In a recent speech, SEC Chair Gary Gensler conveyed a sense of full steam ahead with regard to mandatory disclosure requirements about climate and human capital. (See this PubCo post.) The day before, Commissioner Elad Roisman also addressed potential ESG disclosure requirements, but from quite a different perspective—concern. While he understands that there is a demand for consistent standardized ESG disclosure, especially about climate, is it premature to attempt to standardize, he wonders? To what extent does the SEC have a legislative mandate to construct ESG disclosure rules? And how is the SEC—a bunch of lawyers and accountants and economists—ever going to craft and oversee ESG regulation effectively? When you get down to it, his question is this: Is the SEC the right agency for rulemaking about ESG (particularly climate) disclosure?
Roisman’s speech, Can the SEC Make ESG Rules that are Sustainable?, before the National Investor Relations Institute is a nuanced look at Roisman’s many concerns about the challenges facing the SEC in its efforts to design rules mandating ESG disclosure—rules “that would stand the test of time and fit into our historic frameworks.” (Although Roisman frames his remarks in the context of ESG generally, his focus really seems to be about the “E” and “S” components, especially climate.) This speech is essentially the second part of his remarks earlier this month before the ESG Board Forum, Putting the Electric Cart before the Horse: Addressing Inevitable Costs of a New ESG Disclosure Regime, in which he posed five questions about the ESG initiatives and focused his remarks on one, the costs associated with ESG requirements. (See this PubCo post.) In this speech, he addresses the other issues.
While Roisman has hardly been an advocate for SEC rules mandating ESG disclosure (see, e.g., this PubCo post), he does acknowledge here that he has found it “instructive” to hear from companies about their engagements with investors on ESG issues: “I have yet to hear a company tell me that ESG is not important, and that it ignores ESG information requests. Instead, I often hear from companies that they are constantly asked to provide ESG information; that they feel they must comply with all or a large majority of the requests; that the multitude of requests can be overwhelming; and that each request requires special attention because it is similar to, but different from, the last.” Companies are looking to the SEC, he says, to address the burden of “these overlapping requests” by standardizing disclosure requirements; investors are also seeking rules that would elicit more comparable responses.
What is missing? His first question is: what ESG information are investors missing? While the answer should certainly come from investors, Roisman wonders whether the SEC could even generate a single list of ESG disclosures that investors want? First, he thinks there’s a reason why investors request different ESG information—because they may have different objectives and uses for the information. And, he asks, isn’t it premature to assume that “investors have yet settled on an agreed list of information that they want from companies. Instead, it sounds like there is evolution in this area and in companies’ practices for providing ESG information to investors. I worry that by stepping in to promulgate a static list of ESG disclosure requirements, the SEC would displace a good amount of this private sector engagement and freeze disclosures in place prematurely.” For example, with regard to climate, scientific understanding of physical risks and transition risks is still evolving, making prescriptive requirements about types of risks and benchmarks precarious: “SEC rule-writing is slow by design. When we enshrine new disclosure requirements in our rules, we want to feel confident that they will be appropriate and relevant for many years to come, since the Commission normally does not revisit them for some time. It is not clear to me that we have sufficient certainty about what is and, crucially, will continue to be material information for new line-item ESG disclosures.” (Of course, the notion that prescriptive rules will become stale is a frequent criticism lobbed at prescriptive rulemaking.) He hopes that the SEC will study market solutions to determine what is currently missing. If the problem is really a lack of standardization rather than content, he suggests, the SEC must “understand the contours of the disclosures investors need before we establish our own template from the many already in existence.”
Materiality. In determining disclosure requirements, the SEC must “act consistently with our historic approach by focusing on what information is material to an investment decision,” Roisman advises. This contention speaks to an ongoing food fight about what “materiality” really means. To Roisman, in determining materiality, the perspective the SEC must adopt is that of the “reasonable investor”: “it is relevant that the basic test we use to determine whether something is a security includes as an element an ‘expectation of profit,’ a characteristic that aligns with the dictionary definition of ‘investor.’ So, while any given shareholder may have bought securities for reasons other than or in addition to making money, it seems clear that a ‘reasonable investor’ is someone whose interest is in a financial return on an investment.” Accordingly, he cautions, the SEC must assess potential disclosure requirements against “the question of whether a reasonable investor would consider them material—that is, to a company’s financial value.”
