Over the past five years, international organizations ranging from the United Nations and the G20 to the World Economic Forum and the International Organization of Securities Commissioners (IOSCO) have advocated expanding environmental, social, and governance (“ESG”) or “non-financial” reporting by public companies.[1] In 2019, the European Union introduced a new “taxonomy” to standardize how sustainability measures are integrated into financial systems and announced new ESG disclosure rules for investment managers. This past February, the European Securities Market Authority (ESMA) rolled out a Sustainable Finance Strategy that builds on these frameworks for transparency around sustainability factors and risks. European governments are already implementing the commission’s Non-financial Reporting Directive and its 2018 Action Plan on Financing Sustainable Growth. All told, financial and securities regulators or stock exchanges in over 80 countries are now working to standardize how ESG information reaches investors.[2]
All of this stands in stark contrast to the United States, where ESG reporting reforms lag and still face strong resistance from the business community and from some SEC commissioners.[3] For many within the U.S., the reasons for the SEC’s hesitation in this area are obvious, but it may come as a surprise that mandatory ESG disclosure is rapidly becoming a global norm. Outside the U.S., however, regulators, academics, and policy advocates often wonder whether the SEC’s lack of leadership in this area simply reflects the current administration’s deregulatory bent or has deeper roots.
In a forthcoming article, Non-Financial Reporting & Corporate Governance: Explaining American Divergence & Its Implications for Disclosure Reform, I explain to an audience primarily outside the U.S. why the U.S. approach, which is largely market-driven, still diverges so visibly from the reform paths adopted elsewhere. I also explain why some of these institutional differences are likely to persist even as more U.S. business leaders and policymakers begin to focus on human capital, climate change, and other ESG issues.
By way of background, U.S. federal securities laws already require companies to disclose certain environmental, social, and risk-related information, and most U.S. public companies (and many privately held ones) produce sustainability reports for key stakeholders. However, sustainability reports are not directed primarily at investors, and many companies have not yet assessed what ESG information may be financially material. At present, then, investor access to nonfinancial information under U.S. disclosure rules depends almost entirely on various forms of private ordering — shareholder proposals targeting companies’ ESG risk management and transparency, private standard-setting organizations’ ESG reporting frameworks, and companies’ own voluntary sustainability reports. These efforts have raised companies’ (and investors’) awareness of ESG materiality and increased the quantity of information ESG information reaching the market, but as I argued in a prior article on this blog, this model of nonfinancial risk disclosure is ineffective and produces costly information asymmetries.
In my most recent article, I observe that the key reasons for the divide between U.S. and most other jurisdictions’ approaches to non-financial reporting are the deep roots of shareholder primacy in U.S. business practice and a greater skepticism toward regulation in some quarters of the U.S. public. Other barriers to ESG disclosure reform include companies’ fears of securities fraud litigation and legal obstacles to new disclosure regulation. Another challenge is the lack of clear statutory authority for the SEC to undertake disclosure reforms directed at advancing a sustainable finance transition, addressing the financial risks associated with climate change, or reducing corporations’ impact on non-investor stakeholders.
Given these limitations, non-financial disclosure in the United States will continue to depend heavily on private ordering. In addition, without a direct legislative mandate from Congress,[4] any regulatory change will have to be justified on economic (and investor-oriented) grounds rather than on stakeholder concerns, a commitment to promoting sustainable finance, or an intent to change corporate practice. My article suggests possible paths for non-financial reporting that take account of this institutional context, although an attempt to overcome the barriers to ESG disclosure reform is beyond its scope.
One such path would be for future ESG disclosure reforms to draw more heavily on the comply-or-explain models that are more common outside the United States. These models rely strongly on enforcement by shareholders and offer companies added flexibility. As a form of private ordering, this approach aligns with the current U.S. reporting framework and may be more welcomed by reporting companies, while still encouraging more comparable and reliable ESG disclosure.[5] The article concludes by considering the implications of the United States’ market-driven approach for non-financial reporting reform and for the future of sustainable finance more broadly.
ENDNOTES
[1] The term “non-financial” reporting is somewhat of a misnomer, since many ESG factors are financially material to companies and their investors. As discussed below, however, non-financial reporting reform may also be intended to support regulatory goals like sustainable development and climate change remediation.
[2] Reporting Exchange, https://www.reportingexchange.com (subscription based) (last visited Sept. 25, 2019) (identifying 70 governments that have now adopted sustainability reporting measures, 80 percent of which are mandatory).
[3] SEC Commissioner Pierce’s May 22 statement at the SEC’s Investor Advisory Committee meeting reflects this stance.
[4] In 2018, a climate risk disclosure bill was introduced in the Senate. Climate Risk Disclosure Act of 2018, 115 S. 3481, 2018 S. 3481. In 2019, new proposals on ESG and climate risk disclosure were introduced in the House of Representatives, and the SEC opened the door to expanded disclosure on human capital. See ESG Disclosure Simplification Act of 2019, H.R. ___ , 116th Cong. (discussion draft); Shareholder Protection Act of 2019, H.R. ___ , 116th Cong. (discussion draft); Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019, H.R. ___ , 116th Cong. (discussion draft); To Require Issuers Required to File an Annual or Quarterly Report under the Securities Exchange Act of 1934 to Disclose the Total Amount of Corporate Tax Such Issuer Paid in the Period Covered by the Report, and for Other Purposes, H.R. ___ , 16th Cong. (discussion draft); Climate Risk Disclosure Act of 2019, H.R. 3623, 116th Cong. (discussion draft). All available at: https://docs.house.gov/Committee/Calendar/ByEvent.aspx?EventID=109770). In August 2019, the SEC partially responded to several rulemaking petitions by including human capital disclosure in proposed amendments to risk disclosures under Item 101(c) of Regulation S-K (SEC, 2019). Modernization of Regulation S-K Items 101, 103, and 105, Rel. No. 33-10668, 84 Fed. Reg. 44358, 44369-72, Aug. 23, 2019, https://www.sec.gov/rules/proposed/2019/33-10668.pdf.
[5] I have developed this argument more fully in an earlier article that surveys empirical studies from other jurisdictions. See Virginia Harper Ho, “Comply or Explain” and the Future of Nonfinancial Reporting, 21 Lewis & Clark L. Rev. 317 (2017), reprinted in 2018 Sec. L. Rev. § 3.2 and previously featured on this blog.
This post comes to us from Virginia Harper Ho, the Earl B. Shurtz Research Professor of Law and the associate dean for international & comparative law at the University of Kansas School of Law. It is based on her recent article, “Non-Financial Reporting & Corporate Governance: Explaining American Divergence & Its Implications for Disclosure Reform,” available here.