Analysis from Paul Hodgson: What do the SEC’s new disclosure rules mean for ESG?

Modernising the MD&A but without climate disclosures

The announcement by the SEC last week that it was publishing its rules for simplifying and modernising Regulation S-K Items 301, 302, and 303 and MD&A [management discussion and analysis] Metrics Guidance brought two comment letters from SEC commissioners that serve to reinforce the ‘alternative facts’ movement in Washington. 

Elephant in the room

From Allison Herren-Lee we have a diatribe about the elephant in the room: “Today’s proposal is most notable for what it does not do: make any attempt to address investors’ need for standardised disclosure on climate change risk.” She has other objections – the increase in the use of so-called “principles-based” disclosure rather than line-item disclosure, which she feels gives management too much leeway and leaves investors with disclosure that is not comparable, but her wrath is mostly directed at the complete omission of any rule making that would regulate and enforce climate risk disclosures.

“We purport to modernise,” she says, “without mentioning what may be the single most momentous risk to face markets since the financial crisis. Where we should be showing leadership, we are conspicuously silent.”

ESG metrics not material?

In contrast, Commissioner Hester Peirce fully supports the new rules. “Thanks in part to an elite crowd pledging loudly to spend virtuously other people’s money, the concept of materiality is at risk of degradation,” she says. “We face repeated calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality. Since we do not, allegedly, know which ESG metrics are material we should let companies decide which are material for them and disclose them.”

"Where we should be showing leadership, we are conspicuously silent" – Allison Herren-Lee, SEC Commissioner

Peirce has a long history of inveighing against sustainability disclosures. Last March, at the CII conference, she said that pension funds’ focus on ESG issues is “enabling minority views to dominate the corporate agenda” which is forcing the agency to “shift our focus away from what our mission is” – specifically material investor protection issues and efforts to help more companies go public. She also suggested that asking the SEC to mandate material ESG disclosures was a waste of its time and, in her comments on the new rulemaking, warns: “We ought not step outside our lane and take on the role of environmental regulator or social engineer.”

What does the rule change do

So much for what the rulemaking does not do. What it does do is eliminate some duplicative disclosures such as Item 301 (selected financial data) and Item 302 (supplementary financial data), Paul Hodgsonand amend Item 303 (management's discussion and analysis). The amendments to Item 303 include: a new statement of the ‘objective’ of the management discussion & analysis (MD&A); replace disclosure of off-balance sheet arrangements with a “principles-based instruction to prompt registrants to discuss off-balance sheet arrangements in the broader context of MD&A”; add a new disclosure requirement ‘critical accounting estimates’, “to clarify and codify existing Commission guidance in this area”. It also allows companies, in their interim MD&As, to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.

In what might be a nod to ESG disclosures – though the guidance does not actually mention them – companies that disclose special metrics (the example given is same-store sales) have new requirements attached to such disclosures. The regulations will now require: “a clear definition of the metric and how it is calculated; a statement indicating the reasons why the metric provides useful information to investors; and a statement indicating how management uses the metric in managing or monitoring the performance of the business.”

The proposal has a 60-day public comment period.