It was great to see the “State of Sustainability Reporting” discussed at the SEC Investor Advisory Committee meeting on July 14, 2016. You can view the discussion on the SEC’s archived webcast (click here for link). The sustainability reporting discussion starts around the 23-minute mark of the video.
This meeting is part of the SEC’s process to seek public comment on modernizing certain business and financial disclosure requirements in Regulation S-K. The SEC Concept Release document, Business and Financial Disclosure Required by Regulation S-K, was issued on April 13, 2016 (click here for link). The purpose of this release is to seek input to determine whether SEC business and financial disclosure requirements still provide important information for investors and how registrants can most effectively present this information.
This discussion is an important step as the SEC considers how sustainability information fits into its disclosure requirements. This meeting focused on information that investors receive and in particular sustainability reports or environmental, social, and governance (ESG) reports. In this video you will find a good overview of the history of SEC sustainability disclosures along with existing sustainability reporting frameworks. There are likely to be more discussions in the future. I highly recommend that you watch the video (click here for link). To give you a preview, I have summarized the discussion below.
Over the last several decades, many perspectives and practices on sustainability reporting have come about. Questions raised at the beginning of the discussion provided context for sustainability reporting and SEC disclosures. Some of the questions included:
- How do report issuers engage with investors?
- How are sustainability issues identified and reported?
- What do investors consider important to decision making?
- What methods are used by investors and report issuers to determine material issues?
- What do investors want?
- What should issuers provide?
- How much information should be reported and in what format?
- How much information should asset owners be demanding and using?
- How much should public companies be reporting?
Although these questions were not intended to be answered in this meeting, they do raise relevant concerns regarding what and how sustainability disclosures will be required.
Formal presentations were made by Daniel Goelzer, Senior Counsel and retired partner Baker & McKenzie, original member of PCAOB, Christianna Wood, Chairman of the GRI Board of Directors, Jean Rogers, CEO and Founder SASB, Lisa French, Chief Technical Officer IIRC and Christoph Pereira, Chief Corporate, Securities & Financial Counsel GE.
SEC’s Approach to Sustainability Reporting
Daniel Goelzer provided an excellent, concise overview of the SEC’s traditional approach to sustainability reporting. This approach, established in the 1970s, was in response to rulemaking petitions and litigation against the commission. The actions were sought to get the agency to adopt a comprehensive disclosure scheme for environmental and equal opportunity disclosures. After public proceedings to gather information, the SEC issued a release in 1975. Daniel Goelzer summarized the four conclusions from the release.
- Disclosure requirement must be necessary to protect investors or inform their investment decisions
- Disclosure requirement should have economic significance to investors
- A small fraction of investors in 1975 used or were motivated by corporate social responsibility so there was no basis to require public companies disclosure of corporate social practices
- Even without specific requirements ESG disclosures are sometimes necessary to make other disclosures materially complete or accurate
The National Environmental Protection Act (NEPA) had a major impact on what the SEC required in company disclosures; environmental protection became a consideration. The pertinent rules from the 1970s include:
- In a company’s business description, the company has to disclose the material effects that compliance with environmental protection laws may have on capital expenditures, earnings and competitive position and on estimated expenditures for environmental control facilities.
- The threshold for disclosing environmental litigation is less than for other types of cases.
Since 1975, the SEC has made required risk factor disclosures more tangible in a company’s Management’s Discussion & Analysis of Financial Condition and Results of Operations (MD&A). Sustainability trends and events have the potential to be material risk factors for a company’s business in terms of financial position (balance sheet) or results of operations (net income). For example, drought and water scarcity could be risk factors for a beverage company that depends on a dependable supply of clean water. After the 1970s, not much changed with regard to sustainability related disclosures for public companies until 2010. The SEC issued an interpretive release on disclosure requirements related to climate change issues. Companies must disclose the impacts of climate change on their business as a result of legislation and regulation, international agreements, and physical impacts. In addition, with the Dodd-Frank Act, Congress directed disclosures that involved conflict minerals, resource extraction payments, and CEO pay ratios.
