ESG Investing

SEC Regulations on ESG Disclosure Gaining Traction

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Following the four years of the Trump presidency, new efforts by the US Securities and Exchange Commission (SEC) to elevate environmental, social, and governance (ESG) matters have accelerated under the Biden Administration.

The agency opened new guidance on climate change disclosures to public comment; meanwhile, the SEC Investor Advisory Committee approved a subcommittee’s recommendation to update reporting requirements for corporate issuers on “material, decision-useful” ESG factors.

While specific SEC regulations are still forthcoming, these swift developments are a positive development for those who view ESG metrics as essential in gauging a company’s broader impact.

Responding to Investor Demand

The first changes to ESG disclosure standards since 2010, these updates received a boost in December 2020 when the ESG subcommittee of the Asset Management Advisory Committee recommended implementing standards around ESG disclosures. The group called on the SEC to:

  • Set conventions for corporate issuers disclosing material ESG risks
  • Use those conventions as the foundation for issuer disclosure requirements relating to material ESG risks
  • Require such disclosures be consistent with other financial disclosures

The recommendations acknowledged that public data to measure and validate ESG factors is generally lacking; that the risk-return profile of ESG investments may reflect a longer time frame than conventional financial products; and that standard risk-reward assessments may not capture all facets of ESG issues. The committee stressed that it considered current disclosure regulations around material risks sufficient—but it noted that a mandatory standards framework would lead to more “consistent, comparable, complete, and meaningful” disclosures.

In February 2021, then-acting SEC Chair Allison Herren Lee announced that the Division of Corporation Finance would increase its scrutiny of climate-related disclosures and expand related 2010 guidelines. Lee added broader ESG matters to the mandate a few weeks later, having determined that “investors are demanding more and better information on climate and ESG, and that demand is not being met by the current voluntary framework.”

Additionally, Lee pushed for the expansion of select ESG disclosure practices. She placed an initial emphasis on workforce and board diversity as well as political spending, which she identifies as the “key to any discussion of sustainability.”

Subsequently, acting director of the Division of Corporation Finance John Coates explained in May that he believed new SEC Chair Gary Gensler would further Lee’s efforts on ESG matters. Additionally, Coates anticipated that a new set of rules around ESG disclosure would be published outright rather than handled as an update to the 2010 regulations.

Given the high likelihood of future SEC regulations around ESG disclosures, the agency bulked up its disciplinary capacity in February by creating a senior policy advisor for climate and ESG position that reports directly to the agency chair. A month later, it unveiled a specialized unit in its Division of Enforcement. Initially, the Climate and ESG Task Force aims to investigate misleading or insufficient disclosures by issuers as well as noncompliance with ESG-related guidelines by investment advisors and mutual fund companies.

President Biden has moved ESG matters off the back burner as part of a broader push to reprioritize climate issues.

Finding Industry Solutions

December’s recommendations from the Asset Management Advisory Committee’s ESG subcommittee additionally included two points of clarity around ESG investment products. The group called for improved descriptions of any investment’s strategy and investment priorities, including environmental impact or religious grounding; it also raised issues of disclosing shareholder engagement efforts outside of proxy votes, which are already reported.

The committee explained that enhancing existing guidelines around product disclosure and advertising would improve the consistency and comparability of information between investment options with a modest impact on operating costs. It added that the industry had already produced some effective guidelines, most notably the Investment Company Institute’s July 2020 ESG Roadmap.

Accordingly, subsequent developments around product-related issues have gravitated toward recommendations encouraging investment companies to provide insight into their ESG objectives and priorities. Concluding that the effect of ESG integration on fund performance is unclear, the group did not press for related disclosure requirements. However, it did allow for the possibility to explore them in the future as issuer disclosures improve.

The committee stressed that industry best practices should drive product-related decisions going forward. To help individuals discern what to look for in ESG investments in the meantime, the SEC published an investor bulletin in February.

President Joe Biden has moved ESG matters off the back burner as part of a broader push to reprioritize climate issues. Although revised or new SEC regulations rarely follow a smooth path to implementation, the backing of the Biden Administration may prove a critical inflection point for highlighting ESG matters.

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