Why I responded to the SEC’s call for public input on climate disclosures

On March 15, 2021, the US Securities Exchanges Commission (SEC) acting Chair, Allison Herren Lee, issued a public statement inviting the public to submit commentary on a climate change disclosure framework for publicly listed companies [1]. This announcement arrives in the wake of the EU’s Sustainable Finance Disclosure Regulation (SFDR), whose first level came into effect on March 10, 2021. The second level will go into effect in early 2022, though these regulations only pertain to companies in the financial services sector.

The SEC’s invitation to comment on future disclosure requirements augurs a bold step in standardizing materially relevant ESG disclosures. If enacted, a mandated ESG disclosure framework that goes beyond just climate change considerations would promote accuracy, transparency and ensure comparability across listed US companies.

A quick review of ESG investing

Prevalent in headlines, ESG garners much attention in the investment community and beyond. The evidence of climate change is no longer up for debate, and there is an urgency to respond in action and regulation.

ESG Investing is a process that takes into consideration environmental (E), social (S), and governance (G) indicators to improve upon ‘traditional’ financial analysis and portfolio management, which rest on the balance between risk, returns and a thesis on factors that can impact a company’s performance. It seeks to identify potential ESG opportunities and risks that go beyond traditional valuation metrics.

ESG investing is neither a new nor fringe concept — in 1971, the SEC asked publicly listed companies to consider including sustainability reporting in their disclosures which was promptly met with a backlash that spanned several years. It wasn’t until a decade ago, in February 2010, that these efforts finally culminated in the first interpretative guidance, which provided companies with guidelines on factors that may trigger obligatory disclosures on climate change and greenhouse gas emission.

The link between companies’ risk factors and their ESG profile has been established and championed by academics and investment practitioners via empirical work. A company with poor governance, for example, could be marred in scandals that could lead to its downfall and prove catastrophic to its investors. There is evidence that companies with poor ESG practices are likely to have higher volatility and beta measures -therefore riskier than those with better ESG profiles[2].

The concerted efforts on climate may also comport risks and unintended consequences. Rising temperatures, for example, pose direct threats to our planet and its ecosystems which could decrease demand for heating services and equipment and disrupt industries. Companies subject to cap-and-trade laws and those that fail to meet emission targets could incur high operational costs that impact their bottom line and valuations. Passing on such higher costs to consumers can have ripple effects on markets. The impacts resulting from a transition to a lower-carbon global economy are known as transition risks.

The current state of affairs: ESG is all over the place

Some publicly listed companies voluntarily provide ESG information either separately or included in their financial reports. Such reporting tends to follow a variety of standards (or a combination thereof) like those prescribed by the Sustainable Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), the Task Force on climate-related Financial Disclosures (TCFD), and others. Despite the lack of consensus on what constitutes materiality of ESG disclosures, it is in companies’ best interest to heed stakeholders’ concerns about ethical beliefs, morals, and quest for sustainability. At the very least, their reputation (and bottom line) could depend on it.

The egregious lack of consistency in ESG related information is also rampant across ESG data providers. Each of the ever-increasing numbers of rating providers tends to have their own criteria and rating determination system, exacerbated by a lack of transparency on how analyses are conducted. ESG rating agencies rely on companies’ disclosures and proprietary questionnaires directly submitted to companies. Fielding multiple ESG info requests, typically via lengthy questionnaires, can burden companies that lack the human and capital resources to allocate to such queries. Small companies and resource-strapped companies particularly stand the risk of being penalized in this regard as they might not be able to respond quickly and comprehensively.

Investors depend on data providers, who in turn rely on information provided by companies to make their investment decisions. The primary source information at the company level must be material, accurate, consistent, and comparable. This is where the SEC can step in and control the narrative.

Road to ESG disclosure standardization: What role will the SEC play?

Regulators can play a crucial role in ensuring accurate and standardized ESG disclosures. Such disclosures would provide investors with consistent material data to help inform investment and voting decisions. Clear defined reporting guidelines would help place companies on a fairer footing regardless of size and resources.

The SEC has ample experience in mandating and overseeing standardized reporting requirements such as those set by the Financial Accounting Standards Board (FASB). ESG and sustainability standards must be dynamic as we live in a rapidly evolving world. It is imperative to have periodical reviews of frameworks in place that allow for enhancement initiatives and iterations. The initial implementation will likely require significant time and effort by the regulator and all parties involved. Still, investors and the integrity of the capital markets stand to be the biggest benefactors of such a pursuit, making it all the more worthwhile.

The SEC is currently asking for input on 15 topics related to climate change disclosures. Members of the public can submit commentary via email, webform (https://www.sec.gov/cgi-bin/ruling-comments) or in-person arrangements over 90 days from the initial statement of March 15.

[1] Acting Chair Allison Herren Lee, Public Input Welcomed on Climate Change Disclosures, Public Statement (Mar. 15, 2021).

[2]Dunn, J., Fitzgibbons, S., Pomorski, L., 2018. Assessing risk through environmental, social, and governance exposures. J. Invest. Manag. 16 (1), 4–17.

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