SEC’s Acting Director Of Division Of Corporation Finance Addresses ESG Disclosure Framework – Corporate/Commercial Law

John Coates, the Acting Director of the Division of Corporation
Finance of the Securities and Exchange Commission (SEC), issued a
public statement entitled “ESG Disclosure
– Keeping Pace with Developments Affecting Investors, Public
Companies and the Capital Markets” in connection with the 33rd
Annual Tulane Corporate Law Institute.

In his March 11, 2021 remarks, Mr. Coates noted the growing
importance of Environmental, Social, and Governance (ESG) issues to
investors, public companies, and capital markets and the rapid pace
of ESG developments.

Mr. Coates began his remarks by noting the increasing demand for
ESG disclosures by investors and the role ESG plays in investor
decision-making. He also discussed some of the challenges in
evaluating ESG disclosures, highlighting the fact that such
disclosures are highly individualized and that a
“one-size-fits-all” framework may not effectively measure
ESG for everyone.

The remarks then focused on four issues at the forefront of the
debate around ESG disclosures: how to create an ESG disclosure
system, the pitfalls of not having an ESG disclosure system,
mandatory vs. voluntary ESG disclosures, and the benefits of a
standard global ESG disclosure framework.

We briefly discuss each of these issues below.

Considerations for an Effective ESG Disclosure System

Mr. Coates emphasized that a truly effective disclosure system
is one with flexible standards to accommodate developments in the
ESG space. He then outlined some of the questions the SEC will
grapple with as they develop a framework for ESG disclosures,
including:

  • What disclosures are most
    useful?

  • What is the right balance between
    principles and metrics?

  • How much standardization can be
    achieved across industries?

  • How and when should standards
    evolve?

  • What is the best way to verify or
    provide assurance about disclosures?

  • Where and how should disclosures be
    globally comparable?

  • Where and how can disclosures be
    aligned with information companies already use to make
    decisions?

These questions, along with others, will drive the SEC’s
discussions about ESG going forward.

Costs of No ESG Disclosure Requirements

Next, Mr. Coates discussed some of the concerns associated with
an ESG disclosure system—in particular highlighting the costs
of measuring and preparing such disclosures as an issue raised by
critics. While Mr. Coates acknowledged that there may be financial
costs associated with preparing ESG disclosures, he emphasized what
is, in his view, a larger cost—that is, the cost of not
having an ESG disclosure framework at all. In his view, a lack of
ESG data may drive a reduction in market support as investors
struggle to find the information they need to make informed
investment decisions. Moreover, while the costs of compiling ESG
data and disclosures may be particularly onerous to smaller
reporting companies, they are less likely to be able to absorb
higher costs of capital.

Mandatory vs. Voluntary Disclosure

In addition to the content of ESG disclosures, Mr. Coates
touched on the debates surrounding mandatory as opposed to
voluntary ESG reporting. While not disclosing a preference of one
system over the other, Mr. Coates noted the range of approaches the
SEC currently takes with respect to reporting: mandatory
disclosures, mandatory disclosures subject to materiality
thresholds, and “comply or explain” disclosures, which
give public companies the option to explain why they do not
disclose certain information.

Given the nuanced approach the SEC currently takes to its
disclosure regime, it should come as no surprise that Mr. Coates
expects any ESG disclosure framework to be equally nuanced.

The Virtues of Achieving a Single Global ESG Reporting
Framework

Finally, Mr. Coates emphasized that, as ESG risks are global, so
should be the solutions. One reason for this approach is
efficiency—multiple regulatory frameworks addressing the same
ESG issues would be redundant. But with a truly global ESG
framework comes a number of considerations: adequate funding to
implement such a framework, staffing of truly independent experts
to develop the framework, and ensuring adequate transparency of the
process to create the framework, among others.

What’s Next for ESG Disclosure?

While the statement includes the standard disclaimer that it
reflects Mr. Coates’ own views and not the views of the SEC,
his remarks were well-aligned with other recent public statements
coming from the SEC’s Divisions of Corporation Finance,
Examinations, and Enforcement and from the Acting Chair of the SEC
and other SEC Commissioner. For example, the statement from Commissioners Hester M. Peirce
and Elad L. Roisman on climate change disclosure, the Acting Chair
Allison Herren Lee’s direction to the Division of Corporation
Finance to review climate-related disclosure and begin a process
for enhanced climate change disclosure, the formation of a Climate and ESG Task Force in
the Division of Enforcement, the Division of Examinations focus on climate-related risks as a keystone of
its 2021 enforcement priorities, the appointment of Satyam Khanna in the new role of
Senior Policy Advisor for Climate and ESG, and the investor alert on ESG funds from the SEC’s
Office of Investor Education and Advocacy. 

From these activities, we can conclude that ESG disclosure will
become a regulatory reality for public companies, whether by
enforcement, guidance, or rulemaking or most likely, a combination
of the three. Implicit within the volume of these announcements
over the last several months is the SEC’s sense of urgency on
ESG-related regulatory actions. For public companies, this
regulatory reality will be coming very soon.

The SEC has often said that disclosure of complex, uncertain,
and evolving risks should allow investors to see the company
through the eyes of management. Mr. Coates’rsquo; remarks
should be a call to action to management to carefully survey the
landscape of business risk for ESG-related risks, including climate
change-related risk in particular.

A critical first step to be prepared for what comes next from
the SEC is to explicitly identify and internally articulate the
ESG-related issues impacting the business. The second step is
assessing these risks for materiality to the business—an
important topic Mr. Coates did not address in his remarks. For
public companies with robust ESG engagement with institutional
investors, some of what is considered material has already been
defined by the needs and interests of those investors. Even for
companies that are relatively advanced on their ESG journey, now is
the right time to assess which ESG topics are now, or are likely in
the future to become, material. All companies should include
climate change impacts as an area deserving special scrutiny for
materiality.

Over the last several years, institutional investors have been
telling public companies that it is not enough to manage
ESG-related risks without disclosure. In the absence of robust
disclosures, investors have increasingly concluded that companies
are not adequately managing ESG-related risks. The SEC seems to
have come to the same conclusion and is now on a clear path toward
development of ESG-related disclosure.

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