California passes ESG law

California lawmakers have passed the nation’s broadest carbon emissions mandates, rules that may well force some tough choices on private fund managers.

The Climate Corporate Data Accountability Act requires all companies with at least $1 billion in total revenues and that do business in the Golden State to track and report their Scope 1, 2 and 3 emissions. It covers some 5,400 companies – including many private equity funds and their portfolio companies. Scope 1 emissions are those created directly by a company, including vehicle fleets, boilers, incinerators and manufacturing. Scope 2 emissions are indirect – for instance a company’s heating or cooling systems. Scope 3 covers emissions generated by other parties along a company’s supply chain.

The measure passed California’s Senate on Tuesday, 28 to 7. It now heads to Governor Gavin Newsom’s desk. The governor has until October 14 to sign or veto it. A court challenge is likely. The bill had support from some of the world’s largest corporations, including California-based Apple, but the California Chamber of Commerce called it “onerous” and unnecessary. California’s massive agriculture industry, in particular, is bothered by the reporting requirements because they fear it will bury farmers, ranchers and vintners in paperwork.

The new law comes as the US Securities and Exchange Commission weighs two final rules packages – one that imposes carbon reporting requirements on public companies, the other concerning SEC-registered investment advisers.

For large private fund managers, California’s bill imposes wide carbon reporting mandates in the world’s fifth-largest economy. Similar legislation is pending in New York, the world’s third-largest economy. The European Union – the world’s biggest economy – adopted even broader rules last year.

A handful of states – including Florida, Oklahoma and Texas – have passed laws or adopted rules that either forbid companies from “discriminating” against fossil fuel companies or that require fund fiduciaries to focus solely on the economic returns of a given investment.

The legislation is also likely to intensify the scramble to come up with meaningful metrics to track carbon emissions – and meaningful ways of ensuring those emissions are being measured properly. California’s new law follows the Greenhouse Gas Protocol, a set of standards adopted by a handful of global trade and nonprofit associations. Firms must not only use the Protocol’s measures, but they must attain “assurance” from an outside party – beginning in 2026 for their Scope 1 reports, in 2027 for their Scope 2 reports and 2028 for their Scope 3 reports. Large audit firms have already committed tens of millions of dollars to ramp up their non-currency accounting functions. Countless smaller firms are already offering metrics and assurance services.