Proposed Amendments to Issuer Disclosure: to ESG or not to ESG
In connection with the SEC’s January 30 proposed amendments to certain of the financial disclosure requirements applicable to public companies under Regulation S-K, as well as accompanying guidance thereon, the separate public statements of Chairman Jay Clayton, Commissioner Hester Peirce, and Commissioner Allison Herren Lee underscore the continuing divide over the role of the SEC in disclosure related to ESG factors–and particularly climate-related disclosure–and its materiality to investors.
Commissioner Peirce applauds the proposed amendments and guidance for “not bow[ing] to demands for a new [ESG-related] disclosure framework, but instead support[ing] the principles-based approach that has served us well for decades.” Citing the lack of sustainability-focused metrics disclosed in a recent sample of public disclosure filings, Peirce suggests that, “[t]here is reason to question the materiality of ESG and sustainability disclosure based on existing practices.” Further, Peirce highlights her skepticism of “calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality.”
Commissioner Lee, on the other hand, notes that she cannot support the proposal because the Commission has chosen to “ignore the challenge of disclosure around climate change risk rather than to begin the difficult process of confronting it.” Lee posits that investors have “overwhelmingly” made clear to the SEC, “through comment letters and petitions for rulemaking, that they need consistent, reliable, and comparable disclosures of the risks and opportunities related to sustainability measures, particularly climate risk …[and] that this information is material to their decision-making process, and a growing body of research confirms that.” In Lee’s view, the “principles-based ‘materiality’ standard has not produced sufficient disclosure to ensure that investors are getting the information they need—that is, disclosures that are consistent, reliable, and comparable.”
Chairman Clayton, in his comments, took the opportunity to summarize steps that the SEC has taken over the last several years involving climate-related disclosure, framing the SEC’s commitment as “rooted in materiality,” and citing efforts such as the Commission’s 2010 guidance on climate change disclosure, as well as continuing engagement, both formally and informally, with market participants and non-U.S. regulators. In addition, Chairman Clayton noted certain of the challenges involved, including the “complex, uncertain, multi-national/jurisdictional and dynamic” landscape as well as the forward-looking nature of much of such disclosure, which “likely involve[s] estimates and assumptions regarding, again, complex and uncertain matters that are both issuer- and industry-specific…”
Looking ahead, Chairman Clayton highlighted two “avenues of engagement that currently are of particular interest” to him:
- Discussing with issuers, such as property and casualty insurers, the extent to which they use, and their experience with, environmental and climate-related models and metrics in their operations and planning, including price, risk and capital allocation decisions; and,
- Discussing with asset managers that have been using environmental and climate-related models and metrics to allocate capital on an industry or issuer specific basis their experience with that process.
De Facto Materiality – A Proposal in the ESG Disclosure Simplification Act
While several ESG-related bills have been filtering through Congress, and each will likely continue to face an uphill battle, one such bill, the ESG Disclosure Simplification Act of 2019 would address the materiality question raised in the Commissioners’ public comments referenced above by deeming ESG metrics “de facto material.” As such, the draft law would task public companies with mandatory reporting, while the SEC would be responsible for defining the relevant ESG metrics based on recommendations from the permanent Sustainable Finance Advisory Committee to be established pursuant to the law.
Sometimes, our friends in the press come up with a headline that simply cannot be topped. Yesterday, Ignites published an article called, “Going Green: Shops Work to Navigate ESG Compliance Minefield.” The article opens appropriately, noting that while ESG funds “may be all the rage with investors […] shops that fail to think carefully about their investment methodologies and related disclosures could end up in the SEC’s hot seat.” Indeed, though, the SEC is certainly not the only regulator to keep a close eye on ESG products and mandates. In the United States, the Department of Labor also has ESG on its radar. ESG is also a hot topic for numerous regulators and legislatures globally. What are some of they important compliance challenges?
- Are fund descriptions, registration statements and disclosures accurate? If ESG factors are considered as part of the fund’s strategy, do such documents reflect that reality correctly?
- If the firm has publicly committed to engage in certain conduct (e.g., shareholder engagement, etc.) by reason of membership in a particular group or alliance (e.g., UN PRI, Climate Action 100+, etc.), is the firm following through on its promises?
- Are global legal developments considered, recognizing that Europe, North America and Asia are at different stages of ESG statutory and regulatory promulgation?
- Have proxy voting policies been considered in light of SEC and DOL guidance?
- Does the investment management agreement explicitly require (or prohibit) the investment manager to vote proxies or exercise other shareholder rights on behalf of an ERISA plan?
- Are the investment manager and asset owner on the same page in terms of which ESG strategy will be pursued?
- Does the investment policy statement or investment guidelines specify which E, S or G factor is part of the investment mandate?
- Has the investment manager considered potential conflicts of interest of proxy adviser firms?
- If the client is a governmental plan, has the investment manager diligenced the applicable state statutes and constitutional provisions to confirm that implementation of the mandate complies with applicable law?
- Is disclosure in due diligence questionnaires accurate and factually supportable?
Brian Croce of Pensions & Investments recently reported on a new ISS study. As reported, the study establishes a link between a high/favorable ISS ESG rating and profitability. Similarly, companies with higher ESG ratings are less volatile. The Department of Labor, rather rightly, in Field Assistance Bulletin 2018-01, cautioned fiduciaries against making too many assumptions or wishful thinking in establishing a nexus between an ESG risk factor and investment performance. The ISS study is worthwhile because it helps build a case for fiduciaries that use integration as an ESG strategy. As a reminder, integration is when one “incorporates ESG-related data and/or information in respect of an ESG factor into the usual process when making an investment decision where such data or information is material to investment performance and where the exclusive purpose is to enhance portfolio return or reduce portfolio risk.” See this glossary for more information and context.
"We believe a portfolio that focuses on sustainability and climate change will be a portfolio that outperforms," says Larry Fink. "The main component of the letter is saying this is going to be a great investment over the next 10 years, and it will also help the planet. pic.twitter.com/UVOGFZuN0I
— Squawk Box (@SquawkCNBC) January 14, 2020
Here is an interesting graphic on the ‘G’ factor and its relationship to investment performance. If fiduciaries are integrating G factors into investment decisions, then this sort of data could possibly be helpful.