In a series of blogs, I have been discussing the barrage of environmental, social and governance (ESG) related activity and focus by capital markets regulators and participants. Former SEC Chair Jay Clayton did not support overarching ESG disclosure requirements. However, new acting SEC Chair Allison Herron Lee has made a dramatic change in SEC policy, appointing a senior policy advisor for climate and ESG; the SEC Division of Corporation Finance (“Corp Fin”) announced it will scrutinize climate change disclosures; the SEC has formed an enforcement task force focused on climate and ESG issues; the Division of Examinations’ 2021 examination priorities included an introduction about how this year’s priorities have an “enhanced focus” on climate and ESG-related risks; almost every fund and major institutional investor has published statements on ESG initiatives; a Chief Sustainability Officer is a common c-suite position; independent auditors are being retained to attest on ESG disclosures; and enhanced ESG disclosure regulations are most assuredly forthcoming.
New Corp Fin Director John Coates is fully on-board, making speeches and otherwise being vocal in his support of ESG centered disclosures. On March 22, 2021, the SEC launched a new page on its website bringing together all things ESG including agency actions and the latest information on ESG investing.
Climate change initiatives and disclosures have been singled out in the ESG discussions and as a particular SEC focus, and as such was the topic of the first blog in this series (see HERE). The second blog talked more generally about ESG investing and ratings systems and discussed the role of a Chief Sustainability Officer (see HERE) and this third in the series is centered on ESG disclosures other than climate change.
Non-U.S. countries have also been beating the ESG drum with Europe requiring increased disclosures and the International Organization of Securities Commissions or “IOSCO,” without the participation of the SEC, issued a statement “setting out the importance of considering the inclusion of environmental, social, and governance matters when disclosing information material to investors’ decisions.” At the end of January 2021, 61 companies signed on to the World Economic Forum’s “Stakeholder Capitalism Metrics,” which is a set of ESG metrics and disclosures intended to serve as a “set of universal, comparable disclosures focused on people, planet, prosperity and governance that companies can report on, regardless of industry or region.” A summary of the metrics is below.
Current ESG Disclosure Requirements
Although there is not an ESG facing Regulation S-K item, the current disclosure obligations certainly encompass many ESG topics. For a discussion of the existing and proposed climate change disclosure obligations, see HERE. From a thirty-thousand-foot view, any information that is material to a company’s financial position, regardless of whether it can be labeled under an ESG category, is disclosable. Also, the Nasdaq stock market has published an ESG Reporting Guide, which is discussed below and has proposed a rule requiring listed companies to meet certain minimum board membership diversity targets (that rule proposal will be the subject of another blog).
Countless memorandums and publications have been written on ESG matters, including what in particular and how they should be reported (with countless differing opinions). The recent changes to Regulation S-K added the topic of human capital as a disclosure item including any human capital measures or objectives that management focuses on in managing the business, and the attraction, development and retention of personnel (such as in a gig economy) (see HERE).
Item 407 of Regulation S-K requires disclosure of “whether, and if so how, the nominating committee (or the board) considers diversity in identifying nominees for director” and “if the nominating committee (or board) has a policy with regard to the consideration of diversity in identifying director nominees, describe how the policy is implemented, as well as how the nominating committee (or the board) assess the effectiveness of its policy.”
Audit committees and auditors must also consider ESG. The Center for Audit Quality has published a roadmap for auditors and separate memo directed at audit committees to help them understand the role of auditors in connection with company-prepared ESG information. I’ll cover ESG audit committee and audit-related matters in a separate blog.
Current disclosure rules require a company to make disclosures as needed to prevent other disclosures from being materially misleading. As ESG rises in importance, and impacts financial statements, additional disclosures should naturally be considered by company management today.
Potential ESG Disclosures
On March 11, 2021, Acting Corp Fin Director John Coates issued a statement on ESG Disclosure clearly supporting additional disclosure requirements while at the same time acknowledging the complexity of a standardized system. To invoke more thought on the topic, Director Coates believes the SEC must consider: (i) what disclosures are useful; (ii) what is the right balance between principles and metrics (including mandatory vs. voluntary disclosure); (iii) standardization across industries; (iv) evolving standards; (v) verification of disclosures; (vi) global comparability; and (vi) alignment with current practices.
Of course, the costs of disclosure must be considered, but Coates puts more emphasis on the costs of not requiring ESG disclosure. There is currently a lack of consistent, comparable, and reliable ESG information available for investors. As I noted in the second blog in this series, companies face higher costs in responding to investor demand for ESG information because there is no consensus ESG disclosure system. A unified system would reduce the redundant requests for information from multiple sources.
Coates is a proponent of adding more provisions like certain board audit committee disclosures which allows a company to explain why they make certain decisions (if a company does not have an audit committee financial expert, it can explain why).
