It's widely anticipated that we'll soon be seeing more action from the SEC on sustainability disclosure, including possibly a prescriptive ESG framework that draws on some global metrics. (See, e.g., this PubCo post and this PubCo post.) Trying to head those prescriptive ESG metrics off at the pass is Commissioner Hester Peirce—yes, she who once described "ESG" as standing for "enabling shareholder graft"—in her statement, Rethinking Global ESG Metrics. With Gary Gensler now sworn in as SEC Chair, the revised composition of the SEC does not bode well for Peirce's mission. Peirce concludes her statement with the admonition, "[l]et us rethink the path we are taking before it is too late." But has the train already left that station?
Peirce takes aim at the concept of imposing a prescriptive approach to ESG, particularly adoption of a single global set of metrics. In her view, while it sounds appealing to adopt a set of "common metrics demonstrating a joint commitment to a better, cleaner, well governed society," those metrics would likely come with a number of potential adverse effects: "Common disclosure metrics, however, will drive and homogenize capital allocation decisions. A single set of metrics will constrain decision making and impede creative thinking. Unlike financial accounting, which lends itself to a common set of comparable metrics, ESG factors, which continue to evolve, are complex and not readily comparable across issuers and industries."
According to Peirce, "the result of global reliance on a centrally determined set of metrics could undermine the very people-centered objectives of the ESG movement by displacing the insights of the people making and consuming products and services." In addition, she contends that "preset, government-articulated metrics" will impair the ability of markets to respond to price signals and cramp the public's ability to innovate in ways that might address these challenges.
Perhaps most important to Peirce is that converging with or adopting global standards "would be antithetical to our existing disclosure framework, which is rooted in investor-oriented financial materiality and principles-based requirements to accommodate the wide variety of issuers."
Peirce has previously maintained that to arrive at "broad ESG disclosure mandates for issuers, we have to reimagine materiality. But reimagining materiality is the same as tossing it in favor of a more malleable new edition. Materiality has served us well, and undermining it to accommodate ESG will harm investors. I reiterate a point I have made before—I am happy to consider new SEC mandates for specific metrics that are likely to be material to every issuer in every industry. ESG standards, however, continue to be talked of in broad strokes that obfuscate the immaterial nature of many of the specific underlying disclosures. Although I certainly understand the impetus for asking for mandated issuer disclosures, I urge the Committee to rethink the wisdom of recommending that we embark on a program to write standards for a set of issues nobody can define. They are not akin to accounting standards, which serve a clear, time-tested, universally understood objective. Having the SEC build a GAAP-like edifice around ESG standards would give investors a false sense of confidence in standards that are subjective, shifting, and sometimes even senseless." (See this PubCo post.)
Peirce eschews the European concept of "double materiality," arguing that it "has no analogue in our regulatory scheme." Moreover, she views the imposition of specific ESG metrics that are responsive to the interests of "a broad set of 'stakeholders,'" to be inconsistent with the current disclosure framework, which she considers to be based on financial materiality focused only on shareholder interests.
What is "double materiality"? As discussed in the European Commission's Guidelines on reporting climate-related information, the Non-Financial Reporting Directive requires that a company "disclose information on environmental, social and employee matters, respect for human rights, and bribery and corruption, to the extent that such information is necessary for an understanding of the company's development, performance, position and impact of its activities." In essence, the NFRD "has a double materiality perspective:
- "The reference to the company's 'development, performance [and] position' indicates financial materiality, in the broad sense of affecting the value of the company. Climate-related information should be reported if it is necessary for an understanding of the development, performance and position of the company. This perspective is typically of most interest to investors.
- "The reference to 'impact of [the company's] activities' indicates environmental and social materiality. Climate-related information should be reported if it is necessary for an understanding of the external impacts of the company. This perspective is typically of most interest to citizens, consumers, employees, business partners, communities and civil society organisations. However, an increasing number of investors also need to know about the climate impacts of investee companies in order to better understand and measure the climate impacts of their investment portfolios."
SASB has indicated its support of double materiality:
"The double materiality perspective appropriately acknowledges that non-financial information is important to multiple constituencies. It effectively captures the important interactions between businesses, the markets they serve, and the world in which they operate, and it enables meaningful accountability to a broad range of stakeholders. Therefore, we believe double materiality should be explicitly retained as a core element of the NFRD. We also observe that the double materiality concept usefully recognises the dynamic nature of materiality in the context of sustainable business practices—that is, the idea that an issue that is material solely from a social or environmental impact perspective can also become financially material over time."
The Shareholder Commons has also promoted a somewhat similar approach, seeking to shift the focus from the impact of a company's activities and conduct on its own financial performance to "systemic portfolio risk," the impact of the company's activities and conduct on society, the environment and the wider economy as a whole, which would affect most investment portfolios. (See this PubCo post.)
Peirce attributes the strength of U.S. capital markets to "investor-focused disclosure rules," and she concludes with her concern that this type of expansion of the disclosure requirements "would likely expand the jurisdictional reach of the Commission, impose new costs on public companies, decrease the attractiveness of our capital markets, distort the allocation of capital, and undermine the role of shareholders in corporate governance."
At a meeting of the SEC's Asset Management Advisory Committee, Peirce's fellow SEC Commissioner Elad Roisman has expressed similar reservations. In his view, it is "entirely reasonable for a person to feel that climate change deserves immediate attention from lawmakers and still question whether the SEC mandating new disclosures from U.S. public companies is an appropriate step for the agency. In this forum, I feel confident that we all recognize the fundamental questions here are about the SEC's authority as a regulator and whether this agency's intervention is appropriate to address the problems people have identified in our markets." (See this PubCo post.)
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