Over the last several years, investors, regulators and other stakeholders have sought an increase of environmental, social and governance (ESG) disclosures by public companies.
The U.S. Securities and Exchange Commission (SEC) has taken a cautious approach to developing uniform ESG disclosure requirements, but made a series of public statements and took preliminary steps this year indicating that it may soon enhance its climate-related disclosure requirements for all public companies, including financial institutions. To that end, the SEC’s spring 2021 agenda included four ESG-related rulemakings in the proposed rule stage, noting October 2021 for a climate-related disclosure proposed rule. The SEC is also sifting through an array of comments on its March 15 solicitation of input on how the Commission should fashion new climate disclosure requirements.
Recent speeches by Chair Gary Gensler and Commissioners Allison Herren Lee and Elad Roisman highlight some of the key elements of disclosure likely under consideration by the staff, as well as their personal priorities in this area. Commissioner Lee has asserted that the SEC has full rulemaking authority to require any disclosures in the public interest and for the protection of investors. She noted that an issue also having a social or political concern or component does not foreclose its materiality. Commissioner Lee has also commented on the disclosure of gender and diversity data and on boards’ roles in considering ESG matters.
Commissioner Roisman has noted that standardized ESG disclosures are very difficult to craft and that some ESG data is inherently imprecise, relies on continually evolving assumptions and can be calculated in multiple different ways. Commissioner Roisman has advocated for the SEC to tailor disclosure requirements, and phase in and extend the implementation period for ESG disclosures. Meanwhile, Chair Gensler has also asked the SEC staff to look at potential requirements for registrants that have made forward-looking climate commitments, the factors that should underlie the claims of funds marketing themselves as “sustainable, green, or ‘ESG’” and fund-naming conventions, and enhancements to transparency to improve diversity and inclusion practices within the asset management industry.
Significance for Financial Institutions
In the financial services industry, the risks associated with climate change encompass more than merely operational risk. They can include physical risk, transition risk, enterprise risk, regulatory risk, internal control risk and valuation risk. Financial institutions will need to consider how their climate risk disclosures harmonize with their enterprise risk management, internal controls and valuation methodologies. Further, they will need to have internal controls around the gathering of such valuation inputs, data and assumptions. Financial institutions therefore should consider how changes to the ESG disclosure requirements affect, and are consistent with, other aspects of their overall corporate governance.
Likewise, financial institutions should also consider how human capital disclosures align with enterprise risk management. Registrants will not only need to ensure that the collection of quantitative diversity data results in accurate disclosure, but also how diversity disclosures might affect reputational risk and whether any corporate governance changes may be needed to mitigate those concerns.
We recommend that financial institutions consider the following:
- Expect to include a risk factor addressing climate change risks, and for the robustness and scope of that risk factor to increase.
- Consider disclosing how to achieve goals set by public pledges, as well as whether the mechanisms to measure progress against such goals are in place.
- Expect ESG disclosure requirements to become more prescriptive and for quantitative ESG disclosures to become more sophisticated. Prepare to identify the appropriate sources of information in a manner subject to customary internal controls.
- Establish a strong corporate governance framework to evaluate ESG risks throughout your organization, including how your board will engage with such risks.
- Incorporate ESG disclosures into disclosure controls and procedures.
- Consider whether and how to align executive compensation with relevant ESG metrics and other strategic goals.