SASB Provides Decision-Useful ESG Disclosure Framework
In part 2 of our series on SASB we review the background on the growth of ESG disclosure, reveal the continued dissatisfaction by investors with the lack of decision-useful disclosures and provide guidance on where to turn to enhance disclosure.
You will also find access to: surveys on ESG-related information in SEC disclosures, survey of institutional investors on satisfaction levels with ESG disclosures; CDP, CDSB, GRI, IIRC and SASB joint vision for a comprehensive reporting system, the TCFD Implementation Guide, CDSB’s Good Practice Handbook on guiding principles and SASB industry-specific reporting requirements
- ESG reporting grew significantly in 2020. SASB alone saw a 324% jump in companies reporting under its standards. Similarly, all companies participating in a recent White & Case survey increased ESG disclosures in at least one category within their proxy statements, while 42% disclosed more in at least one category in their 2020 Form 10-K.
- Despite the increase in ESG disclosure, investor satisfaction has declined: while demand for decision-useful information continued to increase exponentially in 2020; supply of quality-data widened only modestly. Generally, investors are seeking more quantitative information, particularly metrics that can be used for comparison purposes.
- Human Capital Management (HCM) was the category that saw the greatest increase in ESG reporting, spurred by changes in SEC Regulation S-K.
- Legislative action, rulemaking and interpretation, as well as changes in exchange listing standards, are increasingly influencing ESG reporting globally- more than organizations strengthening reporting standards for voluntary disclosure.
- Investors believe disclosures outside regulatory filings can be effective if (1) they reliably aid communicating a company-specific investment story, (2) the area of ESG performance is measurable, and (3) the information is easily accessible.
ESG reporting saw significant growth in 2020
Backed by investors managing over $58 trillion, the adoption of SASB Standards accelerated in 2020. The number of companies using these Standards for sustainability reporting increased 324% in just one year.41% of the 497 companies that report under SASB rules are based outside the U.S., a clear indication of their global appeal.
Increased supply of financially material sustainability information has largely been driven by investor demand, as ESG funds continue attracting record inflows. According to Morningstar, U.S. ESG funds saw $21.4B of net inflows in 2019; over four times higher than any previous year of inflows. But in the first three quarters of 2020 alone, that record was shattered, as inflows to these funds hit $30.7B.
Figure 1 – Companies reporting under SASB Standards
2020 data through November
Increased ESG disclosure via proxy statements and 10-K
While the volume of ESG disclosure has been growing, the mostly voluntary nature of it makes comparability a challenge for investors and analysts. Thus, we focused on information filed with the SEC in proxy statements and via Form 10-Ks.
The referenced White & Case survey looked at ESG-related disclosures in proxy statements and 10-Ks in 2019 and 2020 by the Top 50 U.S. companies. The firm found that each company it surveyed had increased its ESG disclosures in at least one category within proxy statements filed between 2019 and 2020. Twenty-one companies, or 42% of those surveyed, also increased disclosures in at least one category in their Form 10-Ks.
Figure 2 – ESG categories with the largest increase in disclosure *
Source: White and Case
*number of filings in which the disclosure in the relevant category increased
HCM in focus: Seventy percent of the filings showed an increase in HCM disclosure versus 2019, with 82% discussing employee diversity. While Covid-19 and the Black Lives Matter movement were drivers of the latter change, the SEC’s amendment to Regulation S-K requiring expanded, in-depth evaluation of HCM as a source of sustainable value was also a significant influence.
More Metrics Added: More companies have added quantitative information related to environmental issues and HCM specifically, but nearly every category saw some increase in quantitative disclosures since 2019. InspIR believes the potential decision-usefulness of environmental disclosure most likely improved, as 84% of the filings included quantitative metrics compared to 64% in 2019.
Two other disclosure developments in the White & Case survey are worth keeping a close eye on:
- 38% of the companies tied executive compensation to ESG metrics/goals in some way, with several noting specific environmental goals or workforce diversity metrics. We believe this trend should be closely monitored by public companies.
