ESG Disclosure – Keeping Pace with Developments Affecting Investors, Public Companies and the Capital Markets

Statement Published in Connection with Remarks at the 33rd Annual Tulane Corporate Law Institute[1]

Not long ago, the title of this statement would have needed to unpack “ESG” into Environmental, Social and Governance. That ESG no longer needs to be explained illustrates how important these issues have become to today’s investors, public companies and capital markets. It also illustrates the pace of ESG developments. There remains substantial debate over the precise contents and details of what ESG disclosures might or should encompass. Part of the difficulty is in the fact that ESG is at the same time very broad, touching every company in some manner, but also quite specific in that the ESG issues companies face can vary significantly based on their industry, geographic location and other factors. As such, there is no one set of metrics that properly covers all ESG issues for all companies. Moreover, the landscape is changing rapidly so issues that yesterday were only peripheral today are taking on greater importance. It is against this backdrop that I think about the regulation of ESG disclosures.

Going forward, I believe SEC policy on ESG disclosures will need to be both adaptive and innovative. We can and should continue to adapt existing rules and standards to the realities of climate risk, for example, and the fact that investors increasingly are asking for ESG information to help them make informed investment and voting decisions. We will also need to be open to and supportive of innovation – in both institutions and policies on the content, format and process for developing ESG disclosures.

Many ESG-related issues are similar to ones we have faced before. Asbestos-related disclosure is a great example. For years, asbestos-related risks were invisible, and information about asbestos would likely have been called “non-financial.” Over time, those risks went from invisible to visible to extremely clear, and clearly financial. Not surprisingly, disclosure about these risks did not initially show up in SEC filings, but there too they went from invisible to increasingly disclosed. How might a different disclosure regime have elicited different disclosures? Would it have resulted in more timely, clear and useful information for investors about asbestos manufacturers, sellers and insurance companies? What lessons can we learn from earlier examples of evolving risks?

My remarks here do not attempt to answer those or the multitude of other questions about ESG disclosures. Rather, I hope to highlight some of the issues that in my view policymakers should consider as the debate over ESG disclosures continues.

Considerations for an Effective ESG Disclosure System

The SEC should help lead the creation of an effective ESG disclosure system so companies can provide investors with information they need in a cost effective manner. An effective ESG disclosure system does not imply a rigid and soon-to-be outdated set of limited disclosures. It means thoughtful engagement by trusted specialists seeking consensus among investors and companies about useful, reliable and comparable disclosures under standards flexible enough to remain relevant. A process to create such standards is not likely to be simple, quick or easy. Important and challenging questions must be addressed, such as:

• What disclosures are most useful?
• What is the right balance between principles and metrics?
• How much standardization can be achieved across industries?
• How and when should standards evolve?
• What is the best way to verify or provide assurance about disclosures?
• Where and how should disclosures be globally comparable?
• Where and how can disclosures be aligned with information companies already use to make decisions?

These are questions that the SEC should be a key part of answering.

As we address these questions, we should keep in mind some additional points. First, while we should be mindful of the costs of new ESG disclosures, we must at the same time acknowledge the costs from the absence of a consensus ESG-focused disclosure system. Second, in thinking about ESG disclosures, we should not view ourselves as forced into a stark choice between voluntary and mandatory disclosure. Finally, a coordinated global disclosure system has great potential benefits, but achieving one will take careful attention to institutional design.

Costs of No ESG Disclosure Requirements

Starting with the costs, critics of ESG disclosure requirements often point to the costs associated with preparing the disclosures. Consideration of such costs is important, as is getting clear about their causes. But just as important is the recognition of the costs associated with not having ESG disclosure requirements. For investors, despite an abundance of ESG data, there is often a lack of consistent, comparable, and reliable ESG information available upon which to make informed investment and voting decisions. Investments are being held back in the absence of that information. The status quo is costly for companies, and increasingly so over time. Companies face higher costs in responding to investor demand for ESG information because there is no consensus ESG disclosure system. Rather, they are faced with numerous, conflicting and frequently redundant requests for different information about the same topics. These higher costs can be particularly burdensome for smaller and more capital constrained companies, and yet if these companies do not provide ESG disclosures, they risk higher costs of capital.

Mandatory vs. Voluntary

As we think about structuring a disclosure system for ESG issues, one question that comes up is whether ESG disclosures should be the subject of mandatory versus voluntary disclosure provisions. People often think of mandatory disclosure in a way that suggests that there is nothing more than an on/off switch between mandatory and voluntary disclosure. Our existing disclosure regime, however, is already more nuanced than that, and there is no reason an ESG disclosure system would need to be less nuanced.

Our existing system contains some mandatory ESG disclosure requirements (e.g., disclosure of how a company’s board considers diversity in identifying director nominees).[2] It permits significant differences in how companies respond to a variety of “mandatory” requirements, including in many cases disclosing items if and only if they are material. Our regime contains “comply or explain” requirements (e.g., if a company does not have an audit committee financial expert, it can explain why),[3] where the ability to explain makes the requirement less than rigidly mandatory and for some companies potentially more informative.

Finally, companies generally are mandated to make disclosures as needed to prevent other disclosures from being materially misleading. As companies continue to disclose more in sustainability reports, they should already be evaluating those disclosures in light of existing anti-fraud obligations. The SEC is well equipped to lead and facilitate a discussion on when and how ESG risks and data must be disclosed, and how to create and maintain an effective ESG-disclosure system that would promote the disclosure of decision-useful, reliable and, where appropriate, globally comparable ESG information.

The Virtues of Achieving a Single Global ESG Reporting Framework

On the issue of global comparability, in the first instance, arguments in favor of a single global ESG reporting framework are persuasive. ESG issues are global issues. ESG problems are global problems that need global solutions for our global markets. It would be unhelpful for multiple standards to apply to the same risks faced by the same companies that happen to raise capital or operate in multiple markets. In this regard, the work of the IFRS Foundation to establish a sustainability standards board appears promising.

Establishing a global framework, however, is complex and raises a number of considerations. Funding, governance and public accountability are all critical elements of a reliable, trusted disclosure system. Funding needs to be reliable and adequate, both now and over a reasonable time period into the future, and should not detract from other essential elements of the system for public company disclosures.

Governance needs to ensure the independence and expertise of any individuals involved in the setting of ESG disclosure standards, and allow for a rigorous, inclusive and transparent process for developing standards. Those involved should be accountable to relevant constituencies, including investors and companies. By seeking to address those considerations adequately and transparently, the SEC can and should play a leading role in the development of a baseline global framework that each jurisdiction can build upon to address its individual needs.