Over the last several years, many investors, regulators and other stakeholders have increasingly sought environmental, social and governance (ESG) disclosures from public companies. These stakeholders seek to require companies to measure, manage and then disclose ESG-related factors in their public filings. Generally, ESG includes the following: (a) environmental, e.g., greenhouse gas emissions and emissions of other air and water pollutants, waste management; (b) social, e.g., human rights, labor rights, working conditions, health and safety, employee relations, employment equity, gender diversity and pay gaps, anti-corruption, and impact on local communities; and (c) governance, e.g., ownership and structural transparency, shareholder rights, board of directors' independence and oversight, diversity, data transparency, business ethics, and executive compensation fairness.1
The US Securities and Exchange Commission (SEC) has made public statements and taken steps indicating that it will soon adopt specific ESG disclosure requirements for issuers that are subject to SEC reporting requirements. This Advisory briefly describes the SEC's current ESG disclosure framework, summarizes the key ESG developments from 2021 (as detailed in our previous ESG advisories), discusses the expected updates to ESG disclosure requirements for public companies expected in 2022, and suggests some actions that companies should consider in preparing for the SEC's forthcoming ESG disclosure rules and enforcement.
Current SEC framework
In 2010, the SEC published interpretive guidance (2010 Guidance) for public companies regarding disclosure requirements relating to climate change matters.2 The 2010 Guidance recommended disclosure, where material to the company, of:
(i) the impact of pending or existing climate-change related legislation, regulations, and international accords;
(ii) the indirect consequences of regulation or business trends; and
(iii) the physical impacts of climate change.
The 2010 Guidance was in line with the longstanding principle that public companies are required to disclose, in their public filings (such as an annual report on Form 10-K or 20-F or a registration statement on Form S-1 or F-1), information that is material to investors, including information concerning climate change. What the 2010 Guidance did not do was create specific reporting requirements related to climate change or other ESG-related matters. The 2010 Guidance remains the main climate disclosure reporting guidance for public companies that the staff of the SEC has issued.
Climate change disclosure by public companies did not change significantly after the 2010 Guidance was issued. Companies that did include climate change disclosure in their public filings generally included brief statements with little quantification of impacts or risks. Likewise, the SEC sent very few comment letters to companies related to their climate change disclosures in past years.3
Between 2010 and 2021, the SEC's only major update to ESG disclosure requirements was the addition to Item 101 of Regulation S-K requiring public companies to provide disclosure about their human capital resources, to the extent material to an understanding of the business. Such disclosure may include the number of persons employed and any human capital measures or objectives that the companies focus on in managing the business (such as measures or objectives that address the development, attraction and retention of personnel). This disclosure requirement became effective in November 2020 and impacts public company filings such as annual reports and registration statements. However, under direction of new leadership since January 2021, the SEC has substantially increased its focus on ESG disclosures.
Recent SEC Statements and Actions
Disclosure Review and Comment
On February 24, 2021, the acting chairwoman of the SEC directed the Division of Corporation Finance to increase its focus on climate-related disclosure in public company filings. As part of its focus in this area, the SEC staff has increased its scrutiny of public company disclosure to review the extent that the topics identified in the 2010 Guidance have been addressed, and has engaged directly with many public companies on these issues. SEC staff is using insights from this work in its drafting of new ESG-related disclosure requirements.4
As part of this work, the SEC has been sending comment letters to public companies relating to their current climate change-related disclosure, including to companies that do not operate in energy-intensive industries. To send a message to the broader market, in September 2021 the SEC posted a sample comment letter (Sample Comment Letter) on its website to give public companies an idea of the types of comments they may receive from the SEC on their ESG disclosure (or lack of disclosure). The Sample Comment Letter requests that public companies provide information on:
- material climate change transition risks (e.g., policy and regulatory changes, market and business trends, credit risks), litigation risks and physical risks with respect to the business;
- purchases or sales of carbon offsets;
- material pending or existing climate-related legislation, regulation and international accords and their effect on the company's business;
- effects (physical and financial) of climate change on operations and results; and
- why certain information disclosed in the company's corporate social responsibility or sustainability reports is not also included in its SEC filings.
