Will ESG Disclosure Rules Force Corporations to Come Clean?
POMERANTZ MONITOR | NOVEMBER DECEMBER 2021
The Covid-19 pandemic, with its resultant lockdowns, has inadvertently exposed the extent to which business activity drives greenhouse gas emissions. In 2020 alone, U.S. greenhouse gas emissions experienced the largest one-year decline since at least World War II. But 2020’s emission reductions were in large part due to decreased economic activity resulting from measures put in place to slow the rate of Covid infection, reduced travel, and changes in demand for goods and services. With much of the population now vaccinated and many returning to work in 2021, emissions will likely rise again. Professor Petteri Taalas, Secretary-General of the World Meteorological Organization, said that while “the Covid-19 pandemic is not a solution for climate change … it does provide us with a platform for more sustained and ambitious climate action to reduce emissions to net zero through a complete transformation of our industrial, energy and transport systems.” This environmental call to arms has been echoed by President Biden and his administration, who have put pressure on organizations to address environmental, social, and governance (ESG) related issues. Similarly, the Securities and Exchange Commission (SEC) has made ESG a priority and weighed in to help drive consistency and transparency for public market disclosures.
Some companies, not waiting for the SEC to direct them on which ESG risks should be disclosed, have already marketed themselves as adhering to ESG best practices. According to a September 2020 report from Morningstar, sustainability-focused index fund assets have doubled in the past three years, to more than $250 billion as of mid-2020. In the U.S., sustainable index funds have quadrupled, now representing 20 percent of the total. No doubt the public’s changing attitudes towards diversity, inequity, climate change, and social unrest are driving factors behind institutional investors’ interest in ESG issues. A September 2019 survey conducted by Morgan Stanley’s Institute for Sustainable Investing found that “[m]ore than eight in ten U.S. individual investors now express interest in sustainable investing, while half take part in at least one sustainable investing activity.” It remains to be seen just how many of these so-called sustainable funds and ESG-labeled investment products are misrepresenting themselves to take advantage of the commercialization of ESG issues – a marketing tactic known as greenwashing.
Earlier this year, the SEC formed its first Climate and ESG Task Force within the Division of Enforcement. According to SEC Commissioner and Acting Chair Allison Herren Lee, its purpose is to “work to proactively detect climate and ESG-related misconduct, including identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules and analyzing disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” On August 25, the Task Force showed its teeth, pressuring managers of ESG-labeled investment funds to demonstrate that they’re being honest with consumers about their ESG-labeled investment products. The Wall Street Journal reported that the SEC and federal prosecutors were investigating DWS Group, an asset management arm of Deutsche Bank, for alleged ESG-related fraud, after its former head of sustainability claimed the firm overstated how much it used sustainable investing criteria to manage its assets. This investigation into DWS may signify the beginning of a larger SEC crackdown on potentially deceptive ESG promises.
In August 2021, InfluenceMap, a London-based nonprofit, announced the results of its analysis of ESG and climate-themed funds, reporting that 55 percent of funds marketed as “low carbon,” “fossil fuel free,” and “green energy” had grossly exaggerated their environmental claims, with more than 70 percent of ESG funds falling short of their goals as well.
In September 2021, SEC Chair Gary Gensler provided a little more insight into the Commission’s ESG requirements. He reiterated the increasing demand from investors to “understand the climate risks, workforces, and cybersecurity risks of the companies whose stock they own or might buy.” Gensler has tasked his staff with reviewing current practices and developing a proposal for climate risk disclosure requirements for the SEC’s consideration. Additionally, the SEC Chair mentioned that the Commission would be pursuing similar disclosure requirements when it comes to human capital and board diversity.
Although it has not yet adopted final ESG disclosure rules, the SEC proposed proxy voting rules that would require funds to clearly disclose their votes on shareholder and management proposals in relation to their ESG claims. The proposed plan would amend Form N-PX, which requires funds to publicly report their proxy voting records annually, to include many new categories established by the SEC that funds could then use to correspond and report their votes on ESG-related topics. The SEC is additionally proposing that institutional investment managers also be subject to section 13(f) reporting requirements on “how [they] voted proxies relating to shareholder advisory votes on executive compensation (or ‘say-on-pay’) matters.” In a September 29 Commission meeting to consider the proposal, Gensler said that the proposed say-on-pay requirements would allow investors to understand and analyze proxy voting information more easily. The proposed rules may have actually left many funds more dazed and confused about disclosure requirements, but this is only the beginning of the SEC’s ESG-related regulations.
On October 5, 2021, Gensler told Congress that the SEC is considering phasing in its anticipated climate requirements, which will require companies to report their greenhouse gas emissions and climate change risk management plans. Still to be determined is whether compliance would vary based on company size and the different types of climate-related disclosures that may be required.
The SEC is expected to propose its new rules soon, possibly requiring companies to publicly disclose climate risks in their annual 10-Ks or other filings. Additional quantitative reporting may be required of greenhouse gas emissions and any financial impacts of climate change, as well as qualitative disclosures on executive management of climate risks and how climate change factors into a company’s business strategy.
It remains to be seen when we can expect final SEC guidance on disclosure requirements, or how they will affect companies going forward. But one thing is certain: the SEC is closely watching ESG-labeled funds and investment products and will hold them accountable for any misrepresentation and deceptive ESG-related practices.