Janine Guillot: ESG and Long-term Value: SEC’s concept release on Regulation S-K

Sustainability disclosure is like the “free-style” financial reporting before accounting standards were established

For decades, detractors said focusing on ESG issues went hand-in-hand with lower investment returns. They also maintained that US investors were prohibited from looking at ESG issues because doing so would breach fiduciary duty.

Mounting evidence shows the opposite is true; ESG factors can influence the long-term risk and return of investment portfolios.1 Recognizing the potential impact ESG factors can have on a portfolio, the U.S. Department of Labor (DOL) amended the Employment Retirement Income Security Act (ERISA), the federal law that establishes minimum standards for pension plans in private industry, specifying that ERISA does not prohibit pension fund managers from considering ESG factors in making investment decisions. In fact, “(f)iduciaries should appropriately consider factors that potentially influence risk and return. Environmental, social, and governance issues may have a direct relationship to the economic value of the plan’s investment.”2

While analysts and investors have tried to better assess the impact of ESG factors on portfolios for decades, they’ve faced significant challenges—namely, the absence of good data. Without a market standard, ESG data has lacked quality and comparability.

Securities analysts use comparable financial statements prepared using generally accepted accounting standards to evaluate companies. This is easy to take for granted. But, prior to the creation of the Financial Accounting Standards Board (FASB) in 1973, there were no Generally Accepted Accounting Principles (GAAP). In 1971, the SEC established a special committee headed by corporate securities lawyer Francis Wheat, to study how to improve consistency and comparability of financial disclosure. The Financial Accounting Standards Board (FASB) was created in response to the Wheat Committee’s recommendations, followed by the establishment of GAAP upon which investors and companies have relied for comparable financials since the 70s.

The state of sustainability disclosure today is similar to the condition of “free-style” financial reporting before accounting standards were established. In fact, people even disagree on what to call it, e.g., sustainability-related information, ESG factors, “non-financial” information.. SASB research shows sustainability-related information to be “pre-financial statement information” i.e., information that is likely to affect financial performance of companies in due course. Sustainability or ESG factors can and do impact the ability of companies to create value over time. However, today they are not captured in financial statements nor are they articulated meaningfully in the SEC filings of publicly-traded companies.Sustainability-related risks cut across investment portfolios, but do so in an industry-specific manner. Companies, though required by existing SEC regulation to disclose material information to investors, disclose material sustainability-related information using generic language that is not decision-useful, if at all. SASB research shows that more than 40 percent of disclosure on sustainability topics in SEC filings consists of boilerplate language. (See Figure A.)3 And, while 81 percent of S&P 500 companies now produce sustainability reports that serve a variety of stakeholders, these reports aren’t designed to serve investors. Investors need and deserve comparable, decision-useful, data on material environmental, social and governance factors in SEC filings.

Recognizing the shortfall of sustainability-related disclosures, the SEC issued a concept release on Regulation S-K in April that, among other things, explores what the SEC could do differently to elicit more meaningful disclosure on sustainability-related issues in corporate SEC filings.4 This is a potentially game-changing opportunity to call for the establishment of a market standard for the disclosure of sustainability-related information in Commission filings. Establishing such a standard can help investors incorporate sustainability-related risk in their analysis of securities more effectively, with rigor and at scale. Whether investors are mission-driven or mainstream, seeking to manage risk or generate outperformance, all can benefit from the establishment of a market standard such as SASB’s for the disclosure of sustainability information in SEC filings. The resultant comparable, decision-useful data on these issues would benefit us all, whether viewed from the perspective of corporation, society, mainstream or mission-driven investor. Companies that perform better on these metrics, where they are material to their business, outperform their peers. [5]

The SEC’s concept release on Regulation S-K presents an historic opportunity to call on the Commission to establish a market standard for the disclosure of sustainability-related information. The SEC is accepting comments on this concept release until July 21st. SASB believes it would be appropriate for the SEC to acknowledge the SASB standards as a credible means by which companies can fulfill their regulatory reporting requirements under Regulation S-K. SASB’s comment letter on this can be found here.

We urge you to add your voice to the mix, which you can do so here. It’s time to call for a market standard for the disclosure of sustainability-related information in SEC filings.

Janine Guillot is Director of Capital Markets Policy and Outreach at the Sustainability Accounting Standards Board (SASB). She is a former Chief Operating Investment Officer at CalPERS. References overleaf.

[1] George Serafeim, Jade Huang, Joshua Linder, Patrick Faul, John Streur, The Financial and Societal Benefits of ESG Integration: Focus on Materiality, The Calvert – Serafeim Series, p. 3 (June, 2016) Link
[2] U.S. Department of Labor, IB 2105-1, p. 5 Link.
[3] Detailed analyses of the current state of disclosure is available in the form of SASB industry research briefs Link. SASB is developing a Disclosure Navigator tool for public use that will be available later this year.
[4] Business and Financial Disclosure Required by Regulation S-K; Concept Release (“Concept Release”), 81 Fed. Reg. 23916 (April 22, 2016)
[5] Mozaffar Khan, George Serafeim and Aaron Yoon, Corporate Sustainability: First Evidence on Materiality, The Accounting Review, p. 22-23 (Harvard Business School, March 9, 2015),