Beyond COVID-19: Crisis response or road to recovery?
Crisis response or road to recovery?
Recent events, including the COVID-19 pandemic, wildfires on the West Coast and the racial justice movement following the death of George Floyd have intensified calls by investors for the SEC to adopt environmental, social and governance (ESG) disclosure standards. Together with the recent inauguration of President Joe Biden, all signals point to the Commission taking action.
In recent years, the Commission has been divided over its role in mandating ESG disclosures and new requirements were not created during the Trump administration. The Republican commissioners have favored maintaining the existing principles-based materiality disclosure framework that governs disclosure generally as opposed to specific ESG disclosure requirements. This framework mandates that management disclose known trends and other material information or risk civil liability. These commissioners view a principles-based approach as providing flexibility and adaptability, as each individual company can tailor its disclosures to meet investors' needs.1
On the other hand, the Democratic commissioners have favored supplementing the principles-based materiality regime with uniform and standardized line-item ESG disclosures. Though they agree that securities laws require disclosure of material information, they have observed that a majority of large US companies fail to acknowledge ESG-related financial risks in their filings. These commissioners view voluntary, principles-based materiality disclosures as producing non-standardized, inconsistent, and incomparable disclosures which hinder investors' ability to price and compare ESG risks and opportunities, such as what they believe to be the systemic, potentially irreversible financial risk that damage from climate change might cause. These commissioners are also concerned that the Commission's failure to engage in ESG-related dialogue has fallen behind international efforts to address sustainable investing and has placed US companies at a competitive disadvantage. Accordingly, they have recommended the Commission form an internal task force and ESG advisory committee dedicated to developing the recommendations of leading organizations and defining a clear plan to address sustainable investing.2
President Biden's inauguration will usher in a Democratic majority of the SEC commissioners and greatly enhance the likelihood that the SEC will mandate ESG disclosures in one form or another. His administration has made climate change a priority, and one of President Biden's first acts was to have the United States rejoin the Paris Climate Accords. Moreover, on February 1, 2021, the Commission announced the creation of a new role—Senior Policy Advisor for Climate and ESG—which will advise the Commission on ESG matters and advance related initiatives.3
New disclosure requirements might arise from the framework proposed by the SEC's ESG Subcommittee (the Subcommittee). On December 1, 2020, the Subcommittee provided a preliminary recommendation that the Commission mandate disclosure by corporate issuers of a limited number of material metrics tailored by industry and overseen by an independent standard setting entity (such as the Sustainability Accounting Standards Board (SASB)).4 The Subcommittee also appeared poised to recommend that the Commission provide best practice guidance for disclosure of ESG investment products. The Subcommittee expects to finalize its recommendations at its next meeting.
With respect to issuer disclosures, the Subcommittee has proposed that the Commission (i) take steps to require corporate issuers to adopt standards for disclosing material ESG risks (akin to the requirement for public issuers to follow Generally Accepted Accounting Principles); (ii) utilize standard-setters' frameworks (such as the SASB) to guide disclosure of material ESG risks; and (iii) require that material ESG risks be disclosed in a manner consistent with the presentation of other financial disclosures. In recommending a standards-based approach, the Subcommittee emphasized that it did not see a need to change disclosure laws in light of the significant disclosure requirements for material risks that already exist for issuers and stated, "[w]e do not recommend the highly prescriptive approach that is used, for example, in Europe, as that may result in the production of metrics that are not needed to assess an issuer's material risks, and unnecessary cost."
With respect to ESG investment product disclosures, the Subcommittee has proposed that the Commission advise on best practices, including (i) the use of consistent taxonomies; (ii) clear descriptions of each investment product's strategy and priorities, including a description of the product's non-financial objectives (e.g., environmental impact or adherence to religious requirements); and (iii) descriptions of each investment product's planned approach to share ownership in shareholder reporting, including any notable recent ownership activities outside of proxy voting.
Investor demand for sustainable investments is also likely to continue. For example, New York State recently announced that its US$226 billion pension fund would divest from fossil fuel stocks within five years, and in other companies contributing to global warming by 2040.
The precise framework for ESG disclosures remains to be seen. However, it is clear that the issue of ESG disclosures—and climate change in general—will be a key priority of President Biden's administration and the Commission in the years to come.
1 See Opening remarks at the December 1, 2020 Meeting of the Asset Management Advisory Committee (Dec. 1, 2020), available at https://www.sec.gov/news/public-statement/peirce-opening-remarks-amac-meeting-120120; Statement at the Meeting of the Asset Management Advisory Committee (Dec. 1, 2020), available at https://www.sec.gov/news/public-statement/roisman-statement-amac-meeting-120120; Modernizing the Framework for Business, Legal Proceedings and Risk Factor Disclosures (Aug. 26, 2020), available at https://www.sec.gov/news/public-statement/clayton-regulation-s-k-2020-08-26; Keynote Speech at the Society for Corporate Governance National Conference (July 7, 2020), available at https://www.sec.gov/news/speech/roisman-keynote-society-corporate-governance-national-conference-2020.
2 See Joint Statement by Commissioners Lee and Crenshaw on Amendments to Regulation S-K (Nov. 19, 2020), available at https://www.sec.gov/news/public-statement/lee-crenshaw-statement-amendments-regulation-s-k; Regulation S-K and ESG Disclosures: An Unsustainable Silence (Aug. 26, 2020), available at https://www.sec.gov/news/public-statement/lee-regulation-s-k-2020-08-26; Statement on the "Modernization" of Regulation S-K Items 101, 103, and 105 (Aug. 26, 2020), available at https://www.sec.gov/news/public-statement/crenshaw-statement-modernization-regulation-s-k.
3 Satyam Khanna Named Senior Policy Advisor for Climate and ESG (Feb. 1, 2021), available at https://www.sec.gov/news/press-release/2021-20?utm_medium=email&utm_source=govdelivery.
4 See SEC, Asset Management Advisory Committee, Potential Recommendations of ESG Subcommittee, at 4 (Dec. 1, 2020), available at https://www.sec.gov/files/potential-recommendations-of-the-esg-subcommittee-12012020.pdf; see also SASB, SEC AMAC ESG Subcommittee (Oct. 17, 2020), available at https://www.sec.gov/files/10152020-sasb-sec-amac-esg-subcommittee.pdf; Potential Recommendations from the ESG Subcommittee (Dec. 1, 2020), available at https://www.sec.gov/files/update-from-esg-subcommittee-12012020.pdf. The draft recommendations followed recommendation by the Investor-as-Owner subcommittee of the Commission's Investor Advisory Committee to amend reporting requirements to include ESG factors. Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisor Committee Relating to ESG Disclosure (May 14, 2020), available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/recommendation-of-the-investor-as-owner-subcommittee-on-esg-disclosure.pdf.
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© Norton Rose Fulbright LLP 2020