Over the past few years, there has been an increasing focus on the reporting of company performance. Reporting now extends to environmental, social, and corporate governance (ESG) issues. Investors and policymakers alike have been demanding more detailed disclosures of corporate social responsibility information in addition to financial statements.
Currently, there are already certain ESG factors that public companies must include as material information in their mandatory filings with the Securities and Exchange Commission (SEC). However, many companies have been publishing ESG reports on their websites and incorporating voluntary ESG metrics in their SEC filings.
Although there has been a lot of hype surrounding ESG reporting, the numerous competing standards have led to a lack of clarity about how to disclose ESG information. In some cases, this has resulted in shareholder litigation over voluntary ESG-related disclosures that purportedly provide materially misleading information.What Counts as ESG Factors?
ESG does not just encompass more highly-discussed factors like climate change. It also encompasses a host of other factors such as workforce diversity, data privacy, supply chain sustainability, audit committee structure, and other corporate governance best practices.
A company’s ESG report should be tailored to the specifics of their company and their industry. Although numerous issues can qualify as ESG matters, only a handful are actually relevant to key company stakeholders. Knowing the ESG issues that will be relevant to key stakeholders such as major shareholders, customers, and employees is essential in crafting a satisfactory ESG report. For example, an Internet technology company should cover how it protects data privacy, an oil company should focus on environmental sustainability, and a family-owned business should make sure there is adequate diversity in board representation.Pressure from Large Investment Management Firms
Investment firms that manage trillions of dollars have become increasingly vocal and are actively implementing measures to nudge companies into reporting sustainability-related factors.
State Street, a large investment firm similar in scale to Blackrock and Vanguard, has been ramping up pressure on companies that have been failing to report material ESG issues to shareholders. Cyrus Taraporevala, President and CEO of State Street Global Advisors, commented: “We believe that addressing material ESG issues is good business practice and essential to a company’s long-term financial performance—a matter of value, not values.”
Blackrock has taken an even firmer stance, with CEO Larry Fink stating: “We will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.”Pressure from Policymakers
External pressure to ramp up ESG disclosure has also stemmed from policymakers. In January 2020, the World Economic Forum collaborated with the Big Four accounting firms to draft a report called “Towards Common Metrics and Consistent Reporting of Sustainable Value Creation” that sets forth broad goals. The report builds upon metrics from existing frameworks and lays out its mission to reduce the amount of fragmentation in ESG reporting.ESG Reporting Frameworks
The most prominent voluntary regimes used by companies are the UN’s Sustainable Development Goals (SDGs), the Task-Force on Climate-Related Financial Disclosures (TCFD), the Global Reporting Initiative (GRI), and the Sustainability Accounting Standards Board (SASB).
Adopted in 2015, the United Nation’s Sustainable Development Goals identifies 17 universal goals embraced by UN member states. They include poverty elimination, climate action, and reducing gender inequality. Many companies will cite the SDGs in reporting their sustainability priorities in order to demonstrate their commitment to global goals.
The Financial Stability Board established the TCFD in 2015 with the aim of improving voluntary climate change disclosures. The framework was extended in 2017 to guide companies in evaluating and disclosing business financial risks resulting from climate change.
The Global Reporting Initiative is an international nonprofit. It came into existence in 1997. Responsible for creating the first international ESG standards, the GRI currently has the highest market penetration with companies. These standards are organized into modules and then companies can select the relevant topics to cover in their ESG report.
A U.S. nonprofit organization founded in 2011, the Sustainability Accounting Standards Board developed a voluntary ESG framework that offers the choice of 77 industry-specific sustainability accounting standards. On the SASB’s website, companies can select their sector and industry to a list of disclosure topics and accounting metrics tailored to them.
Investors and policymakers have endorsed the usage of standardized frameworks. The SASB acknowledged in its 2018 annual report that the SASB metrics has been embraced by over 1,000 investment managers with a combined total of approximately $30 trillion of assets under management.Shareholder Litigation on ESG issues
Federal claims regarding material misstatements or omissions in ESG disclosures are usually brought under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. Although numerous lawsuits have been brought, few have been successfully litigated. At the state level claims are usually brought under state consumer protection laws, although these lawsuits have likewise had limited success. Nonetheless, these cases often bring negative publicly to the company being sued and result in reputational damage. Therefore, it is important for companies to spend time considering the appropriate reporting metrics and frameworks for their ESG disclosures.