Current US law mandates disclosure of certain environmental and social information under Regulation S-K and other banking and securities acts, but the vast majority of ESG reporting remains largely optional and market-driven. Most ESG information does not reach investors, regulators, or corporate stakeholders in a company’s typical annual report or other SEC-mandated filings; instead, companies typically opt to release a separate voluntary report aimed at sustainability and other ESG initiatives, which may be subject to greenwashing due to lack of oversight and regulation. More troubling is that the select few nonfinancial ESG-related disclosure requirements hinge on materiality, which evinces a nonfinancial regulatory regime that is principles-based, rather than rules-based. This requires investors to “trust” companies to act objectively and precisely when gauging the materiality of complex ESG issues. This causes both uncertainty in reporting requirements on the discloser side and the need for private actors to draw attention to sustainability issues and enhanced ESG disclosures.
But would investors even use this information if it was mandated by the SEC? Various studies seem to think so. McKinsey & Company claims that investors and asset owners adjust their investment strategies based on corporate sustainability disclosures. Ernst & Young’s 2016 report on ESG also indicates a global trend toward an increased interest in nonfinancial information by investment professionals. Investors have shown a clear proclivity towards using ESG information in investment decisions, exemplifying the need for a regulatory framework dedicated to ESG disclosure. These claims are only amplified by an examination of the public sector. A July 2020 Government Accountability Office report on ESG disclosures found that most institutional investors seek information on ESG issues to better understand investment risks. SEC Commissioner Allison Herren Lee stated in response to the Commission’s passing of a final rule in August 2020, “It has never been more clear that investors need information regarding, for example, how companies treat and value their workers, how they prioritize diversity in the face of profound racial injustice, and how their assets and business models are exposed to climate risk as the frequency and intensity of climate events increase.” Information, survey results, and public statements from both the private and public sectors recognize the importance of ESG disclosures and the incessant use of such information by investment professionals today. So, what should be done about this?
With robust firm-level ESG policies gaining notoriety as a driver of value for a firm due to its impact on company operations and efficiency, the SEC should consider mandating an ESG-disclosure regime based around this very specific principle. The current nonfinancial disclosure regime exists as a principles-based, materiality-focused framework; any recommended solution to the lack of ESG disclosures must fit this framework for the SEC to even consider it. Thus, the SEC should adopt mandated disclosures for certain ESG factors that materially impact a company’s operations. By mandating a principles-based disclosure regime based on a very specific principle, disclosers are less likely to face uncertainty in their reporting requirements and investors are better able to pinpoint the value drivers within the firm’s ESG initiatives. This “fix” is a starting point that addresses the SEC’s repeated neglect to adopt mandated ESG disclosures by framing such disclosures in a principles-based manner—thus, conforming to the SEC’s current nonfinancial disclosure regime while supplying investors with true, accurate, and influential nonfinancial ESG information.