We spoke with the former chair of the U.S. Commodity Futures Trading Commission to get answers about the SEC’s new regulations on climate and ESG disclosure

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Ethic’s chief compliance officer, Alex Acosta, recently spoke with Tim Massad, the former chairperson of the U.S. Commodity Futures Trading Commission (the “CFTC”), the independent governmental agency tasked with regulatory oversight of the derivatives markets, from 2014 to 2017. Before the CFTC, Tim served as assistant secretary for Financial Stability in the U.S. Department of the Treasury. In this position, he oversaw the Troubled Asset Relief Program (TARP), which served to help stabilize the U.S. economy in the wake of the 2008 financial crisis and extend much-needed help to distressed homeowners. He also served as chief counsel for the program prior to assuming the role of assistant secretary.

Currently a research fellow at the Kennedy School of Government at Harvard University and director of the school’s new Digital Assets Policy Project, Tim is also a widely-respected consultant on financial regulatory and fintech issues who writes regularly for publications such as Bloomberg. In other words, Tim has a very busy schedule. 

That’s why we appreciated it when he gave us 15 minutes of his time on a recent Monday morning to share his perspective on the Securities and Exchange Commission’s (SEC) proposed regulations on climate and ESG disclosure, which are expected to be finalized and published soon, as well as the recently adopted enhancements to the Commission’s Fund “Names Rule.”

The transcript has been lightly edited for length and clarity. 

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Ethic: The SEC has been issuing what many call a “tidal wave” of regulation since Gary Gensler’s appointment as chair of the SEC. What are your thoughts on the current state of the SEC?

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Massad: The SEC has a very ambitious agenda. They currently have about 30 proposed rules that they want to finalize and some additional proposals they hope to issue. That's a lot. The proposals they wish to finalize include some significant changes to existing rules and the way the markets work today, as well as entirely new subjects.

The Climate Risk Disclosures Rule for Public Companies proposal, which we’ll discuss momentarily, is, of course, one of the SEC’s proposed rules. They have proposals on equity market structure and order execution, custody of assets by investment advisors, shareholder proxy proposals, and a variety of other things. In addition, they're contemplating some new proposals on the use of AI by broker-dealers and other topics. Again, it is a very big agenda.

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Ethic: Yes, it is, indeed, a big agenda. Before we talk about the Climate Risk Disclosures Rule, I’d first like to ask you about the SEC’s Amendments to the “Names Rule,” which they adopted on September 20th. 

Under the proposed amended “Fund Names” rule, an ESG Integration Fund that considers ESG factors alongside non-ESG factors, but not as the primary factors of its investment decisions, would no longer be allowed to use the term “ESG.” To continue doing so would be deemed materially deceptive and misleading by the SEC. However, the SEC withdrew the proposed amendments that would have prohibited “ESG Integration Funds” from using ESG terminology in their names. SEC chair Gary Gensler has asked his staff to prepare recommendations to address how these funds could refer to ESG integration in their name. 

Can you share a brief history of the “Names Rule” as well as your thoughts on what SEC chair Gary Gensler’s recommendations might look like?

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Tim: The Fund “Names Rule” action broadens the scope of funds that must comply with a requirement that dates back to 2001 that says a fund must invest at least 80 percent of its assets in accordance with the investment focus that the fund’s name suggests. The SEC said that the growth of assets under management and the proliferation of investment strategies made this necessary, because a fund’s name is a signal to investors as to the fund’s strategy. 

The requirement now applies to funds that have “growth” or “value” objectives as well as environmental, social, or governance (“ESG”) objectives. The SEC did not adopt one aspect of the proposed rule, which would have applied the requirement to so-called ESG “Integration Funds,” which are funds where ESG factors are considered alongside, and are no more significant than, non-ESG factors. The SEC has said they will continue to look at this issue.

Ethic: Thanks for that, Tim. Now, let’s return to the proposed Climate Risk Disclosures Rule, which is expected to be finalized and published soon. Once enacted, it would mark the most sweeping overhaul of corporate disclosures in decades. What type of impact do you think standardized disclosures will have on investors and public companies?

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Massad: Well, standardized disclosure of climate risk would be of huge benefit to investors. A lot of companies today make disclosures, but they aren't using common standards or metrics. Greater standardization would make it a lot easier for investors to understand and evaluate risks and make comparisons. This would put them in a better position to incorporate judgments about those risks to the extent they wish to in their investment decisions. But, of course, this proposal has been the subject of a lot of criticism and controversy. Some people say the SEC is going too far and that it's requiring information that isn't material, so we'll have to see what the final rule looks like when it comes out.

Ethic: Yes, we will have to wait and see. For my next question, I’d like to ask you about the proposed rule’s requirement to report on Scope 3 emissions — this is of particular interest to some of our clients that may partner with or somehow are part of a public company’s supply chain. What, if anything, should they do to prepare?

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Massad: Well, just to be clear, the Climate Risk Disclosure proposal requires disclosure of Scope 1, 2 and 3 emissions. Scope 3 has been, I would say, the most controversial part of the proposed rule because those emissions are indirect, or what are often called value chain emissions that come from a company's suppliers and distributors and not from the company's own activities or sources. To measure them, you need to look up and down the entire value chain. Many people feel it's very hard to measure this, and that a company shouldn't be responsible for providing that information.