This last point is of particular concern to public companies that have published reports on "Corporate Sustainability," "Corporate and Social Responsibility," "Climate Change" or similar topics in which public companies describe their policies and efforts with respect to one or more aspects of ESG. The SEC may, in comments on disclosure in publicly-filed documents, require companies to augment their disclosure in such documents with information from the published corporate reports, subjecting them to potential liability for material misstatements or omissions under the Securities Act of 1933 and/or the Securities Exchange Act of 1934.
Request for Public Comment and Future Disclosure Requirements
In March 2021, the SEC announced a request for public comment on required climate disclosures.5 The request for public comment set forth several questions, including the advantages and disadvantages of drawing on existing third-party, voluntary frameworks such as those developed by the Sustainability Accounting Standards Board (SASB) or the Task Force on Climate-related Financial Disclosures (TCFD); whether to require disclosure about any ties between companies' executive compensation and their climate change goals; the advantages and disadvantages of developing a single set of global standards applicable to companies around the world; and how to consider climate change within the broader spectrum of ESG disclosure issues. The majority of the comments received by the SEC were in support of mandatory climate disclosure rules, in particular supporting the adoption of a standardized reporting framework. Some public comments recommended that the SEC look to recommendations from the TCFD, a framework for assessing and reporting on climate risks and opportunities that has been endorsed by many market participants and governments.6 The comments received will inform the SEC's efforts in updating ESG disclosure requirements.
New Disclosure Requirements Expected
In addition to reviewing disclosures for compliance with the current climate disclosure framework, the SEC expects to propose new rule amendments to establish mandatory7 ESG disclosures for public companies. Proposed rules are expected to cover:
- corporate board diversity (e.g., requiring companies to provide enhanced disclosures about the diversity of board members and board nominees);
- climate change;
- human capital management8 (e.g., requiring disclosures about workforce diversity, workforce turnover, skills and development training, compensation and benefits); and
- cybersecurity risk governance.
SEC Chairman Gary Gensler has asked SEC staff to consider the following in drafting climate disclosure recommendations for the rules:
- qualitative disclosures such as how a company's leadership manages climate-related risks and opportunities and how managing those risks and opportunities plays a role in the company's strategy;
- quantitative disclosures, such as comparable metrics across companies related to greenhouse gas emissions, financial impacts of climate change and progress towards climate-related goals;9
- whether to establish specific or different climate disclosure metrics based on a company's industry;
- potential requirements for companies that have made forward-looking climate commitments (such as carbon neutral goals), or that have significant operations in jurisdictions with national requirements to achieve specific, climate-related targets such as the Paris Agreement, that could lead to regulatory or economic changes in those jurisdictions;
- the feasibility of drawing from an established ESG disclosure framework, such as the framework under development by the TCFD; and
- whether companies might provide analyses on how their businesses would adapt to the range of possible physical, legal, market and economic changes they may contend with in the future.10
Although the specifics of the proposals have not yet been released, the considerations outlined above are a good indication of the type of disclosure the SEC may propose. Further, for those companies seeking to be responsive to the increasing call of institutional investors for greater disclosure, Chairman Gensler's comments can help serve as a guide in current drafting of ESG disclosure for public filings.
Initial SEC proposals regarding new ESG disclosure requirements were expected in late 2021, but such a rule is now expected to be released to the public some time in 2022. Further, because any such rule proposal would need to undergo a period of public comment, it is likely that actual reporting requirements under the new rules would not take effect until 2023. Another consideration is whether there will be different disclosure requirements that apply to, for example, foreign private issuers, sovereign issuers, or other classifications of issuers, including different disclosure by industry (e.g., energy/industrial companies, agricultural companies, or financial services companies), or whether a different timetable will be adopted for certain issuers, such as emerging growth companies, to come into compliance.
