level regulation of a national issue could prove to be inefficient, potentially leading to a race-to-the-bottom, as affected businesses may relocate to states with less stringent regulations, thus undermining the overall effectiveness of the regulatory framework.
Conclusion and Future Perspectives
The bills signed into law by Governor Newsom impose major burdens on companies operating in California. While the need to intervene in the context of a global issue is understandable, it is also necessary to consider how such policies could affect the businesses involved.
According to the entity theory, the purpose of a corporation should not be limited to enhancing shareholders’ value, but should also be focused on other needs felt by stakeholders. However, it is worth noting that it is one thing to make private parties comply with state laws to avoid climate and social disasters with devastating impacts, and quite another to request them to overhaul their system and pursue objectives intended to benefit all stakeholders, thereby adopting a “stakeholder governance” model.
There is no doubt that the urge to reduce carbon emissions is a top priority for international institutions, and that cooperation with private entities in achieving this objective is crucial. Nonetheless, burdening companies (and directors) with additional duties, without incentivizing them, may not be an efficient strategy. In other words, public powers should not only concentrate on establishing new responsibilities for companies. Indeed, their actions should be based on incentivizing ESG-focused changes, allowing rewards in relation to the new disclosure burdens and avoiding potential counterproductive, opportunistic behaviors such as greenwashing or selective reporting.
Luca Vernero is a Corporation Law LL.M. candidate at NYU School of Law, a Graduate Editor for the NYU Journal of Law & Business and a current Ph.D. candidate in Corporate Law at the University of Turin. Prior to attending law school, Luca worked as a lawyer in an Italian boutique law firm, focusing on corporate litigation and arbitration proceedings.