US banks need to prepare for regulation on ESG

US financial institutions need to accelerate the development of their compliance departments in anticipation of new rules regarding environmental, social and governance (ESG) issues.

Rules are expected coming into force on ESG disclosures that will limit, and possibly punish, banks that lend money to clients that are actively ignoring policies on climate change.

David Silk, a partner at law firm Wachtell, Lipton, Rosen & Katz, said in a recent Reuters article: “I think what the banks will ultimately be asked to do at some level is to take account of the sustainability impact of their investments or loans. They should understand, for example, whether for a real estate loan the builder is complying with best practices from an environmental perspective.”

The EU is currently leading on this front. The Sustainable Finance Disclosure Regulation, introduced in March this year, requires mandatory ESG disclosures from asset managers and other financial market players.

However, the SEC’s Hester Peirce recently warned against following a Europe-style regulatory structure or ‘taxonomy’ and that implementing a similar structure in the US would “homogenize capital allocation decisions” and in turn “impede creative thinking”.

US banks will soon be asked to calculate how risky their investments are to sustainability, while also increasing transparency for investors.

In December last year, the US Federal Reserve joined the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), an international group focused on climate change risk, and in March the SEC formed a task force on climate and ESG.

The SEC launched its own Climate and ESG Task Force earlier this year to focus its work on the sector, particularly regarding investment funds marketed as ESG-friendly or ‘green’.

Despite the huge increase in interest in this area, a recent poll by Procensus found that just a quarter of investors felt that corporates would be able to hit net-zero carbon emission pledges by 2050.