Building a sustainable and competitive economy: an examination of proposals to improve ESG disclosures.

By James R. Barrett, Paul A. Davies and Kristina S. Wyatt

The US House Committee on Financial Services, Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets has held the first ever US Congressional hearing on environmental, social and governance (ESG) issues. The hearing focused on reporting requirements for US public companies in response to increasing interest in the investor community for enhanced ESG disclosures and uniform reporting standards.

The hearing follows on the heels of the UK’s announcement that all listed companies and large asset owners will be required to report on climate-related information in line with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD). The hearing also follows the EU’s adoption of requirements that financial professionals provide information on the incorporation of ESG criteria into their financial management processes.

Why the Congressional Focus on ESG Reporting?

The House Financial Services Committee Majority Staff published a memorandum outlining five ESG disclosure bills that were introduced in this session of Congress and the broader landscape framing the hearing. The memorandum explains the impetus for the hearing, including the following key points:

Addressing investor demand for ESG information. The memorandum emphasizes that the hearing is indicative of the growing investor demand for ESG information from public companies and the “growing evidence that ESG disclosures are material to investors.” The memorandum notes that more than 2,300 investment professionals representing more than US$80 trillion in assets under management (AUM) have signed up to the UN Principles for Responsible Investment. These signatories commit to incorporate ESG factors into their investment processes. 458 of these signatories are US organizations, representing more than US$40 trillion in AUM. Further, the memorandum points to the October 2018 rulemaking petition submitted to the Securities and Exchange Commission (SEC) by a coalition of pension funds, asset managers, and other interested parties asking the SEC to develop a comprehensive ESG disclosure framework.

Bringing the US regulatory regime in line with its counterparts around the world. The memorandum stresses the growing importance of ESG in the larger investment and regulatory landscape. It highlights the International Organization of Securities Commissions’ (IOSCO’s) statement in January of this year, which urged companies to report on material ESG issues in their disclosures to investors.

Recognizing the correlation between strong ESG performance and strong company performance. The memorandum notes that the major credit rating agencies now include ESG factors in their rating methodologies. The S&P, for example, reportedly changed its rating on more than 100 companies based on environmental and climate issues between 2015 and 2017.

The Five ESG Disclosure Bills

ESG Disclosure Simplification Act of 2019[1]

This bill would require the disclosure of ESG information and the establishment of a Sustainable Finance Advisory Committee.

  • ESG disclosure requirements. The bill would require annual proxy statement disclosure of the link between ESG metrics and the issuer’s long-term business strategy, as well as the processes the issuer uses to determine the impact of ESG metrics on its business strategy. Further, the bill would require the SEC to mandate disclosure of ESG factors in any filing that requires audited financial statements. The bill provides that ESG metrics are by definition material.
  • Sustainable Finance Advisory Committee. The bill would establish a Sustainable Finance Advisory Committee to advise the SEC on sustainable finance and to report on challenges and opportunities for investors associated with sustainable finance. The Advisory Committee would also provide the SEC with policy recommendations to facilitate capital flows toward ESG investments.

Shareholder Protection Act of 2019[2]

This bill would require reporting of expenditures for political activities including the date, amount, description, and identity of candidates or trade associations that are recipients of contributions by a company.

Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019[3]

This bill would amend the Exchange Act to require issuers to disclose information about their human rights practices. Specifically, issuers would be required to conduct an annual analysis that identifies and ranks by severity any human rights risks in their operations and supply chains. Issuers would be required to include in their annual reports disclosures related to their human rights risks and impacts, including any mitigation efforts undertaken to reduce such risks and impacts.

Bill to require issuers required to file an annual or quarterly report under the Securities Exchange Act of 1934 to disclose the amount of corporate tax such issuer paid in the period covered by the report[4]

This bill would require issuers to disclose the total pre-tax profits and total amounts paid in federal, state, and foreign tax during the reporting period on a country by country basis.

Climate Risk Disclosure Act of 2019[5]

This bill would require issuers to disclose in their annual reports information concerning physical and transition risks posed by climate change, as well as mitigation efforts undertaken to reduce the impact of such risks. Issuers also would be required to discuss the corporate governance processes in place to assess and manage their climate-related risks. The SEC would be directed to enact rules in specified industries that, among other things, articulate reporting standards for estimating and disclosing direct and indirect greenhouse gas emissions and assign a social cost of carbon to such issuer’s activities.

ESG is on the Agenda

Some participants in the hearing strongly favored the proposals while others expressed significant concerns about the costs to companies of providing additional disclosures. The matters discussed include many of the issues that have been the subject of debate since the SEC issued its Concept Release on Business and Financial Disclosures Required by Regulation S-K in April 2016. The following  issues were highlighted in the comments accompanying the concept release, and were raised in the hearing as important considerations in this continuing dialogue:

  • Who the “reasonable investor” is for purposes of assessing what information is material in light of investors’ manifest concern over ESG issues
  • How best to provide investors with relevant, material, decision-useful, and comparable information related to ESG factors
  • How to ameliorate companies’ reporting fatigue and the expense incurred in responding to myriad questionnaires and reporting standards, that in many cases are not targeted to their industries or businesses
  • How to reconcile the many different reporting standards that exist across the globe, creating confusion and placing undue burdens on the investor and issuer communities alike

While the hearing did not seek to resolve these issues, it does highlight increasing interest at the Congressional level in the United States regarding ESG reporting.  This issue is clearly on the US and global agenda, and stakeholders should stay tuned for more developments.

[1] ESG Disclosure Simplification Act of 2019 [DRAFT], H.R. __, 116th Congress (2018-2019), available at https://financialservices.house.gov/uploadedfiles/bills-116pih-simpesg.pdf.
[2] Shareholder Protection Act of 2019 [DRAFT], H.R. __, 116th Congress (2018-2019), available at https://financialservices.house.gov/uploadedfiles/bills-116pih-shareprot.pdf.
[3] Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019 [DRAFT], H.R.__, 116th Congress (2018-2019), available at https://financialservices.house.gov/uploadedfiles/bills-116pih-corphuman.pdf.
[4] To require issuers required to file an annual or quarterly report under the Securities Exchange Act of 1934 to disclose the total amount of corporate tax such issuer paid in the period covered by the report, and for other purpose [DRAFT], H.R. __, 116th Congress (2018-2019), available at https://financialservices.house.gov/uploadedfiles/bills-116pih-annual.pdf.
[5] Climate Risk Disclosure Act of 2019 [DRAFT], H. R. 3623, 116th Congress (2018-2019), available at  https://financialservices.house.gov/uploadedfiles/bills-116pih-climate.pdf.