U.S. financial regulators, including the SEC, figure to play a crucial role in the Biden administration's fight against climate change. Source: Mario Tama/Getty Images via Getty Images

Wall Street seemed a world away to Satyam Khanna growing up.

Born in the U.K. and raised in Oklahoma, Khanna, the son of Indian immigrants, once saw finance as an "East Coast mystery." He attended Washington University in St. Louis with the goal of heading to medical school, before switching course to a legal and policymaking career.

Then the financial crisis hit. Suddenly, Khanna found himself captivated by high finance. Equities, distressed debt and subprime mortgages entered the national conversation, and Wall Street was no longer an amorphous presence hundreds of miles away. Its influence had proven to stretch far beyond the tri-state area — to Oklahoma, California and everywhere in between. In the wake of the financial crisis, Khanna decided he wanted to be part of the solution.

Now, at 35, Khanna is working to demystify financial markets in the context of what many see as their biggest threat: a rapidly changing climate.

"For a lot of younger Americans in my generation, 2008 was a defining moment for how we view financial markets and financial regulation," said Khanna, senior policy adviser on climate and environmental, social and governance issues to U.S. Securities and Exchange Commission Acting Chair Allison Herren Lee, in an interview. "This is really no different. Climate change clearly poses risks to investors and financial stability."

The SEC has opened a floodgate of news about ESG since Lee took over in January. It launched a task force in its policing unit to weed out ESG-related fraud. The SEC's Division of Corporation Finance has started reviewing whether companies are complying with its decade-old guidance on climate disclosures. The regulator has beefed up its examinations of whether companies' business continuity and disaster recovery plans are factoring in extreme weather threats. And it has increasingly signaled that a new regime of corporate disclosures around climate and ESG risks is coming.

Behind the scenes, as Lee's senior policy adviser on climate and ESG, Khanna has looked across the SEC's different legal authorities, working with its offices and divisions, other financial regulatory bodies, and Lee herself to identify and coordinate ESG initiatives. The role has put Khanna, who worked for former SEC Commissioner Robert Jackson Jr. before leaving in 2019, at the center of the SEC's work to stand up its own internal infrastructure around climate and ESG. That work is setting the stage for a full suite of climate policies under Gary Gensler, who will become SEC chairman pending Senate confirmation.

"What you've seen in the last two months is what happens when you give Satyam Khanna the ability to get things done," said Jackson in an interview. Jackson taught Khanna at Columbia Law School before hiring him several years later. "At the end of the day, he's convinced that the SEC has not played the role it should in climate, social and corporate governance issues. And I'm inclined to agree with him."

After leaving Jackson's staff, Khanna was a senior adviser for the Principles for Responsible Investment and a financial expert on the agency review team for President Joe Biden's transition following the 2020 election. Gensler, who did not respond to a request for comment for this story, led that team.

In a statement, Lee said Khanna's "strong leadership and effective coordination" have driven "significant progress in creating an agency-wide framework that will form the basis for providing investors with information on these important issues."

Once viewed as an issue that posed little systemic risk to U.S. financial markets, climate change has emerged as the biggest threat to the American economy, in the view of regulators and executives alike.

A 2020 report commissioned by the top U.S. derivatives regulator detailed the potential damage that unmitigated climate change could cause, from rising mortgage defaults to crop failures to mass write-downs of mortgage-backed securities tied to coastal metro areas like New York, Houston and Miami, where climate change has wreaked havoc in recent years. Those three cities were home to 20% of CMBS properties by market value in the Bloomberg Barclays Aggregate Index, as of March 2019, according to the BlackRock Investment Institute.

Under Biden's aggressive climate plan, financial regulators including the SEC figure to play a critical role in quantifying and curbing the climate threat.

Federal Reserve officials and the Commodity Futures Trading Commission have issued new calls for action. Most recently, Treasury Secretary Janet Yellen said the Financial Stability Oversight Council, where Khanna was a staff member from 2015 to 2017, would be taking a harder look at how prepared financial markets and institutions are for a "rapid transition to a net-zero carbon economy."

"Human capital, human rights, climate change — these issues are fundamental to our markets, and investors want to and can help drive sustainable solutions on these issues," the SEC's Lee said in a March 15 speech, where she outlined how the regulator has been laying "the groundwork for more progress to come" on ESG issues.

