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ESG: Environmental

EXECUTIVE PERSPECTIVE: The Evolution of SEC Regulation for Sustainability Disclosure

Shari H. Littan

10 May 2016

Sustainability is sometimes referred to by the acronym “ESG,” which stands for environmental, social, and governance. Others use the phrase “non-financial” to distinguish these categories of data from the financial statements prepared under US GAAP or IFRS. Many proponents view the term “non-financial” as missing the mark, however, because they view a direct relationship between sustainability activities and financial results, particularly in the long-term.

In early April, the Sustainability Accounting Standards Board (SASB) completed the initial phase of its ESG standard-setting process for the global economy by issuing provisional standards for the last of 10 economic sectors that represent 79 individual industries. The SASB approach, generally, is based on identifying the most material sustainability matters for an organization based on its sector and industry. For example, information about water use would likely be material for a beverage company but not for a telecommunications company.

Under the SASB framework, material information regarding sustainability belongs within the financial reports issued under the SEC regulatory scheme.  The SASB’s framework calls for the reporting of certain sustainability metrics and qualitative information directly in the Forms 10-K that public companies in the US issue publicly and file with the SEC.

Having completed this initial phase, the SASB will seek to finalize its provisional standards and enhance coordination with regulators, corporate issuers, investors, and other stakeholders toward implementation.

Given this milestone, Shari Littan of Thomson Reuters’ Tax & Accounting editorial team put questions to Dr. Jean Rogers, SASB’s Founder and CEO:

SASB’s completion of all 79 industries in 2 – 3 years is quite an accomplishment. How does SASB have the institutional stamina to get this accomplished?

Our timeline was ambitious, but we felt it was important to get a set of provisional standards to the markets quickly. We did it by maintaining a laser focus on a rigorous timeline of issuing one sector per quarter.

There’s been recent correspondence by members of Congress, urging the SEC to increase its oversight of climate change disclosures. Do you know what prompted members to move?

The members of Congress who signed that letter see a gap between what investors are entitled to (decision-useful information on material climate risk) and what investors are receiving (boilerplate disclosure that doesn’t evaluate performance). This is not an issue of the regulation not existing, it’s an issue of the regulation not being enforced.

Where is the SEC? Do you expect any movement toward greater adoption of ESG or sustainability information, per the SASB’s framework?

The SEC is evaluating sustainability disclosure as part of its disclosure effectiveness initiative. In a recent Concept Release, the SEC states “we are interested in receiving feedback on the importance of sustainability and public policy matters to informed investment and voting decisions.” This is an opportunity for investors to tell the SEC what they need: standardized, comparable disclosure on material sustainability factors, which differ at the industry level.

Will it take a regulatory mandate to get companies to adopt reporting (in general) in the US? To adopt SASB specifically? Is a voluntary system enough?

The disclosure of material sustainability information is already required under Regulation S-K. Our research shows that information regarding 74 percent of SASB disclosure topics is already being disclosed in the Form 10-K, but 40 percent is boilerplate. Regulators and investors are calling for better-quality disclosure. For example, in November 2015 New York Attorney General Eric Schneiderman found that Peabody Energy made misleading statements and omitted material facts when disclosing climate risk to investors, and negotiated an agreement for Peabody to file revised disclosures.

EU Member States are moving toward transposing the 2014 non-financial reporting directive (2014/95/EU). Although SASB’s standards specifically apply to US reporting, to what extent do you expect the SASB’s work to serve as a model?

While SASB standards are grounded in US securities law and are appropriate for disclosure in SEC filings like the Form 10-K and 20-F, the topics that SASB sets standards for are industry-specific, not region-specific, and therefore apply to most companies and investors in global markets. SASB standards offer a single solution for companies that must comply with both the Directive and SEC requirements.

If the disclosures required by the SASB Standards are material, are issuers already out of compliance with SEC reporting requirements? If that’s true, is it really voluntary?

Sustainability disclosures are an evolving area. As the SEC stated in its Climate Change guidance, “Improvements in technology and communications in the last two decades have significantly increased the amount of financial and non-financial information that management has and should evaluate, as well as the speed with which management receives and is able to use information.” In other words, MD&A and related disclosures tend to change and evolve over time, based on investor interest, availability and usefulness of information, as well as access to relevant and meaningful disclosure or accounting standards, such as those developed by SASB. SASB standards are designed to help companies meet the changing information needs of today’s reasonable investor.

Can you explain how the SASB framework is an integrated approach?

SASB standards are designed to provide an integrated look at financial and sustainability performance within the regulatory filings. By comparing financial fundamentals and sustainability fundamentals side by side, investors can get a complete view of performance.

There’s also the International Integrated Reporting Council’s IR framework? Can you compare their framework to SASB?

The IIRC framework guides companies in the development of integrated reports, which explain to providers of financial capital how an organization creates value over time. SASB standards guides companies in the disclosure of material sustainability information in SEC filings.

SASB’s work of promoting disclosure of material sustainability information in mandatory SEC filings is a practical implementation of IR in the context of U.S. capital markets. SASB standards provide specific disclosure and accounting metrics to put IR into practice.

What challenges are you hearing from reporting companies about implementing SASB standards?

            Data/information processes?

            Legal department buy-in?

            Coordination with traditional financial accounting teams?

We’re hearing the real challenge is more about high-level leadership than it is about tactics. We see data/information processes and legal alignment are most common in companies that are more broadly regulated, while the financial accounting teams are most coordinated within companies that have recently gone public. The challenge then, for SASB, is to elevate the conversation on sustainability accounting implementation to the same level that a regulation or an IPO would garner.

Is adoption easier in some industries than others? Are some more proactive than others?

Some industries have been doing sustainability reporting for decades, and are more advanced in developing industry-specific sustainability metrics. When developing our SASB standards, SASB seeks to incorporate metrics that are already in use by industry.

What is the latest on investor demand for ESG/sustainability information?

In June, CalPERS will start a one year ESG integration pilot project in which they require all managers to identify and articulate ESG in their investment processes. They’re also considering SASB standards as they update their investment principles this summer. In the words of CA State Controller Betty Yee: “Controller Yee is also hopeful that CalPERS will work with other investors to push for widespread use of the Sustainability Accounting Standards Board‘s evolving decision making metrics that will enable investors to track, compare, and measure the long-term material risks of climate change.”

Shari Helaine Littan is an Editor/writer for Thomson Reuters Tax & Accounting’s GAAP Reporter, available on Checkpoint.

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