When it comes to the performances of companies and financial markets around the world, the influences of climate change and social issues cannot be understated. Toward this end, investors are increasingly prioritizing environmental, social, and governance (ESG) factors, with climate change broadly understood to be among the most imminent threats. The U.S. Securities and Exchange Commission (SEC) has yet to adopt mandatory disclosure requirements, which could prove instrumental in helping investors evaluate companies’ progress toward a variety of climate-related goals. Still, the SEC’s delay may allow it to adopt a new set of global, high-quality sustainability standards; prior to the UN Climate Change Conference (COP 26), the International Financial Reporting Standards Foundation (IFRS) announced a global, consolidated sustainability disclosure requirement. This explainer explores the SEC’s previous efforts with respect to climate disclosures, the IFRS’s new sustainability standards initiative, and argues that the United States should consider adopting these global standards.
The SEC and Climate Disclosures
President Biden issued an Executive Order on Climate-Related Financial Risk on May 20, 2021. The Order highlighted the “intensifying impacts of climate change” on “publicly traded securities, private investments, and companies.” It also noted that the global shift away from fossil fuel use and industrial processes creates opportunities to enhance U.S. competitiveness in the global economy.
The SEC responded quickly to the call by taking a series of actions, including then-Acting Chair Allison Herren Lee’s statement calling for a review of Climate-Related Disclosure requirements. Current-Chair Gary Gensler has asked the SEC to provide the Commissioners with a proposal for a mandatory climate-risk disclosure rule by the end of the year. Disclosure requirements are a primary feature of U.S. securities laws, which were passed after the Great Depression to ensure full and fair disclosure of information so investors could make informed decisions. Information that must be disclosed is information that is material. Information is considered to be material when there is a substantial likelihood that a reasonable investor would view it as important in deciding how to vote or make an investment decision.
The SEC has provided guidance for climate disclosure risk in the past. In 2010, the SEC adopted the guidance because of pressure from various constituencies. The impact of the guidance was modest. The SEC found that filers tended to use boilerplate language that was not helpful to investors, and investors did not quantify risk or past impacts as they related to climate. In 2012, the U.S. Government Accountability Office prepared a report for the Senate Committee on Appropriations that determined that the SEC did not find a significant change in disclosures after the Guidance as compared with before. Additionally, the SEC’s enforcement of the disclosures was not aggressive. Another report found that between 2010 and 2013, only 25 of the more than 45,000 SEC comment letters sent to companies raised issues of climate. A more recent report showed even more lackluster enforcement by the SEC, finding that the SEC sent only six comment letters that mentioned climate change in the four years under the Trump-appointed SEC Chair Jay Clayton.
However, while the 2010 guidance was an important step in the right direction—despite its lack of acceptance—as current SEC Chairman Gary Gensler said, “[a] lot has changed since then” regarding climate: investors are expecting more.
Gensler offered prepared remarks for the Principles for Responsible Investment “Climate and Global Financial Markets” webinar on July 28, 2021. In those remarks, he said that investors are asking regulators for more climate risk disclosures. Specifically, he said that “[i]nvestors are looking for consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs.” He went on to say that companies are already publishing sustainability disclosures, but they are using a variety of third-party standards. Voluntarily choosing disclosure types can lead to variations and inconsistencies in disclosures. Because of this, Chairman Gensler said that investors would benefit from the consistency and comparability of mandatory disclosures.
The Chairman’s remarks are supported by recent trends in the markets. ESG issues seem to be a consideration of investors big and small. For instance, Larry Fink, the Chairman and CEO of BlackRock—the world’s largest institutional investor with $9.5 trillion under management, released a letter to CEOs in 2020 stating the importance of ESG disclosures. Fink wrote that “companies have a responsibility—and an economic imperative—to give shareholders a clear picture of their preparedness.” Another instance occurred more recently when a small activist hedge fund, Engine No. 1, took on fossil fuel giant Exxon, claiming that Exxon could perform better financially if it made better progress toward renewable resources. At the time, Engine No. 1 was a 0.02 percent shareholder in Exxon, but won the proxy battle, acquiring two board seats. Additionally retail investors and retirement funds are increasingly investing in companies addressing ESG investments. These trends suggest that investors find ESG information important when deciding how to vote or make an investment decision.
