Commissioner Roisman recently shared his thoughts on ESG and asked what the term means to “You and Me”. Such keynote speeches are often meant to be provocative, and reasonable minds can differ. Given my experience advising both corporate and investor representatives, this is what ESG means to me:
(1) ESG is a three-syllable acronym that has come to be associated with significant issues that impact the long-term sustainability of companies, our capital markets, capital formation and society. You can find different articles about its origin, but that’s not really the point. Environmental, Social and Governance issues vary in importance across companies and industries, and they appropriately evolve over time. It is important that management teams and boards think about whether and how these issues are financially material to their companies over different time horizons, generally acknowledging that they need to get their “G” right in order to get their “E” and “S” issues right.
(2) It is well established that “financial materiality” under our federal securities laws is what a reasonable investor would consider important in making investment or voting decisions. Nevertheless, I still see some confusion as to which ESG disclosures belong in SEC-filed documents. Many reasonable investors have decided that both filed and unfiled ESG information is material to their investment and voting decisions, which is supported by research (see note 10) linking positive financially material ESG indicators to superior financial results. These investors want to find this information in the public domain, and want the information to be accurate, relevant and comparable, which I believe necessitates explicit disclosure requirements.
The SEC has considered mandated disclosures in the past (see notes 37-39) as a way to provide relevant and comparable data, as opposed to the inconsistent “private ordering” of ESG disclosures championed by Commissioner Roisman. In the meantime, many investors are urging their portfolio companies to disclose information pursuant to the Sustainability Accounting Standards Board (SASB) standards and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Both of these frameworks use the SEC definition of financial materiality. The SASB identifies financially material issues using their research, back-testing and feedback from shareholders, companies and other financial market participants.
(3) ESG is part of Enterprise Risk Management (ERM). ERM oversight is a core board responsibility. Companies generally consider ESG as part of their long-term ERM, to understand, monitor and address risks to, and opportunities for, them and their businesses. Contrary to Commissioner Roisman’s statements, this is not a feel-good company exercise about “doing its part” in the world. Effective board understanding and oversight of ERM are relevant to investors and the long-term viability of their portfolio company investments. The SEC has recognized the importance of this board role by requiring that companies explain the board’s risk oversight to their investors in their annual proxy statements.
(4) Investors want and use ESG data to analyze and protect their financial interests and those of their clients or beneficiaries, not – again in Commissioner Roisman’s words — because they are “thinly veiled political operatives pushing their own agendas”, nor are they “grandstanding” or “conflat[ing] greater societal debates” and “blur[ing] their personal views” with what should be required disclosures. The U.S. Government Accountability Office (GAO) recently published a report, confirming that investors want corporate ESG disclosures to better understand and compare their investment risks, as well as to inform their decisions on voting and buy/sell actions.
Investors and other stakeholders may share their ESG concerns with companies, but these concerns are not presumptively “demands” and “pressure”. Hopefully companies are already monitoring ESG issues that they consider to represent financially material risks and opportunities, as well as making the related capital allocation decisions that benefit their businesses and our capital markets more broadly. Risk management of ESG issues is not a simple corporate responsibility, especially as the issues become more complex and interrelated for companies and our financial markets, communities, and planet.
The G&A Institute has reported that 90% of S&P 500 companies are already publishing voluntary sustainability reports, using many of the sustainability disclosure frameworks as guides. Yet, this voluntary reporting, accompanied by the principles-based approach currently used for disclosure in SEC filings, seems to fall short of providing comparable and reliable information to investors and does not provide a consistent framework to companies, making it difficult for them to discern which information and formats are relevant to investors. Mandated ESG disclosures would more strongly and efficiently support the three-part SEC mission on which Commissioner Roisman is rightly focused.
