The incoming Biden administration is likely to accelerate efforts for the Securities and Exchange Commission (SEC) to mandate corporate disclosure of environmental, social and governance (ESG), but challenges will persist with clearly linking a company’s performance to individual ESG factors, says a top corporate legal expert.
Richard Fields, a corporate governance legal authority with the global law firm King & Spalding, says in an exclusive interview that overcoming the challenges will require extensive new data and research into ESG, which generally refers to the three main factors that businesses use to assess their sustainability and related efforts.
In the last decade ESG has gained in prominence among companies as part of a “broad secular shift” in which it has become more mainstream and sophisticated, says Fields. Efforts to standardize or expand ESG disclosure “hit rocky shores in the Trump administration,” and with the SEC in particular, Fields says. But he adds that President-elect Joe Biden’s administration will likely have a greater willingness to consider “more mandatory ESG disclosure policies and targets” in the SEC and elsewhere that would advance the growing ESG disclosure movement.
Richard Fields
The adoption of “hard ESG performance targets” by the Biden administration is possible but less likely than “hard ESG disclosure developments,” Fields says. During the past year, SEC discussions have made it clear that two of the current five SEC commissioners would support “clearer definitions of what ESG means” and more robust disclosure requirements of financially material ESG information, he notes.
Democratic Commissioner Caroline Crenshaw recently said at an online conference hosted by the McDonough School of Business at Georgetown University that she believes the new SEC chairman replacing Republican Jay Clayton will take a hard look at ESG issues.
And fellow Democratic Commissioner Allison Herren Lee has publicly touted the value of bringing more sunlight to these issues, so it is likely there will be more discussion of mandatory ESG disclosure, Fields says.
But Fields raises the caveat that ESG is defined differently by many people, with many immediately associating it with climate change, greenhouse gas reductions and other environmental issues. Others, especially lawyers, think of ESG “more holistically,” since the bulk of lawyers’ work has been on governance issues that are subject to SEC, stock exchange, and other investor requirements, he adds.
What constitutes ESG is not as well understood as it could be, and what is “material” in ESG terms for one company may be very different for others, Fields says.
The key ESG issues facing a big technology company, for example, differ from the issues facing a big energy company. Figuring out where and how to improve and mandate ESG disclosure will not be a simple matter of “let’s turn ESG on” under a Biden administration but will require “a more nuanced analysis,” Fields says.
Fields states that he has “long railed against” the term or phrase “ESG” because all of the issues pertain to corporate oversight of the relevant topics. He notes that in a July 7 keynote speech at the national conference of the Society for Corporate Governance, Republican SEC Commissioner Elad Roisman discussed the concept of ESG and described how environmental and social issues became “lumped together” with governance, which Roisman said was “a component that had research tying it to firm value.” In Fields’ view, all of the ESG issues are fundamentally about governance and company responsiveness to key stakeholders’ concerns.
Lingering Challenges
The most likely near-term development is that the adoption of the Sustainability Accounting Standards Board (SASB) framework for “financially material sustainability disclosure” will accelerate and might become mandatory, Fields suggests. The number of companies reporting their industry’s SASB-required metrics has grown exponentially, and even more companies are in the process of evaluating, cataloguing and preparing to disclose their metrics. Because SASB’s framework focuses on financially material information for investors it fits well with the SEC’s mission. “I would be watching closely to see what role the SASB plays in the Biden SEC,” he says.
In September, SASB was among five major standards-setting organizations that announced they were joining forces to develop globally consistent corporate sustainability accounting standards to “reduce burdens on reporting organizations while facilitating analysis, interpretation, and action by users of information” amid company complaints that there were too many different standards.
The most serious ESG discussions focus on finding proof that the ESG metrics “actually relate to value,” either as an opportunity to outperform competitors or as a risk if not handled well, Fields says. In some cases, there is a clear connection to financial performance, such as the recognition that “if we don’t have a planet to live on” a given company will not be worth anything, while in other cases debate remains. Most serious companies understand that if there is a link between an ESG factor and corporate value, they must consider it alongside all the other factors that affect the company’s long-term performance, he says.
An issue to watch during the Biden administration is a Department of Labor (DOL) policy regarding whether ESG investments by covered retirement plans will be regulated. If ESG disclosures generate more data providing proof that such investing brings value it will be easier to meet the DOL standards for retirement plans, Fields says. Data exist now, but it is not as clear as some want, and studying the issue will help sort actual ESG impacts from those “that don’t hold up under scrutiny,” he says.
But establishing clear links is challenging. For example, historically, studies on governance issues have shown that having a board chair who is not the company CEO is good for corporate performance, while other studies have concluded the opposite. “Everyone can point to their favored study,” and there is no consensus on how to design studies that will produce verifiable conclusions. In addition, when linking one ESG factor to performance, it is difficult to “isolate all the other variables” affecting corporate value, Fields says.
Given the breadth of organizations and companies involved in promoting ESG, demands to go further will not subside, Fields says. Government policy will become more central to the efforts for several reasons, he says.
First, there is not the same level of standardization or comparability as is now required for financial reporting metrics. Reporting under SASB’s framework is not quite the same as reporting a financial metric under Generally Accepted Accounting Principles (GAAP) that are uniform for every company, although SASB metrics are closer to GAAP than early corporate sustainability reports that used undefined terms vaguely and did not enable a reader to know “who’s doing well and who is not.” Standardization and comparability will be hard to obtain from purely private action.
Second, while adoption of voluntary disclosure has accelerated dramatically, it is still a relatively small percentage of all public entities in the United States disclosing on ESG.
Many who are advocating for more companies to disclose argue that expanded coverage would create more of the data needed to figure out the link between ESG factors and performance, thereby giving investors more information to compare investments and develop engagement strategies with companies. Those arguments will likely be compelling to Democratic SEC commissioners and others in the Biden administration, Fields suggests.
However, he is not optimistic that global standardization efforts can succeed, noting decades of challenges trying to get agreements on international accounting standards. -- David Clarke
