In recent months, the Securities and Exchange Commission (SEC) has been increasing their focus on environmental, social and governance (ESG) issues and investing. ESG investing, where investors prioritize or take into consideration the environmental or social impact of their investments, is a trend that has surged in popularity the past few years. Under new leadership, the SEC has pledged to make ESG a main priority for the agency. Given that former acting SEC Commissioner Alison Herren Lee recently stated that she does not believe current regulations adequately provide investors with enough ESG related information, it appears the agency is taking that pledge seriously. So what does this mean for filers?
What is ESG?
Before getting into what changes filers should expect, we will first take on the difficult task of defining what ESG is. There is no clear consensus on what issues fall under the broad umbrella of ESG, or what strategies ESG funds and investors use. This lack of clarity has caused confusion and prompted the SEC to issue a Risk Alert for ESG investing. For the purpose of this blog we will separate the overall concept of “ESG” from the actual investing practice, “ESG investing”.
“ESG” can be thought of as the issues that investors may care about that are not directly related to the traditional investment concerns of making or preserving money. Issues could include a company's impact on the climate, human rights, corporate transparency, among other things.
“ESG investing” is when investors take one or more of these issues into consideration when picking their investments, whether it be to support or influence a cause, or because they think that ESG friendly companies will outperform others.
ESG investing can be done through different strategies. The most common method is for an investor to invest in companies whose values match their own, and screen out ones that may negatively impact an issue the investor cares about. This could be an individual who only invests in companies known to treat their workers well, or that do significant charity work. Another method used by funds and other large shareholders is to invest in companies with room for improvement, and to then use their shareholder sway to influence companies toward an ESG related goal. A perfect example of this occurred recently when a small hedge fund led a successful push to unseat multiple members of the board of directors at ExxonMobil in an effort to steer the company towards a business strategy that takes combating climate change more seriously.
The Role of the SEC
Currently, companies and funds disclose ESG related information on a voluntary basis, and as noted above there are no set definitions or standards for what filers do decide to provide. What this often means is that ESG information can be selectively chosen, and one company's approach to ESG can be vastly different from a different company. There has also been a high amount of misleading or inaccurate claims. The agency now seems poised to change all of that, and has two main goals to do so.
The first goal is for increased scrutiny and better guidance for ESG information disclosures. By increasing scrutiny on ESG related information the agency hopes to hold companies accountable for the claims they make in the same way they would with a company’s financial data. A task force has already been created to crack down on ESG related misconduct and a new advisory position has been created to oversee climate and ESG policy. Alongside tougher enforcement, the SEC has put out ESG disclosure guidance for filers and investors in order to avoid the pitfalls currently caused by the lack of standards and structure, and to move towards more widely accepted definitions. With stricter oversight and a more uniform understanding of ESG, the SEC hopes to allow investors to make more informed decisions.
While there have already been significant steps taken towards better oversight and guidance, the actual disclosure of ESG information is still almost entirely voluntary. This may be changing in the near future. No concrete proposals have been made as of this writing, but it appears that the SEC’s second goal is to make certain ESG related information disclosures mandatory. Earlier this year, Commissioner Lee stated in a speech that the demand for ESG information “is not being met by the current voluntary framework”, and that “human capital, human rights, climate change — these issues are fundamental to our markets, and investors want to and can help drive sustainable solutions on these issues.” Gary Gensler, the agency’s current Commissioner, has expressed similar concern.
The agency's messaging around new disclosure requirements has remained vague, although climate related information is likely to be at the forefront of any new regulations. The IFRS Foundation’s work to establish a sustainability board has been cited as a promising first step. It’s important to note that the SEC’s new focus on ESG has not gone without pushback, with some officials arguing that incorporating ESG oversight is outside of the agency’s core mission.
Preparing for Changes
Predicting what or how ESG related regulations will be proposed is anyone's guess. What we do know is that new disclosure requirements are likely on their way, and it’s important for filers to be ready when they arrive. Transform is our fast and easy-to-use SEC reporting software platform that is always up to date with the latest reporting requirements. Contact us to learn more about how we can help your company meet its compliance requirements.