Demand from investors

For Khanna, the SEC's role boils down to uncovering the ESG risks and opportunities ingrained in companies' business models. The U.S. requires transparency on everything from food to consumer products so that buyers know what they are getting, Khanna says. Similarly, the SEC should make sure investors are not in the dark about the potential ESG risks a company faces.

"Having an effective ESG disclosure system would level the playing field for investors and companies alike," Khanna said. "There's nothing short of a clamoring from investors at this point for climate- and ESG-related information."

For decades, the SEC has faced louder and louder calls from investors urging it to require more aggressive climate disclosures on the basis that such information is material. In 1971, the SEC said companies should publicly disclose how complying with environmental laws would financially impact their businesses. The SEC released new guidance roughly 40 years later on how companies should report information related to climate change, including the impacts of existing and new climate-related legislation and regulation and what physical risks their businesses face from climate change.

Today, everyone from BlackRock Inc.'s Larry Fink to pension fund managers to large insurers are pouring money into ESG products and strategies while pressing for standardized data they say will help develop the $17 trillion sustainable investment market in the U.S. Some issuers already release information about the risks and opportunities that ESG issues pose to their businesses under voluntary frameworks like those devised by the Sustainability Accounting Standards Board and the Task Force on Climate-related Financial Disclosures. But to many, including Lee, optional disclosures are not enough.

"New issues are emerging all the time," SASB Founder Jean Rogers said in an interview. "We're not addressing the systemic, structural root cause of either climate change or inequality, so these things are creating emerging issues within industries and for specific companies that are in some ways evergreen."

Conservative-leaning lawmakers and regulators have questioned whether the SEC's ESG campaign is appropriate.

Sen. Pat Toomey of Pennsylvania, the top Republican on the Senate Banking Committee, wrote to Lee in late March to ask why the SEC is pressing forward when it has not concluded its review of the 2010 guidance. West Virginia Attorney General Patrick Morrisey went further in a March 25 letter to Lee, writing that his state would not "hesitate to go to court to oppose a federal regulation compelling speech in violation of the First Amendment," if the SEC were to move forward with an ESG disclosure regime.

Commissioners Hester Peirce and Elad Roisman, the SEC's top Republican officials, have raised questions of their own about the agency's ESG plans. Peirce, speaking at a March 19 committee meeting held by the SEC, said a broad ESG disclosure mandate would require the SEC to "reimagine materiality," which would be the same as "tossing it in favor of a more malleable new edition."

"Materiality has served us well, and undermining it to accommodate ESG will harm investors," Peirce said. "I reiterate a point I have made before — I am happy to consider any new SEC mandates for specific metrics that are likely to be material to every issuer in every industry. ESG standards, however, continue to be talked of in broad strokes that obfuscate the immaterial nature of many of the specific underlying disclosures."

'End of the beginning'

Gensler, the hard-charging former head of the CFTC, has already signaled an interest in bringing "consistency and comparability" to climate risk disclosures. How he and the SEC might do that is unclear, however.

While some sustainability investors have suggested a catch-all taxonomy, SASB's Rogers says that would be a mistake considering how the materiality of ESG factors can change over time and vary among companies and industries.

Instead, the SEC should start with a specialized disclosure report for climate like the one it already requires for conflict minerals, and proceed from there, Rogers said. John Coates, the acting head of the SEC's Corporation Finance division, echoed that sentiment in March, saying there is no one set of metrics that will satisfy every investor's desire for ESG clarity from every company, suggesting that industry-tailored disclosures may be more appropriate.

To Jackson, the former SEC commissioner, the adoption of ESG standards will be an "evolution" in the U.S. akin to what took place almost 30 years ago with the SEC's executive compensation disclosure rules.

But already, the early work has been done thanks to Khanna and Lee, he said.

"It's not the end, or even the beginning of the end. But it might be the end of the beginning," Jackson said of the SEC's next steps on ESG, loosely quoting Winston Churchill. "This is what makes it one of the most exciting periods in federal securities law. After 20 years of forgetting that materiality is about investors, I think the SEC is finally remembering that. I know Satyam's focused on it, and I think that the SEC and the markets will be better for it."