Outside of the legal requirements, there has been a major increase in corporate voluntary reports that are not filed with the SEC. Stakeholders such as employees, consumers, NGOs and communities are often the intended report users. Across companies and industries, there is considerable variety in the information and formats used in these reports.
Mr. Goelzer had several recommendations for the SEC on how to proceed regarding ESG disclosure. The current focus on investment decision making of the reasonable investor should be maintained. Although the topics that are material to the reasonable investor have changed since 1975, the SEC should retain its definition of materiality (i.e., information significant to the reasonable investor). The SEC needs to take steps to adopt a disclosure framework that takes sustainability information into account. On that note, sustainability reporting should be principles based rather than prescriptive. To reduce its burden, rather than creating its own reporting framework, the SEC should look at existing frameworks available.
Christianna Wood made a compelling presentation for the use of the GRI standards in SEC disclosures. She presented the history of GRI along with its current standing in the world as the leading sustainability reporting framework. Almost 20 years ago, Ceres (a national coalition of investors, environmental organizations and other public interest groups) created the GRI as the world’s first global sustainability reporting framework. According to a KPMG 2015 study, GRI is used by 74% of the Fortune G250 and by 72% of companies reporting on sustainability issues worldwide that publish stand-alone sustainability reports. In addition, there are thousands of organizations spanning all sectors in over 90 countries using the GRI standards. In response to the Commission’s Concept Release on Business and Financial Disclosure Required by Regulation S-K, the GRI outlined three points that would be in its formal response.
- The responsibility to determine material sustainability issues lies with the registrant
- GRI supports disclosure of all material issues whether they relate to financial or non-financial information
- The use of GRI as an existing robust reporting standard increases the utility and comparability of information
The GRI recommends the GRI Standards be used if the SEC requires companies to file sustainability reports given that 74 percent of the largest global companies use the GRI framework. A potential approach is for companies already preparing comprehensive GRI based reports to include these as an Exhibit in their SEC filings.
Jean Rogers provided a thorough presentation on the SASB perspective on disclosing companies’ sustainability matters in SEC filings. SASB, which is an independent 501(c)3 non-profit, issues standards for disclosure of sustainability topics. The purpose of this disclosure is to help public corporations disclose material, decision-useful information to investors in their mandatory filings such as the Forms 10-K or 20-F. Jean Rodgers covered four topics.
- Rising investor demand for sustainability information
- The current inadequacies of sustainability disclosure
- The need for a market standard for the disclosure of material sustainability information 4) SASB’s qualifications to fill this need
Lisa French made an excellent presentation covering the IIRC perspective. The IIRC is a coalition of some 70 organizations around the world representing businesses, investors, policy-makers, the accounting profession and civil society. Its concern is that traditional financial reporting is not providing capital markets the full range of information that could materially affect a company’s value creation in the long run. The IIRC perspective is that the Integrated Reporting Framework is complementary to the existing sustainability and financial reporting frameworks. Rather than issuing standards for performance metrics and methodologies, the IIRC’s focus is on encouraging discussion and connection of a company’s business model, strategy, governance, performance and prospects. The IIRC sees strong alignment between Integrated Reporting and the concepts supporting Management Discussion and Analysis. Lisa French discussed how the three pillar of integrated reporting drive their work. These pillars are
- Strategic focus and future orientation,
- Simplicity, conciseness and the use of plain language
- Connectivity of information Corporate Reporting Experience.
The GE Story
Christoph Pereira presented the GE experience with its Integrated Summary Report and approach to disclosure. The summary report has the CEO letter, summary of 10k, summary of its proxy statement and summarized at information from its sustainability website. Based on feedback to GE, the level of interest in sustainability in the US is focused on the risk factors. GE’s general philosophy for determining whether to disclose something is their consideration of its impact on investors’ ability to underwrite the risks and opportunities of owning GE stock. By including sustainability pages in its Integrated Summary Report, the company sought to answer the following four questions:
- How does sustainability relate to its overall business strategy?
- What is their governance process for sustainability?
- What are sustainability priorities and the process used to pick them?
- What is their progress on the stated sustainability priorities?
Their approach on reporting focuses on the process in order to provide flexibility as sustainability reporting evolves over time.
The discussion following the presentations is great as well.