However, not everyone in the SEC views ESG disclosure as important to investors. In a speech to the National Investor Relations Institute on June 22, 2021, SEC Commissioner Elad Roisman said that whether the SEC should require disclosure of ESG information is dependent upon the materiality of the information to a “reasonable investor.” According to Roisman, the term “reasonable investor” means someone whose interest is in a financial return. Accordingly, Roisman suggests that the materiality of ESG information is separate and distinct from information related to financial returns. Roisman’s statements seem to contradict the comments of Fink and the actions of Engine No. 1, retail investors, and retirement funds, which are showing that sustainability risk factors are tied to financial performance.
A Global, Consistent, and Comparable Disclosure Regime
Prior to the COP26 summit in early November 2021, the International Financial Reporting Standards Foundation (IFRS) announced the International Sustainability Standards Board (ISSB) and the publication of prototype disclosure requirements. The goal of this activity is to consolidate reporting initiatives to create “the global standard-setter for sustainability disclosures for the financial markets.” The development of the ISSB will consolidate the Climate Disclosure Standards Board and the Value Reporting Foundation (which houses the Integrated Reporting Framework and the Sustainability Accounting Standards Board (SASB) Standards) by June 2022. The IFRS, whose Accounting Standards are required in more than 140 jurisdictions, says that the ISSB will work closely with its International Accounting Standards Board (IASB) to ensure connectivity and compatibility between the Accounting Standards and the ISSB’s standards. Echoing many of Fink’s comments, the IFRS’s release announcing the ISSB says that “[f]inancial markets need to assess the risks and opportunities facing individual companies which arise from … ESG issues, as these affect enterprise value.” Like Gensler’s comments, the announcement noted the innovation from voluntary reporting frameworks but said the fragmentation of such reporting mechanisms resulted in “increased cost and complexity for investors, companies, and regulators.”
Despite the fact that the ISSB’s intention is to provide information sought by investors in a global and consolidated fashion, SEC Commissioner Hester M. Peirce submitted a comment to the IFRS Foundation urging them “not to wade into sustainability standard-setting.” Commissioner Peirce said the IFRS should avoid establishing the ISSB because it would “(i) improperly equate sustainability standard-setting with financial reporting standards, (ii) undermine the Foundation’s current important, investor-centered work, and (iii) raise serious governance concerns.” The Commissioner elaborates on her concerns by saying that the sustainability is an imprecise term and requires value judgments, but the Commissioner notes in her conclusion that “[w]e do not have perfectly converged global financial reporting standards.” Yet, the SEC still requires financial disclosures.
Why Should the United States Consider these Global Standards?
Proponents suggest that the SEC should consider adopting the ISSB as the mandatory disclosure requirement for two reasons: 1. adopting a single standard for mandatory disclosure will create consistency and comparability and 2. the global nature of the ISSB will serve companies and investors now and into the future.
For years, companies and investors have relied on a variety of standard setters, but the variety creates inconsistency in the disclosures. The disclosure inconsistencies make it more difficult for investors to be informed. However, the ISSB will create a global standard for ESG disclosure. Companies and investors could go beyond the information required in ISSB disclosures, but the baseline disclosures would create consistency for companies and investors.
Additionally, global standards are imperative. The United States’ adoption of accounting standards can serve well in understanding the need for global standards. The U.S. adopted the Generally Accepted Accounting Principles (GAAP) for disclosure requirements; however, GAAP is not the global standard—the IFRS Accounting Standards are. When advocating for the acceptance of the IFRS Accounting Standards, then-SEC Chair Mary Jo White said that U.S. companies and investors had a strong interest in adopting global accounting standards: “Global standards facilitate decision making about cross-border investments, transactions, and acquisition opportunities.” U.S. investors in foreign companies and U.S. companies making investments in foreign jurisdictions will be required to use the globally accepted sustainability standards, like the accounting standards, regardless of the U.S. disclosure standard. For comparability and to better inform and protect investors, adopting the global standard would be the best practice in an ever-increasing global economy.
Vigorous action on climate change must be taken as soon as possible. Investors and companies are expressing their interest in contributing to the efforts to mitigate the effects of climate change, but the lack of a consistent and mandatory disclosure regime is causing both investors and companies to hesitate in disclosing their efforts. Climate-related and economic challenges and opportunities are global, and adopting global, consolidated disclosure standards for financial markets would create consistency and comparability for companies and investors of all sizes in many jurisdictions. The SEC should take advantage of its delay in providing a mandatory disclosure regime and consider adopting the recently announced, global, consolidated ISSB sustainability disclosure.
