Uncoordinated Coordination and Vicarious Experimentation: The Brussels Effect in ESG Regulation

Posted on Apr 6, 2021

Jenny Li

 

The “Brussels Effect,” a term first coined by Professor Anu Bradford of Columbia Law School in 2012, refers to the phenomenon of stringent regulations of the European Union being exported to other countries through market forces rather than formal laws, resulting in “unilateral regulatory globalization.”[1] While the Brussels Effect has traditionally manifested in areas of cybersecurity, health, environmental, and other product standards geared towards consumer protection,[2] this phenomenon has important implications for Environmental, Social, and Governance (“ESG”) regulation as well.

In her article published in the Northwestern University Law Review in 2012,[3] Professor Bradford describes the Brussels Effect as a phenomenon of upward regulatory convergence to stringent EU standards. She argues that the EU, through market mechanisms rather than formal legal changes, exerts regulatory influence outside its borders, which “converts the EU rule into a global rule—the ‘de facto Brussels Effect.’”[4] “Without the need to use international institutions or seek other nations’ cooperation,” she points out, “the EU has a strong and growing ability to promulgate regulations that become entrenched in the legal frameworks of [non-EU markets], leading to a notable ‘Europeanization’ of many important aspects of global commerce.”[5] The Brussels Effect manifests itself in cases where the EU creates incentives to adjust upwards to its stringent standards, and market participants respond to such “involuntary incentives” through reluctant emulation.[6]

One classic illustration of the Brussels Effect concerns data privacy regulation: multinational companies such as Google[7] tend to adopt one company-wide privacy protection policy that meets strict EU standards across all jurisdictions where they operate, so that they may reduce costs arising from having to comply with multiple regulatory regimes.[8]

Unlike those industries that have historically been most impacted by the Brussels Effect—where segmenting markets and complying with different standards across different jurisdictions are infeasible—the asset management rendition of the Brussels Effect is unlikely to be a one-step process: in a one-step process, global asset managers would radically adopt one-size-fits-all policies and then ratchet up their policies across all jurisdictions to meet the stringent EU ESG rules. Rather, the Brussels Effect in the ESG space will likely manifest in two steps. First, U.S. and other non-EU asset managers will choose to start ESG funds in the EU due to lower liability and fiduciary duty standards there with respect to maximizing investor value. As a result, ESG funds will opt to subject themselves to the EU’s ESG regulatory regime. Second, if and when these funds prove to be financially viable and compliant with the systematic and stringent regulations in the EU, ESG asset managers will then import their ESG investment strategies into the U.S. and elsewhere—now with greater confidence that their ESG-integrated investment practice is financially lucrative and regulatorily compliant as tested by the stringent EU standards. This will have the impact of significantly reducing the ESG funds’ risks of violating U.S. regulations arising out of fiduciary duties to and primacy of shareholders.

Currently, the U.S. and EU are taking not just different, but perhaps diametrically opposed, positions on ESG investments and disclosures. While EU regulators are making sweeping regulatory efforts to accept and fuel ESG integration, U.S. government regulators are hesitant to take the leaps necessary to encourage, or even define the contours of, ESG investing.

However, despite differences between U.S. and EU approaches to ESG regulation, there is a clear parallel between the two regimes: where the EU set up the EU Emissions Trading System (“EU ETS”) in 2005, the U.S. made an attempt at establishing a variant of an emissions trading scheme similar to that of the EU through the American Clean Energy and Security Act of 2009 (“ACES Act”), which, if passed into law, would have achieved that goal; where the U.S. has the Green New Deal, the EU has the Green Deal.[9] While the U.S. was one step ahead of the EU in adopting a policy package like the Green New Deal, the EU is in the leading position in terms of specific, binding regulations that carry out the agenda of the policies.

The phenomenon of U.S. regulators learning from the successes and failures of EU ESG regulations is further reflected in a 2009 Heritage Foundation report titled “The Economic Consequences of Waxman-Markey: An Analysis of the American Clean Energy and Security Act of 2009.”[10] In their discussion on the potential costs and problems of Waxman-Markey (i.e., ACES Act), the authors note that “Europe’s experience with climate-change laws similar to Waxman-Markey strongly suggests both high costs and uncertain emissions reductions.”[11] This comment reflects the general approach of U.S. regulators in looking to the EU and its prior regulatory experiments and experiences: since the EU is an early adopter of the emissions trading system, U.S. regulators likely evaluated the favorable and unfavorable results of the EU’s system, and contemplated what kind of costs and problems the U.S. could avoid in adopting or not adopting a similar system.

This kind of process is effectively a manifestation of the Brussels Effect in regulatory experimentation. Although ultimately the ACES Act was not passed into law, its sponsors put serious efforts into drafting and evaluating the viability of this bill potentially with the EU ETS in mind, and such vicarious experimentation provides valuable lessons for U.S. legislators and regulators on enacting laws and regulations that promise the efficacy while avoiding the mistakes of their precedents.

As of now, the U.S. is not the most welcoming market for field-testing new, especially actively managed, ESG investment strategies as it has not caught up with the international benchmark of making ESG integration a requirement and a positive fiduciary duty for asset managers. The EU thus becomes the natural choice for such experimentation because of its ESG-friendly regime, advanced regulations, and considerable market size. As U.S. asset managers introduce and develop more ESG investment funds in the EU, they are inevitably subjecting themselves and ratcheting up to the suite of EU ESG regulations. Further, as these asset managers get more experienced with compliance with the EU’s set of regulations, they will be more prepared for launching ESG funds in compliance with future ESG regulations of the U.S., which will likely bear some resemblance to those of the EU. As such, uncoordinated coordination with respect to ESG regulation may be said to exist not only between U.S. regulators and EU regulators but between U.S. regulators and U.S. asset managers as well.

As ESG investing goes mainstream, the U.S. regulators are likely to follow suit in enacting ESG regulations with a set of clear and objective criteria once they see the financial performance of ESG funds and the potential success of the EU ESG regulatory regime, thereby externalizing the EU regime and realizing the Brussels Effect.

 

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[1] See generally Anu Bradford, The Brussels Effect, 107 Nw. U. L. Rev. 1 (2012), https://scholarship.law.columbia.edu/faculty_scholarship/271.

[2] Id. at 18.

[3] Bradford, supra note 1.

[4] Id. at 6.

[5] Bradford, supra note 1, at 1.

[6] Bradford, supra note 1, at 9.

[7] Google LLC, Privacy Policy, https://policies.google.com/privacy?hl=en-US (“Data protection laws vary among countries, with some providing more protection than others. Regardless of where your information is processed, we apply the same protections described in this policy.”)

[8] Bradford, supra note 1, at 25–26.

[9] See Richard G. Newell et al., Carbon Markets: Past, Present, and Future 10–11 (National Bureau of Economic Research, Working Paper No. 18504, 2012), https://www.nber.org/system/files/working_papers/w18504/w18504.pdf.

[10] David Kreutzer et al., The Economic Consequences of Waxman-Markey: An Analysis of the American Clean Energy and Security Act of 2009, The Heritage Foundation (Aug. 6, 2009), https://www.heritage.org/environment/report/the-economic-consequences-waxman-markey-analysis-the-american-clean-energy-and.

[11] Id.