So, how do you prepare? Well, that's a tough one, given that we don't know what the final rule will look like and that there's been a lot of speculation that this is one area where the rule might change. I think we will see companies trying to offer services to help people begin to develop this information and the metrics. But overall, I would probably wait until the rule comes out before trying to do too much, because we just don't know yet what it would look like. 

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Ethic: There has been some indication that this new rule will be challenged in the courts once it is published. What grounds would there be for challenging the rule? And is there anything we should do between now and the time courts have issued their final ruling? 

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Massad: All indications are that it will be challenged. The first question would be, assuming this is the case, is the implementation of the rule halted while the challenge is pending in the courts? Not necessarily. The rule could still be in effect as the challenge makes its way through the courts, which might take some time.

There are likely a few grounds for challenges. Some will argue that the SEC is only supposed to require disclosure of information that is material to a reasonable investor. They will say the rule goes beyond the sort of information that could be construed as material. By applying the rule to all public companies, some will argue this violates a doctrine of case law called the Major Questions Doctrine, which basically says a regulatory agency doesn't have the power to enact rules that address major questions where it hasn't really been given authorization by Congress.  There are other challenges that may be made as well. 

The Supreme Court already has on its docket some cases pertaining to a regulatory agency's power and authority. They're not directly relevant, perhaps, to a challenge to this law, but it does signal that the Supreme Court may at least be looking more critically at regulatory agencies and the scope of their actions.

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Ethic: If it were to get to the Supreme Court, and knowing that we currently have a conservative court, what do you think could happen?

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Massad: Well, again, we’ll have to see what the final rule is. But I think this Supreme Court would likely be conservative in interpreting the scope of an agency's power. The cases they have before them today, that they'll decide by June or July in 2024, will give us further indications of that. If, for example, they cut back what's called the Chevron doctrine, which is where a court is supposed to defer to an agency if that agency's action appears to be reasonable, that would clearly be a signal that they're going to look very critically at agencies that are doing things that might be arguably beyond the narrow standards of their authorizing legislation.

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Ethic: I’d like to talk to you about the Congressional Review Act (CRA), which has been used by Congress to overturn 20 rules since its enactment in 1996. Can you provide an overview of the Act and what effect you think it may have on the SEC’s rules around climate risk and ESG?

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Massad: Sure. The CRA provides a way for Congress to overturn rules and certain other actions taken by a regulatory agency. It requires that Congress pass a joint resolution overturning a rule, and then it must then be signed by the President. Or, if the President vetoes the resolution, then Congress must override that veto. But Congress must act within 60 days of the rule being submitted to Congress by the agency. Note that we’re talking about 60 legislative session days, not calendar days, so that’s a longer period of time. 

Because  the Democratic Party controls the Senate today and  Democratic President Biden appointed SEC Chair Gary Gensler, this is not likely to be relevant unless the Republican Party makes dramatic gains in the 2024 election. They would likely need to control both houses of Congress to take action under the CRA. Because chances are, even if some Democrats don't like particular things that the SEC has decided, taking action under the CRA is an extreme measure.  But if the Republicans were to make those gains, then it could be relevant for SEC actions taken in the last half of 2024.  

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Ethic: Let’s move from what’s happening at a federal level to discuss what’s happening in the states. We’ve been getting a lot of questions from our clients about how some U.S. states have been adopting anti-ESG regulations to limit government agencies from making investments motivated by societal goals. What effect, if any, would the new SEC rules have on these states' regulations if they conflict with each other? 

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Massad: At the state level there have been many proposals to limit the ability of state pension funds and other institutions to consider climate risk or other ESG-related information, or to limit hiring of firms for state business if they  prioritize ESG considerations.  I’ve heard an estimate of around 150 proposals to this effect. For example, many would say that a state pension fund or other institution with state ties can't consider these factors in its investment decisions, and therefore it cannot invest in certain investment funds it might otherwise choose.

I've seen estimates that these types of restrictions can be quite costly. There was one study in Indiana that said if its pension funds were forced to divest of certain investment funds because of this climate and/or ESG issue, that could cost several billion dollars in returns. I don't know if that's a fair estimate or not, but if so, it would be very unfortunate.

Ultimately, the SEC Climate Disclosure rule is going to delve into what type of information companies will have to disclose – but it won’t mandate that investors consider this information or weigh it in any particular way. In this sense, the SEC rule and the state rules won’t directly collide. But this obviously makes it very, very difficult for investment managers to know what to do. On the one hand, you could have an SEC rule that requires companies to provide standardized disclosures and you may feel that a lot of your investors want you to consider that information. But on the other hand, if you factor that into your decisions, then are you going to lose business in certain states? This would be a very unfortunate situation, as it could make it hard for certain investment funds and investment managers to figure out how to navigate their way through what could become a difficult environment.   I don’t think we should try to prohibit investors or pension funds from considering information about climate risk or ESG.

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Ethic: OK, we’ve been talking for just about 15 minutes. I have just one more question: What’s your prediction for what the impact of these rules will be on sustainable investing over the next 10 years?

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Massad: I think we will get to a point where we have much better disclosure about climate risk. It's simply becoming too significant and other jurisdictions are moving in this direction. Having more information and more standardization about that information makes it much easier for investors to evaluate these risks and make their investment decisions. That's all for the greater good, in my view. Obviously, this is going to continue to be a big issue for many, many years.