How Do Investors Use ESG?

Last week, the SEC's Investor Advisory Committee held a meeting focused in part on the use of environmental, social and governance information in the capital allocation process—how do investors use ESG information in making investment decisions? The panelists—an academic and several representatives of asset managers—all viewed ESG data as important to decision-making, particularly in relation to potential financial impact, even for investment portfolios that were not dedicated to sustainability.

To open the meeting, Commissioner Allison Lee, after acknowledging how much emphasis investors are now putting on ESG issues, observed that the SEC "last issued guidance on climate-related disclosure in 2010. A lot has changed since then in terms of what we know about the significance of climate risk from a scientific standpoint, as well as what we know about the risks companies face as a result. A lot has also changed in terms of the kinds of disclosure that investors need to accurately assess and price that risk, on everything from board oversight of the risk to estimates related to stranded assets."

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In August, Lee and fellow Commissioner Robert Jackson published a joint statement to encourage public comment about, among other things, the absence of climate risk as a topic for discussion under the Description of Business in the proposal to modernize Reg S-K (see this PubCo post), released on August 8. According to Lee and Jackson, while estimates of the scale of climate risk vary, "what is clear is that investors of all kinds view the risk as an important factor in their decision-making process. Yet it remains tough for investors to obtain useful climate-related disclosure. One argument against mandating such disclosure is that climate risk is too difficult to quantify with acceptable accuracy. Whatever one thinks about disclosure of climate risk, research shows that we are long past the point of being unable to meaningfully measure a company's sustainability profile." (See this PubCo post.)

Chair Jay Clayton, who was not in attendance at the meeting, but nevertheless provided a statement, expressed interest in understanding what data companies and investors use to make decisions, recognizing that the answers could be complex: "1) not all companies in the same sector use the same or comparable data in their decision making and (2) investor analysis also varies widely. In the areas of 'E' and 'S' and 'G,' in particular, the approach to investment analysis appears to vary widely, in some cases incorporating objectives other than investment performance over a particular time frame or frames." To generate "decision-useful" (Clayton translation: material) information, these complexities must be taken into account. Clayton also noted that "E," "S" and "G" are very different in terms of disclosure:

"For example, 'G' is significantly rooted in and bounded by law, regulation and governance agreements, lending itself to a fair degree of precision. 'G' also generally is more historical than forward-looking and is substantially under the control of the registrant. 'E' has some similarities to 'G'—for example, 'E' disclosure is often based on law and regulation or at least the effects of law and regulation. However, 'E' disclosure can be significantly forward-looking, including estimating or otherwise discussing the effects of current law and regulation as well as pending or potential regulation. We have long recognized there can be a substantial difference between historical information and forward-looking information. As I have previously discussed with this Committee, due to this complexity, I have concerns that imposing a uniform, mandatory disclosure framework for many areas [of] 'E,' 'S' and 'G' disclosures runs the risks of sacrificing what may be the more relevant, company-specific disclosure for the potential for greater comparability across companies."

As he has historically, Clayton continued to promote the SEC's longstanding disclosure framework as the right approach to ESG.

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Clayton has consistently been far from enthusiastic about marketwide ESG regulation: in the face of rulemaking petitions and other mounting calls for rulemaking that standardized ESG disclosure, Clayton's view was "that in many areas we should not attempt to impose rigid standards or metrics for ESG disclosures on all public companies. Such a step would be inconsistent with our mandate, would be a departure from our long-standing commitment to a materiality-based disclosure regime, and could effectively...