Blueprint for SEC Climate Risk and ESG Disclosure Regulation Emerges

As the popularity of environmental, social, and governance (ESG) investing booms, the SEC continues to make its support clear. In fact, this past Wednesday, July 28^th, SEC Chair Gary Gensler spoke at length on the regulator’s ESG and climate risk disclosure plans as part of a Principles for Responsible Investment (PRI) event.

The PRI is an independent network of investors who promote responsible and sustainable investing by incorporating ESG factors and considerations into their investment decisions. Although the PRI is not a part of the UN itself, the UN supports and partners with the group. In 2006, when the PRI was formed, it managed about $7 Trillion in assets, and in 2020, it managed over $100 Trillion. [1]

So why should you as an investor care about ESG investing? ESG factors and criteria empower investors to make “socially responsible” and sustainable investment decisions by providing important insight into a company’s operations, standard practices, and culture through the lens of Environmental, Social, and Governance considerations.

For example, a company might disclose Environmental factors such as their carbon emissions or water usage, aimed at conserving our natural world. Social factors place an emphasis on how a company treats both its employees and the public and include employee diversity statistics or human rights considerations. Finally, Governance factors focus on the way in which the company is led and include information like executive pay scales as well as political leanings. [2]

When an investor is equipped with meaningful – and truthful – ESG information, they can be confident in their monetary support of a company. As a result, ESG investing continues to be top of mind for investors and regulators in the United States. However, investor interest is not the only factor influencing ESG popularity. Sound ESG investing also yields relatively high returns when compared to conventional funds while providing relatively lower risk, according to a study by Morgan Stanley in 2019. [2]

While many companies voluntarily disclose ESG data, there is currently a gap in investor knowledge, as many ESG disclosures are not yet compulsory. One particular area in which this is true is with regard to climate change disclosures – which the SEC published guidance on in 2010 but have not been adjusted since then.

At Wednesday’s PRI event, Commissioner Gensler focused in on the value and importance of climate change disclosures and provided a glimpse into the future of SEC regulation of the topic. In particular, Gensler emphasized that these disclosures must be “decision useful,” meaning that they include sufficient factual information to allow proper decision-making to take place.

Gensler also highlighted the intense interest modern investors have in the climate risks associated with stocks they purchase, likening the investor push for climate risk disclosure today to the push for disclosure of basic financial information decades ago. In response to this investor interest, Gensler announced that he has tasked his staff with developing a proposal for mandatory climate risk disclosures for review by the end of 2021. [3]

The transition from the SEC’s current climate risk guidance to mandatory SEC climate risk disclosures is monumental, and it will allow investors to compare “apples to apples” when analyzing climate risk data between companies.

Furthermore, Commissioner Gensler spoke about the possibility of requiring disclosure of carbon emissions data not only for the company itself, but for each member of the company’s value chain. Granular data like this will provide investors with a truly actionable and “decision useful” basis for making investment decisions by providing not just a piece of the puzzle, but instead the full picture of a company’s true impact on the environment.

As we enter the back half of 2021, investors should be on the lookout for additional remarks by Commissioner Gensler relating to climate risks and ESG disclosures. While we have only a blueprint now, support and demonstrated investor interest in ESG factors will encourage the SEC to continue its pursuit of meaningful regulation to benefit investors like you.

Sources:

[1] https://www.unpri.org/pri/about-the-pri

[2] https://www.nerdwallet.com/article/investing/esg-investing

[3] https://www.sec.gov/news/speech/gensler-pri-2021-07-28