ESG and Private Markets: Navigating Federal Scrutiny

The Expanding Reach of ESG Disclosure Regulations

The tightening of regulations concerning ESG (environmental, social, governance) disclosure reporting, initially observed in public markets, is poised to significantly influence participants in the private market sector – encompassing founders, companies, and investors alike.

Federal Focus on ESG

Since assuming the role of chair of the U.S. Securities and Exchange Commission in April, Gary Gensler has prioritized the reformation of ESG disclosures, particularly regarding climate change risks and human capital management. This commitment is clearly reflected in the SEC’s current regulatory agenda.

Gensler’s emphasis on ESG is mirrored at the federal level. President Joe Biden issued an executive order directing regulators to evaluate climate-related financial risks. Furthermore, Treasury Secretary Janet Yellen emphasized on Twitter the dependence of future economic stability on the financial sector’s commitment to a sustainable and resilient economy.

Legislative bodies are also considering measures to enhance ESG disclosures. These include the Improving Corporate Governance Through Diversity Act, the Diversity and Inclusion Data Accountability and Transparency Act, and the Climate Risk Disclosure Act.

Impact on Private Markets

This heightened federal attention to ESG issues will strengthen the SEC’s efforts to establish disclosure standards for public companies and mutual funds. Regardless of the ultimate fate of these federal policies, the prevailing momentum will inevitably affect private markets in several ways:

• Companies aspiring to become publicly traded – through SPACs, direct listings, or traditional IPOs – may need to prioritize board diversity and environmental reporting, potentially well before their market debut.
• Private entities seeking partnerships or vendor relationships with public companies may be required to adhere to specific ESG criteria as a condition of engagement.
• Startup founders and venture capital firms securing funding may proactively address ESG considerations to maximize their appeal to investors with ESG-focused investment strategies.

During his Senate confirmation hearing in early March, Gensler stated, “Markets — and technology — are always changing. Our rules have to change along with them.”

The federal government’s move to increase regulation around ESG disclosure aims to establish greater transparency and quantifiable metrics for public companies. This response is driven by evolving market demands, investor scrutiny, and a broader societal expectation for enhanced corporate responsibility.

Investor Sentiment and Future Adaptations

Private markets are not shielded from these forces. A 2020 survey revealed that three-quarters of investors consider measuring the success of sustainability initiatives to be very important, yet they also acknowledge a lack of clarity regarding the definition and measurement of outcomes.

While a complete adoption of ESG regulations isn’t anticipated in the private market, it’s unlikely to be subjected to the same reporting frameworks as public entities – at least not in the immediate future.

However, private investors, funds, and companies may proactively adapt to anticipate ESG regulations and position themselves for success within a related regulatory landscape. The fundamental rules may remain unchanged, but the competitive dynamics could shift significantly.