What’s more, Roisman contends, to the extent that ESG disclosure requirements are directed at societal goals, “the SEC has no legislative mandate” to craft rules to further those goals. That’s for Congress or other elected officials to debate and decide. But for now, he argues, the SEC does not have the authority to just “copy international standards, given the different mandates.” Rather, the SEC must consider how the types of information that “other standards require companies to report, such as greenhouse gas emissions, are material to investors. If such information is relevant primarily for purposes of a climate-focused goal, then I question how the SEC is the appropriate agency to undertake requiring its disclosure. The U.S. has other federal regulators (e.g., Environmental Protection Agency) with mandates and expertise to address these issues.”
Which investors to consider. And to which investors should the SEC be listening? All too often, he suggests, the expressed interests of institutional holders and asset managers are conflated with those of the true beneficial owners. But they’re not necessarily the same—institutional owners and asset managers may be subject to conflicts of interest, he asserts. For example, if asset managers are subject to European ESG reporting requirements, they are likely to prefer that the U.S. requirements be identical to those of Europe to ease their reporting burden, but that wouldn’t necessarily benefit the beneficial owners. While many point to increases in green investing as an indication of interest from beneficial owners, Roisman warns again that, to “the extent that investors’ objectives are unrelated to risk/return, it is hard to see how the information relevant to those strategies could be considered material, per the SEC’s historical understanding of the term.”
Expertise and standard setters. And then there’s the question of expertise. The SEC does not have climate scientists on staff or other experts “to develop and oversee a disclosure regime that includes specifically “E” and “S” information. Our agency’s staff is predominately composed of lawyers, accountants, and economists, all of whose principal expertise is in financial markets…. It is fair to question how our staff is equipped to determine which climate or environmental information—such as various measures of companies’ greenhouse gas emissions, or strategies for adapting to future climate scenarios—is material to an investment decision today. Given how quickly research in these areas is developing, it raises additional questions on how, and how often, the Commission would update these standards over time.”
So instead, many have recommended that the SEC simply “plug and play”—just rely on the ESG frameworks of the independent standard setters, such as the TCFD or SASB. But it’s not as easy as that, Roisman maintains. To illustrate his point, he looks back to the 1960s, after the Wheat Report recommended the redesign of the accounting standard-setting process, leading to the development of the FASB under the oversight of the SEC. According to Roisman, despite the establishment of the FASB as an independent accounting standard setter, some of the same concerns raised in the Wheat Report continue to plague FASB, such as concerns about the FASB’s independence and its credibility being compromised by its proximity to the industry it regulates, as well as the influence of other market participants. He also observes that “critics have questioned whether the level of control the Commission has over FASB compromises FASB’s independence from the political process.” Moreover, oversight of the FASB expends significant SEC resources in monitoring and providing guidance to “promote consistent application” of the FASB standards. While Roisman believes the FASB has done “excellent work,” he asserts that it “did not happen overnight, and we have worked through many issues along the way to get to this point.”
Using the FASB experience as an example, Roisman contends that, if the SEC were to look to an independent ESG standard setter, the SEC would need to think through
“how such an entity should be governed, funded, and staffed; how the representation of investors, industry participants, and other experts in the organization should be calibrated to best serve the Commission’s objectives; and how the Commission’s need to oversee the entity’s operations should be balanced with the standard-setter’s need to remain independent from political pressures. The Commission would also need to make sure that its own staff had adequate resources to carry out its monitoring and enforcement responsibilities. Since the world of ESG involves many more stakeholders and more potential areas of expertise than the world of accounting—including in environmental science and others—I fear that the challenges we have grappled with over the course of our history with FASB will be even more difficult to mitigate and manage in this new context.”
And how would the SEC select the third-party standard setter among the proliferation of standard setters? While there have recently been efforts at harmonization of frameworks and standards among some standard setters, Roisman believes that these efforts are “still in their early days.” Would selection by the SEC of one standard setter “risk cutting short these efforts and artificially constraining the development of true consensus in this area. If the Commission instead were to pick several different entities, we would likely exacerbate the challenge of conducting effective oversight.”
Roisman concludes that the SEC will need to address these challenges in crafting rules that are themselves “sustainable”; however, he believes that challenges are “not necessarily insurmountable” and is keeping an open mind and an open door.