ESG disclosures: What is the current state of play?

The topic of environmental, social, and governance (ESG) criteria has garnered increased attention by investors in recent years and has emerged as an increasingly important and popular metric by which potential investors evaluate investment opportunities. While ESG has increasingly risen to the forefront of investor considerations, public companies demonstrate significant discrepancies in their approach to ESG disclosures. Let’s take a look at the current state of disclosure requirements as well as how companies are approaching ESG disclosure demands and the opponents to such demands.

Beginning with the more global approach, international organizations including the United Nations and the World Economic Forum have called for increased ESG disclosures, demonstrating the international community’s acknowledgement of the importance of ESG in organizational, especially public company, governance and investing.

In the United States, the mandates are not so clear. The Securities and Exchange Commission (SEC) has faced criticism for its failure to compel ESG specific disclosures. Under current SEC regulations, the disclosure of ESG is required only if it is “material,” putting ESG among an assortment of other factors that companies must independently examine to determine what is material to investors.

In June 2020, the SEC Investor Advisory Committee approved a recommendation regarding ESG disclosures, stating that the SEC should undertake an effort to update reporting requirements to include “decision-useful” ESG factors. The recommendation highlighted a common complaint of disclosure advocates, that without effective disclosure obligations investors cannot make informed investment and voting decisions.

In early July 2020, SEC Commissioner Elad L. Roisman delivered a virtual Keynote Speech to attendees of the Society for Corporate Governance National Conference which focused on the topics of mandated ESG disclosure for public companies and the current state of ESG disclosures by asset managers.

Roisman highlighted inherent concerns the SEC faces as it addresses calls for increased ESG disclosure, including that mandated disclosures could potentially blur the lines between personal beliefs about ESG topics and the responsibility of the SEC to regulate the actions of companies and ensure that investors remain adequately informed.

With respect to whether increased disclosure is necessary to ensure adequate information is supplied to investors, Roisman argued that materiality is the hallmark of the SEC disclosure framework, requiring that public companies adequately inform investors regarding material factors while minimizing unnecessary and irrelevant over-disclosure.

Interestingly enough, Roisman made a compelling argument for enhanced ESG disclosure requirements for asset managers, echoing the concerns raised with respect to providing adequate information to investors.

Specifically, Roisman noted that ESG information is important to funds marketed as having an ESG strategy, including those that are ESG, “green” or “sustainable,” because ESG is at the root of the fund.

When an asset manager markets a fund as having an ESG strategy, that information is material to the fund, and disclosure to investors is warranted. In circumstances where ESG metrics are advertised as driving an asset managers’ investment decisions, disclosure of specific ESG information is the only means through which investors can be adequately educated on material information. In these circumstances, he confirmed, enhanced ESG disclosures would be necessary to ensure adequate disclosure for investors.

Companies have responded in a variety of ways to the emerging investor demand for disclosures around ESG matters.

Some companies have gone so far as to employ ESG criteria as a guide for strategic business decisions and have publicly disclosed those standards that inform such strategic decisions, while other companies remain less transparent about the impact ESG criteria has on business decisions.

Beyond the debate regarding required disclosures, companies have increasingly released voluntary ESG disclosures to evidence their individual approaches to ESG.

Certain companies have determined that ESG factors are more than merely evaluation criteria for socially conscious investors, but may also be indicative of positive financial outcomes for the companies employing ESG initiatives. Some companies are building ESG into the fabric of their operations by, for example, establishing sustainability departments with chief sustainability officers.

In contrast, some companies remain less dedicated to showcasing ESG initiatives as part of revised business models. Opponents to the ESG-driven business model argue that ESG investing is misguided, in that it fails to effectively obtain the highest returns for investors.

Specifically, certain opponents argue that the movement pressures companies and funds to make irresponsible financial decisions that favor emotional advocacy over shareholder profitability, ultimately eroding financial potential overtime.

Though not all otherwise non-ESG focused companies subscribe to the anti-ESG conversation, the opponent argument highlights a common problem that many public companies face which is, without uniform disclosure requirements, it is difficult to determine whether ESG advocacy is truly a company’s guiding principle or if it is merely a talking point to attract progressive investors.

A key consideration in how a company should approach ESG initiatives and disclosure is based on whether a company’s dedication to ESG can have a substantial impact on their long-term profitability, be it positive or negative.

The failure to disclose a company’s ESG initiatives may leave investors in the dark about impactful investing strategies. Moreover, to the extent that the matter may have a substantial impact, the disclosures of such information would also be required if material to an investment decision.

As companies, funds and investors continue to grapple with the materiality of ESG as it applies to investor decisions, the SEC has yet to compel line-item disclosure of ESG in all circumstances.

Though voluntary disclosures are on the rise and companies continue to incorporate ESG into their frameworks and public filings, the lack of uniformity has created uncertainty for companies with respect to what they must disclose. This lack of uniformity continues to lead participants in the industry to advocate for prescriptive requirements with respect to ESG disclosures for public companies.

Finally, 2020 has exposed the real-life implications that ESG may have on society, further informing how the ESG landscape is evolving.

Specifically, both the COVID-19 pandemic and the nationwide movement toward racial justice have brought greater attention to ESG matters and have shifted the conversation about companies’ responsibilities with respect to environmental, social and governance matters.

Many companies have shifted their short and long-term business models to adequately address and respond to the issues raised by both the pandemic and the movement toward racial justice.

As companies, funds and investors adapt to the changing landscape that has emerged in 2020, companies may consider whether they need to reevaluate their ESG strategies and, consequently, their decisions with respect to ESG disclosures.

Katayun I. Jaffari is chair of the corporate governance and securities group at Cozen O’Connor. She counsels public and private companies in the areas of corporate governance and securities law and compliance, including capital-raising transactions and reporting requirements under SEC, NYSE and Nasdaq regulations, as well as providing general corporate advice and execution, including with respect to mergers and acquisitions transactions and board and business counseling. She can be reached at kjaffari@cozen.com.

Lindsey M. Stillwell is an associate in the firm’s business law department and a member of the corporate and corporate governance and securities practices. She can be reached at lstillwell@cozen.com.