In recent years, several jurisdictions including the UK, France, the EU, South Africa and China have moved to mandate corporate disclosure of environmental, social and governance (ESG) information. Now it’s the USA’s turn to consider the question of whether to make such disclosures mandatory for publicly listed corporations.
In its capacity as regulator of the U.S. securities industry, the Securities Exchange Commission (SEC) promulgates rules that aim to provide investors with meaningful financial and other information to enable them to make sound investment decisions. By way of an example, as a result of the 2010 Dodd-Frank Act, U.S. public companies are now required to disclose their use in product manufacturing of certain minerals sourced from known conflict zones. This has been a game changer as companies now have a legal duty to exercise due diligence on the source and chain of custody of the minerals covered by the rules.
In the U.S., Regulation S-K is the central repository for nonfinancial statement disclosure requirements for public companies. Many of these requirements were established more than 30 years ago, and the SEC is currently undergoing a review of the requirements as part of its Disclosure Effectiveness Initiative.
SEC asks for public comment on a range of nonfinancial reporting requirements, including public policy and sustainability matters
In its 340-page Concept Release released in April, the SEC asks for public comment on a range of nonfinancial reporting requirements, including public policy and sustainability matters. The release seeks feedback on the disclosure of such matters, characterized broadly as environmental, social and governance (ESG) concerns.
In considering the issue of whether and how to require ESG disclosure, the SEC is specifically asking for feedback by 21 July on a range of questions (pages 204-213), including the importance of ESG disclosures to investors’ decisions, what a disclosure framework for ESG matters might look like, and the costs and challenges related to providing these disclosures.
Of course this is not coming out of the blue, nor is it happening in a vacuum. The CDP reporting program has over 800 investor signatories who collectively represent or manage approximately $100 trillion. These signatories, it can reasonably be assumed, consider climate change to be material to their investment decisions, and the majority of the S&P 500 responded to the CDP Climate Change survey in 2015. As another indicator that investors view ESG factors as material financial risks, there is an increasing trend in the use of shareholder resolutions to prompt companies to take action on ESG matters. In May of this year for example, investors gave unprecedented voting support (around 40% for each company) for climate ‘stress-test’ resolutions at the ExxonMobil and Chevron annual meetings. Despite the fact that these proposals drew more support than any climate-related votes in the history of the two biggest U.S. oil and gas companies, the resolutions were voted down, albeit narrowly. Despite growing investor-led pressure, there remain plenty of hold-outs – companies for whom legally mandated disclosure is perhaps the only thing that will drive any transparency.
There are several ongoing initiatives to develop standard approaches to disclosure of material nonfinancial information in mainstream reports, such as annual reports and 10-k filings. These include the Sustainability Accounting Standards Board (SASB), the Climate Disclosure Standards Board (CDSB), and the Climate-related Financial Disclosures Task Force established by the Financial Stability Board which monitors and makes recommendations about the global financial system.
While these initiatives help to move things forward, they all share something in common. They exist within a context where companies can frankly choose whether or not to adopt them. Now, existing SEC rules do already require companies to publish material non-financial information and arguably certain ESG factors will be material for some companies under current definitions of materiality. However, despite the SEC’s publication of guidance on climate change disclosures in 2010, this requirement goes largely ignored and unenforced. Today, the number of U.S. corporations that disclose anything other than boilerplate ESG language in their SEC filings is by far in the minority.
Needless to say CDP and SASB are excited about the prospect of mandatory disclosure. But, just to step back for a moment, given that the majority of S&P 500 companies already publish sustainability information – how much of a game changer could new SEC disclosure requirements really be in terms of informing investment decision-making? In a 2015 CFA Institute survey, 73% of institutional investors indicated that they take ESG issues into account in their investment analysis and decisions. However, a 2015 PwC study found that 82% of investors said they are dissatisfied with how risks and opportunities are identified and quantified in financial terms and 79% of the investors polled said they are dissatisfied with the comparability of sustainability reporting between companies in the same industry. It seems therefore that there is a problem to be solved.
While many companies already publish sustainability reports, typically they are aiming to provide a broad overview of their sustainability performance to multiple stakeholders, not just investors. As such, these reports often contain large amounts of information and data that is not standardized across companies. While the latest GRI reporting framework encourages a focus on material issues and reporting against a core set of metrics, it remains challenging for investors to evaluate the information in the context of their decision making. CDP and SASB strongly advocate for a sector-based approach by SEC that focuses reporting around standardized metrics relevant to ESG factors that are identified as material for individual sectors.
Putting aside the value of new disclosure requirements for the investment community, what role might they play within individual companies? This of course remains to be seen, but we can speculate. Anthesis team members have long standing relationships with clients, sometimes stretching back over a decade or more. Over this time, we have seen ESG issues transition in terms of their strategic relevance, so that today, they are matters for board room discussion within many of our client organizations. This is progress for sure. But there remains a leap to be made inside many companies towards truly understanding the relationship between business success and ESG factors. One can hope that any new SEC disclosure requirements will play an important role in not only elevating and broadening the conversation within companies, but also in building a more integrated approach to evaluating and managing ESG factors within the context of the overall business strategy. Watch this space!
Emma Armstrong is a Partner on our North American team. Emma can be contacted via e-mail at email@example.com.