Yesterday, at a meeting of the SEC’s Asset Management Advisory Committee, the Committee adopted recommendations (developed by the ESG Subcommittee) regarding ESG disclosure by issuers, intended to improve the information and disclosure used by investment managers for ESG investing. While addressing a broad array of issues regarding ESG investment products, the Committee recognized “that issuer disclosure is the starting discussion point for all ESG matters.” Given the dependence of the investment management industry on issuer disclosure regarding ESG matters and the resulting demand for consistent and comparable ESG disclosure, the recommendations are surprisingly mild—designed to prod rather than mandate.
The Committee observed that “requirements are already in place requiring issuers to disclose material risks, and the [Committee] does not recommend changes to the regulatory framework, but rather the adoption of standards to guide those disclosures.” While initially, the Committee was inclined to advocate mandatory adoption of a third-party ESG disclosure framework, a number of challenges became evident, including the still-developing state of ESG metrics and the absence of a consensus regarding the materiality of some social issues. Accordingly, the Committee ultimately concluded that a recommendation for SEC rulemaking to require specific ESG disclosure or mandate use of a disclosure framework was “premature.” Nevertheless, the Committee urged the SEC to commence a process to encourage enhanced ESG disclosure.
The Committee’s specific recommendations were as follows:
- “The [Committee] recommends the SEC take steps to foster meaningful, consistent, and comparable disclosure of material environmental, social, and governance (ESG) matters by issuers.” Notably, however, the “recommendation does not contemplate revising the materiality standard requirement that has guided issuers in determining whether disclosure of a matter is warranted,” but rather recognizes that issuers’ determinations of materiality of ESG matters can vary and “issuers’ disclosure of material ESG matters can take various forms, complicating analysis and making comparison harder.”
- “To foster meaningful, consistent, and comparable disclosure, the SEC should encourage issuers to adopt a framework for disclosing material ESG matters and to provide an explanation if no disclosure framework is adopted,” essentially advocating a voluntary “comply-or-explain” regime. The framework could be developed either by an industry group or a third-party standard setter, but, in any case, “should clearly articulate the principles by which an issuer determines the backward-looking quantitative and forward-looking qualitative metrics and disclosures it should present on material ESG risks. It also should prioritize disclosure of material ESG risks applicable to most issuers, such as climate risk, while specifying disclosure of specific material ESG risks pertinent to the issuer’s business and industry.” The Committee believes that this recommendation “would usher in needed improvements,… underscore the importance of presenting information on material ESG matters in a consistent, comparable way [and signal] to issuers that they must coalesce around material ESG matters relevant to their industry/sub-industry. This approach would also afford issuers some flexibility to determine and refine an appropriate disclosure framework.”
- “In addition, the [Committee] recommends the SEC accelerate its study of third-party ESG disclosure frameworks for the disclosure of material ESG matters and acquire relevant subject matter expertise to assess how frameworks could play a more authoritative role in a near future.” The Committee believes that this action “would not only serve to catalyze the process for further improving these standards, but also demonstrate the SEC’s commitment to harmonizing the way in which issuers determine what constitutes a material ESG matter and conveying that information to investors.” It would also, the Committee suggests, “provide a roadmap for potential establishment of a standard setting body to develop ESG disclosure standards. Consistent applications of those standards by issuers can be enforced by the SEC, like the enforcement of U.S GAAP accounting standards developed by the FASB.” As discussed below, this last point was particularly unsettling to Commissioner Hester Peirce.
In describing the recommendations, a Committee member noted that ESG disclosure is not monolithic: governance issues, which have been actively considered for years, have achieved a broader consensus surrounding best practices, while best practices and metrics for environmental and social matters, such as climate change and diversity, are still being debated. The Committee recommended that the SEC consider the significance that investors now attach to ESG, which the Committee examined through three different lenses: the impact of ESG on investment performance (which is still unsettled), market interest (in light of the level of activity in sustainable investing) and the volume of global regulatory activity and standards, which must be navigated. Viewed from these perspectives, the Committee observed that “market participants, regulators, and standard setters view material ESG matters to play a role in capital formation, capital allocation and risk/return expectations.”
Accordingly, although the Committee ultimately did not, at this point, advocate mandatory adoption of a third-party framework as initially intended, still, the Committee believes “there is a pressing need for the SEC to effect a process for enhancing the quality, consistency, and comparability of ESG disclosures that issuers make to investors.” When ESG metrics “attain widespread market adoption and acceptance, the SEC could revisit whether to provide more specific guidance codified in regulation. Any such regulation should be principles-based, consistent with the approach the SEC has traditionally taken to matters where issuers must exercise considerable discretion in determining whether they would be relevant and important to investors. It also should be founded on the same notions of ‘materiality’ that have been a fundamental underpinning of disclosure practices issuers have followed through the years.” The Committee “believes this approach will accelerate the emergence of generally accepted standards and metrics in an area that is evolving rapidly.”
In her opening remarks at the meeting, Commissioner Peirce expressed reservations about the use of third-party standard-setting entities in this context, advocating that the Committee
“think further about how differences between financial reporting and ESG reporting could make a FASB-like standard-setting entity for ESG unworkable and imprudent, even in the longer term. Financial reporting lends itself to concrete, objective, comparable metrics. ESG standard-setting, by contrast, as the draft recommendation acknowledges, is a much more fluid project that covers a wide range of issues, many of which are not objectively quantifiable and comparable across issuers. With respect to the draft recommendations’ interim step of requiring issuers to choose a third-party disclosure framework or explain why they are not doing so, please consider whether the consequent power—both financial and regulatory—of these standard-setters raises concerns.”
In a similar vein, see also Peirce’s comment letter to the IFRS Foundation.
Not surprisingly, Commissioner Allison Herren Lee (whose remarks have not been posted as of this writing) also had reservations about the recommendations, but from quite a different perspective. She said that the three goals for ESG disclosure were consistency, comparability and reliability. Currently, the ad hoc nature of ESG disclosure results in disclosure that is inadequate in that regard. She was concerned that the Committee’s recommendation to “encourage” issuers to adopt an ESG framework or explain why not would not address these inadequacies. How would the recommended course of action “get the job done”?