- 42% increased disclosure related to ESG issues in shareholder engagements in proxy statements
Although ESG disclosure is increasing, investors demand more of it that is decision-useful
Given the increase in overall disclosures in the interim, it’s understandable that one could mistakenly believe that investor satisfaction has also been rising. But, in fact, the opposite is happening: demand for decision-useful ESG information is rising exponentially and supply is increasing only modestly.
Figure 3 – ESG reporting in 10-Ks for FY 2016
In 2016, SASB research of ESG reporting in SEC filings showed that as many as 80% of companies already disclosed information related to at least one sustainability topic relevant to their industry. But half of those disclosures were boilerplate, lacking any company-specific context- and only 18% contained related metrics.
Recently, E&Y’s Climate Change and Sustainability Services (CCaSS) survey of 298 institutional investors showed that 34% were dissatisfied with environmental risk disclosures in 2019, up from 20% in 2018. The percentage of respondents who said that companies do not adequately disclose the social and governance risks that could affect their business models increased to 41% in 2019 (from 21% in 2018) and 42% (from 16%), respectively.
Separately, a U.S. Government Accountability Office (GAO) report in July 2020 on ESG disclosures highlighted several areas of investor dissatisfaction.
ESG reporting in SEC filings is guided by Regulation S-K
As most ESG disclosures are voluntary, they are made outside regulatory reporting. Considering the growing trend of more ESG reporting in SEC filings, it is useful to learn where we see this happening. Of note, Regulation S-K guides the disclosure of non-financial and qualitative factors, including ESG information.
These four areas relate to guidance on sustainability disclosures:
Description of Business
If risks or opportunities related to sustainability matters materially affect the issuer, the company should provide disclosure of the impacts on each of its reportable business segments. Disclosures about material effects on CapEx, earnings, competitive position or compliance with environmental regulations would also be found in this area of the filing. The amendment in 2020 requiring enhanced HCM disclosures also applies here.
Pending/Contemplated Legal Proceedings
Disclosures about pending or contemplated legal proceedings related to material ESG matters, such as pollution or theft of a significant amount of private customer information, is reported in this section.
Management Disclosure & Analysis
Management’s view of known ESG trends and uncertainties that are reasonably likely to have a material effect on results of operations and financial condition must be disclosed. Given the narrative style of the MD&A section of filings, the SEC encourages the use of KPIs and non-financial metrics and the provision of adequate context that promotes understanding and comparability of a company’s performance.
Factors that Make an Investment in the Security Speculative or Risky
Descriptions of material sustainability risks and how they affect the filing company specifically. Additionally, disclosures of the most significant sustainability factors that may adversely affect the issuer’s business, operations, industry or financial position, or its future financial performance.
Any decision to include ESG information in an SEC filing must be made with care, as it comes with heightened liability risk. Public companies that do so should be assessing ESG matters they face well in advance of their SEC filings and confirming whether any of these issues present material risks to their businesses and therefore must be disclosed in a manner consistent with Reg S-K.
Third-party assurance of ESG disclosure is recommended
Auditor assurances are another way of improving ESG disclosure. Chad Spitler, CEO of InspIR’s ESG partner Third Economy, emphasizes that assurance is a best practice. Further, audited ESG information is increasingly necessary if a company is to be included in ESG-oriented indexes and, in the case of GHG emissions, this is required for reporting via CDP (global disclosure system for environmental impact).
Investors are also seeking harmonized ESG reporting standards.
Given the many different ESG reporting frameworks that exist today, coupled with investors’ need for consistent standards that would enable reasonably accurate company comparisons, the major standard setters CDP, CDSB (Climate Disclosure Standards Board), GRI, IIRC (International Integrated Reporting Framework) and SASB issued a joint statement in September 2020, outlining their combined vision for a comprehensive reporting system, shown in Figure 4 below. The new system calls for two ways for companies to communicate ESG information to stakeholders:
- An integrated report, targeted primarily at investors, encompassing all material financial and non-financial factors
- Combining the financially material ESG disclosures in the integrated report with information about the company’s impact on the economy, environment, and people (outside the realm of financial materiality to the company) to produce reports that serve the information needs other stakeholders.
Figure 4 – Sustainability disclosure standards as a compliment to GAAP
Collaborations between some of these organizations preceded this announcement and are worth noting.