Coming in second place behind climate change, political spending disclosures are a favorite topic at the SEC. In her March 15 speech, which was mainly focused on climate change, Chair Allison Herron Lee stated, “[A]nother significant ESG issue that deserves attention is political spending disclosure.” And that “political spending disclosure is inextricably linked to ESG issues.” One example raised is a company that makes carbon neutral pledges or other climate change friendly disclosures but donates heavily to a politician that consistently votes against these initiatives. Commissioner Caroline A. Crenshaw has also been vocal in her support of political spending disclosures.
However, for now, any rule-making is on hold. Although both a recent House and Senate bill have been introduced that would require additional political spending disclosures, the Consolidated Appropriates Act of 2021, which has already been passed into law, currently restricts the SEC from finalizing a rule requiring company political spending disclosures.
Gary Gensler, who will likely take over as SEC Chair in April, expressed support for the SEC to consider company political spending disclosures while testifying at his senate confirmation hearing in early March. As an aside, Mr. Gensler is very knowledgeable about and supportive of cryptocurrencies. Many are hopeful he will implement the regulatory clarity the industry needs and wants, and in any event, should provide lots of blog material on that topic.
General Topics – World Economic Forum’s “Stakeholder Capitalism Metrics”
As mentioned above, the World Economic Forum has put together Stakeholder Capitalism Metrics. Although a complete summary of the publication is beyond the needed scope for this blog, the main topics include:
- Governing Purpose – a statement by companies as to how they propose solutions to economic, environment and social issues;
- Quality of governing body – qualifications, background and diversity information on board members and executives;
- Stakeholder engagement – what topics are engaged on and how were they decided;
- Ethical behavior – (a) anti-corruption – including training against and disclosure of incidences; and (b) ethics – including training and internal reporting mechanisms;
- Risk and opportunity oversight – risk disclosures and a mandate that opportunities and risks should integrate material economic, environmental and social issues, including climate change and data stewardship;
- Climate Change – including greenhouse gas emissions and implementation of the Task Force on Climate-related Financial Disclosures;
- Nature Loss – land use and ecological sensitivity;
- Freshwater availability – water consumption and withdrawal in water-stressed areas;
- Dignity and equality – including diversity and inclusion; pay equality; wage levels and risks for incidents of child, forced or compulsory labor;
- Health and well-being – work related injuries and fatalities;
- Skills for the future – training provided;
- Employment and wealth generations – absolute number and rate of employment; economic contribution; and financial investments;
- Innovation of better products and services – R&D spending; and
- Community and social vitality – total tax paid by category.
Many other articles and memos have been published recently containing similar lists of proposed and expected ESG reporting.
Nasdaq ESG Reporting Guide
Nasdaq has had a corporate sustainability program in place for six years and has a decidedly positive viewpoint on ESG, seeing these factors as beneficial to investors, “but also for public companies trying to increase operational efficiency, decrease resource dependency, and attract a new generation of empowered workers.” Nasdaq states, “[E]ffective management of sustainability issues helps Nasdaq (and our listed companies) better understand operational performance, address resource inefficiencies, and forecast enterprise risk. In addition, there is a growing body of academic and analytic evidence suggesting that ESG excellence correlates with other benefits, such as lower costs of capital, reduced shareholder turnover, and enhanced talent recruitment and retention. With a renewed market emphasis on long-term value creation, we also believe that ESG is an effective and mutually beneficial communication channel between public companies and the investment community.”
With that said, the Nasdaq ESG Reporting Guide is merely a recommendation for the record keeping and reporting of material information on ESG matters. In determining materiality, Nasdaq suggests that companies consider impacts to external stakeholders and ecosystems in addition to those directly affecting the company. Nasdaq does not impose financial or legal reporting requirements beyond those required by Regulations S-K and S-X. Many companies choose to report ESG matters in separate ESG reports made available to investors on their website, rather than in formal reports to the SEC.
The Nasdaq guide focuses on economic principles and specific data, rather than moral or ethical arguments. The ESG topics that Nasdaq address include:
- Environmental – (i) GHG Emissions (i.e., greenhouse gas emissions); (ii) emissions intensity; (iii) energy usage; (iv) energy intensity; (v) energy mix; (vi) water usage; (vii) environmental operations; (viii) climate oversight/board; (ix) climate oversight/management; and (x) climate risk mitigation.
- Social – (i) CEO pay ratio; (ii) gender pay ratio; (iii) employee turnover; (iv) gender diversity; (v) temporary worker ratio; (vi) non-discrimination; (vii) injury rate; (viii) global health and safety; (ix) child and forced labor; and (x) human rights.
- Corporate Governance – (i) board diversity; (ii) board independence; (iii) incentivized pay; (iv) collective bargaining; (v) supplier code of conduct; (vi) ethics and anti-corruption; (vii) data privacy; (viii) ESG reporting; (ix) disclosure practices; and (x) external assurance.
For each topic, Nasdaq provides an explanation as to why such a measurement is important and a formula for completing the measurement or setting a policy addressing the topic.