In addition to the comment letters and imminent rule proposals relating to ESG disclosure, the SEC's examination and enforcement arms have also increased their focus on ESG matters. On March 3, 2021, the SEC's Division of Examinations announced its 2021 examination priorities, which include a greater focus on climate-related risks.11 Further, on March 4, 2021, the SEC announced the creation of a Climate and ESG Task Force in the SEC's Division of Enforcement. The Climate and ESG Task Force identifies ESG-related misconduct, and one of its initial areas of focus is the review climate risk disclosures and identification of any material gaps or misstatements under existing rules.12
As foreshadowed by these announcements, the SEC has increased its activity, scrutinizing climate-related claims and forward-looking statements made by companies and bringing actions against companies for noncompliance with previously-stated ESG commitments. For example, the SEC and the United States Attorney's Office for the Eastern District of New York are investigating statements made by asset management firms advertising their use of sustainable investing criteria.13 The SEC's Acting Director of Enforcement has also warned that, in addition to increased scrutiny of funds advertising green investments, the public should expect more general ESG disclosure-related enforcement actions.14
Preparing for New Disclosure Requirements
Given the SEC's recent activity in policing public company adherence to ESG disclosure requirements, it is important for public companies to (a) review current ESG disclosure in public filings and consider whether additional disclosure should be made in the light of the SEC's new emphasis in this area (e.g., the inclusion of a risk factor addressing climate change risks as they relate to the company); (b) carefully evaluate such disclosures in the light of the 2010 Guidance and the Sample Comment Letter; (c) ensure that any disclosures made are substantiated and not misleading; (d) review any disclosures made in the company's ESG or Corporate Social Responsibility reports or other similar documents to identify any climate-related statements that could raise questions as to whether they should be included in SEC filings. Evaluating existing disclosures is particularly important because (i) the SEC touched on this topic in the Sample Comment Letter, and (ii) the SEC's new Climate and ESG Task Force has been given the initial task of identifying material gaps or misstatements in disclosure of climate risks under existing rules. In particular, public companies should be careful about selectively disclosing metrics that paint a positive picture while not presenting other information that may not only balance the disclosure but contradict the statements made.
As described in this Advisory, ESG disclosure requirements for public companies are expected to increase. To prepare for more robust requirements, companies should establish a corporate governance framework to evaluate their ESG risks. This should include an allocation of responsibilities among its various committees (or a single committee, as appropriate) for each of the ESG elements with a focus to define the risks, goals, strategies and mitigation plans for each element. For example, one way to begin to quantify these risks and refine the company's strategy pertaining to climate change is to review the TCFD framework. Companies can review their climate-related governance, strategy, risk management, and metrics and targets as called for by the TCFD. Further, as discussed above, given the TCFD framework's widespread adoption, the SEC may rely on it in crafting a proposed rule. Importantly, ESG-related disclosures should have the same factual support as would be expected of all other public company disclosures, so the board of directors and management should identify the appropriate sources of information in a manner subject to customary internal controls and disclosure controls and procedures.15
1 EYGM Limited, The Future of Sustainability Reporting Standards: The Policy Evolution and the Actions Companies Can Take Today (June 2021).
2 Securities and Exchange Commission, Guidance Regarding Disclosure Related to Climate Change (Release Nos. 33-9106; 34-61469) 17 CFR parts 211, 231 and 241.
3 Ceres, SEC Climate Guidance & S&P 500 Reporting—2010 to 2013 (February 2014).
4 Acting Chair Allison Herren Lee, Statement on the Review of Climate-Related Disclosure(February 24, 2021).
5 Acting Chair Allison Herren Lee, Public Input Welcomed on Climate Change Disclosures(March 15, 2021).
6 Securities and Exchange Commission, "Comments on Climate Change Disclosures".
7 Some of the comments received by the SEC on climate change disclosure pointed out that the SEC may be straying from a materiality threshold in requiring these types of disclosures from all issuers, regardless of relevance to their business. The SEC separately indicated that they have the power under the securities laws to require any disclosures necessary to protect investors, regardless of materiality.
8 Note that, as described above, the SEC already requirespublic companies to provide disclosure about its human capital resources. However, the SEC is expected to propose rules requiring more robust disclosure on this topic.
9 In connection with these metrics, Gensler noted that any required quantitative disclosures should include more than a "net zero" emissions goal announcement and should provide specific/ supporting information for such disclosures.
10 Chair Gary Gensler, Prepared Remarks Before the Principles for Responsible Investment "Climate and Global Financial Markets" Webinar(July 28, 2021).
11 SEC Division of Examinations Announces 2021 Examination Priorities (March 3, 2021).
12 SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (March 4, 2021).
13 Patricia Kowsman, Corinne Ramey, and Dave Michaels, U.S. Authorities Probing Deutsche Bank's DWS Over Sustainability Claims (August 25, 2021), The Wall Street Journal.
14 Al Barbarino, Top SEC Official Suggests More ESG Enforcement Is Coming (July 13, 2021), Law360.
15 Robert Azarow, Erik Walsh and Paul Nabhan, ESG Disclosure on the Horizon for Financial Institutions(September 7, 2021).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.