- SASB and CDSB jointly developed a TCFD Implementation Guide and Good Practice Handbook that combine CDSB’s guiding principles and reporting requirements with SASB’s industry-specific metrics to provide an integrated solution for companies seeking to report in line with TCFD recommendations
- GRI and the IIRC formed the “GRI Corporate Leadership Group on integrated reporting” that helps companies adopt both GRI and the International <IR> Framework
Changes to public policy and listing standards will accelerate disclosures
Changes in public policy are impacting ESG disclosure regimes globally, as can be seen in Figure 5 below. In the U.S., President-elect Joseph Biden campaigned on requiring companies to provide more detail on environmental risks and greenhouse-gas emissions within their operations and supply chains, as part of a broader agenda to combat climate change. Previously introduced bills in the US House and Senate that would require companies to disclose climate change risks and the racial and gender composition of boards of directors and senior management teams will both have a new legislative audience. Additionally, some market participants have recommended the SEC endorse specific ESG disclosure frameworks like SASB’s.
Given the hunger in the private sector for better quality information, mandated ESG disclosures might not face the hurdles they faced a few years ago. Companies themselves might welcome the clarity that could result from regulation-induced harmonization. But such moves won’t come close to addressing the sheer range of ESG issues that are material to specific industries and individual companies.
Figure 5 – Regulatory Initiatives
Many stock exchanges around the world have been incorporating ESG into their listing standards. In late 2020, Nasdaq proposed a new requirement focused on board diversity that received a lot of attention. Accordingly, this exchange would adopt new rules that would require all companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics regarding their board of directors.” The rules would also require most Nasdaq-listed companies to have, or explain why they do not have, at least two directors that would achieve sufficient board diversity, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ. Nasdaq views this listing requirement and related disclosure as a way to satisfy the growing proportion of investor AUM that values diversity.
How should public companies effectively respond to investors’ evolving ESG disclosure requirements?
The rapid growth in SASB Standards adoption underscores investors’ need for more decision-useful, financially material ESG information. Further, investors seeking this information do not necessarily expect any or all of it to be presented in SEC filings, and sustainability disclosure via corporate websites and in earnings materials can be effective vehicles, provided it improves the decision-usefulness. Including metrics or company-specific narratives are two areas worthy of focus.
Regarding decisions around what ESG information to disclose and how, Sidley Austin LLP’s general guidelines are useful:
- Stay informed: Public companies should stay updated on developments and trends in the area of ESG disclosure
- Monitor approach Companies disclosing only the limited SEC-required ESG information should revisit their approach periodically to consider whether it remains appropriate to their circumstances, while building an understanding of the competing voluntary disclosure regimes and peer company approaches
- Monitor peer disclosures Companies that already disclose ESG information based on a voluntary disclosure regime should keep a close eye on peer disclosure, ideally through a detailed benchmarking exercise, to identify information gaps and methodological concerns potentially identified by investors
- Identify those disclosures directly relevant to your company and industry Every public company should make a strategic decision about which ESG disclosures to develop, if any, and how
- Consider investor demand Companies should consider investor needs for expanded disclosure while also applying business judgment
- Assess opportunities and risks Consider whether and how adopting or refining ESG policies, initiatives and voluntary disclosures presents both opportunity and risk
SASB standards reflect investor demands and SEC focus
According to the E&Y CCaSS survey referenced earlier, 46% of investors identified the disconnect between ESG reporting and mainstream financial information as their top challenge, while 37% said a lack of materiality in disclosures was the key problem. SASB’s reporting standards, which we will dive deeper into in Part 3 of this series, address these problems.
The SEC’s views on mandated disclosures are firmly rooted in financial materiality and that, in turn, is partly based on the needs of one key stakeholder, the investor. SASB’s Standards cover ESG issues whose selection is market-informed and based on evidence of material financial impact. An emphasis on measurability and cost-effectiveness for the company to collect and report this information ensures decision-usefulness for both investors and management. All this makes for a very compelling reason why every company should be looking to SASB Standards.
Article by InspIR consultant Sudarshan “Sudi” Setlur, a SASB-credentialed sustainability analyst and expert in using data and analytics to optimize investor relations and corporate governance programs and InspIR Group.
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