2020 was a transformative year in recent history, and it also marked a pivotal year for ESG. Between the COVID-19 pandemic that upended the world, the swell of activism over social injustice, rising populism and political polarization, and the increasing occurrence of natural disasters linked to climate change, the events of 2020 warranted a major reckoning for “business as usual” in just about every sense of the phrase. Emphasis on ESG has been steadily growing over the past several years, and with all that occurred last year, the stage has been set for ESG to enter a new era characterized by heightened scrutiny and expectations surrounding corporate behavior and transparency.
The ESG landscape is evolving rapidly, and a reactive approach to ESG—which may have worked in prior decades—no longer appears viable for investors or corporations. Succeeding in this new era of ESG requires getting ahead of potential legislation and rulemaking. This involves closely examining the linkages between ESG issues and corporate strategy and risk, and taking steps to help preserve and create long-term value for all stakeholders. A number of ESG concepts are currently being examined in depth by regulators in the U.S. and abroad, and we want to shed some light on a few recent developments with potential lasting implications for public companies.
Securities and Exchange Commission (“SEC”) Task Force on Climate and ESG
On March 4, 2021, the SEC announced the creation of a task force focused on climate and ESG issues. The 22-member task force within the enforcement division will “develop initiatives to proactively identify ESG-related misconduct” in partnership with other SEC divisions. A probable outcome of this new task force’s work is a set of proposed rules on mandatory public company disclosure of information related to climate change and other ESG topics. On March 15, 2021, Commissioner Allison Herren Lee, who was then Acting Chair of the SEC, solicited public input on climate-related disclosure as well as ESG disclosure more broadly. Submitted comments can be viewed on the SEC’s website. Many of the comments encourage the SEC to incorporate existing disclosure standards from organizations such as the Task Force on Climate-Related Financial Disclosures (TCFD) or the Sustainability Accounting Standards Board (SASB; now known as the Value Reporting Foundation). With SEC action seeming imminent, we advise companies to examine these frameworks and identify potential intersections with their current or future ESG disclosure strategies.
House Bill H.R. 1187, the “Corporate Governance Improvement and Investor Protection Act”
Building on the SEC’s efforts, on June 16, 2021, the House of Representatives narrowly passed H.R. 1187, the “Corporate Governance Improvement and Investor Protection Act.” Two of the bill’s main titles focus on ESG disclosure requirements, and the bill would give the SEC enforcement and rulemaking authority over such disclosures. While the bill will be challenged to move through the Senate and signed into law, it nevertheless helps reinforce elevated expectations for corporate transparency and ESG reporting. Regardless of the ultimate outcome of H.R. 1187, we view this bill as another signpost that the ESG landscape is accelerating towards a state where public companies implement more comprehensive disclosure.
International Organization of Securities Commissions (“IOSCO”) Examination of ESG Ratings Firms
We at Gilmartin Group have written about ESG ratings before, and we continue to believe it is important for companies to take ownership over their ESG narratives, understand the third-party data and ratings that influence investor decision making, and take steps to triangulate ESG improvement opportunities with the highest potential to strengthen stakeholder perception, company reputation, and long-term performance. A July 2021 consultation report from the International Organization of Securities Commissions (IOSCO) examines ESG ratings firms and recommends that regulators focus greater attention on the influence these firms have on sustainable investing.
Some key themes that emerge from the report include:
- The lack of clarity, alignment, and transparency around the methodologies and evaluation criteria utilized by ESG ratings firms
- The wide divergence among conclusions reached by different ratings firms and uneven coverage across industries, with certain industries or geographical areas benefiting from more coverage than others
- The potential for conflicts of interest to arise when certain ESG ratings firms attempt to objectively evaluate a company’s ESG performance while simultaneously offering rating improvement consulting services to the subject company
- The need to further evaluate communication mechanisms between ESG ratings firms and companies being evaluated
While we continue to monitor the ongoing work of IOSCO and others in examining the above, we recognize that ESG ratings firms can have significant influence over the perception of a company’s ESG performance. That influence should not be ignored; however, we consistently advise our clients not to be overly concerned by the specific ratings and to instead focus efforts on being the source of truth for ESG data they believe to be relevant to their business. Through thoughtful and accurate ESG disclosure, we believe ratings improvements will be a natural outcome over time.
Now is the time for companies to be more proactive in understanding and addressing ESG expectations for their business. While it may still be possible to “fly under the radar” of ESG scrutiny in the short term, multiple signals indicate that window is coming to a close. If you want to learn more about ESG, contact the Gilmartin team today.
“Boards that proactively seek to integrate climate and ESG into their decision-making not only mitigate risks, but better position their companies and business models to compete for capital based on good ESG governance.” – SEC Commissioner Allison Herren Lee; Keynote Address at the 2021 Society for Corporate Governance National Conference, June 28, 2021
Matt Berner, Managing Director, Head of ESG