Modernizing ESG Disclosure
In November 2021, the IFRS Foundation announced prototype global corporate reporting standards for climate and sustainability disclosures, and created the International Sustainability Standards Board (ISSB) to oversee their development. The prototypes build on existing standards and frameworks, including those developed by the Climate Disclosure Standards Board (CDSB), the Task Force on Climate-Related Financial Disclosure (TCFD), the World Economic Forum, and the Value Reporting Foundation, which itself had already brought together earlier in 2021 two other international standard-setters—the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council IRRC). The ISSB’s plans have been hailed as ‘the biggest change in corporate reporting since the 1930s’.
As a global ESG reporting standard looks to become reality, a looming question is how it will affect corporate reporting in the United States and whether the US approach will support greater international harmonization of ESG reporting standards or will instead chart a different course.
In my forthcoming article, Modernizing ESG Disclosure, I present a roadmap which could help the US Securities Exchange Commission (SEC) align the US reporting framework for corporate ESG disclosure with these emerging international standards. My article proposes climate risk, corporate governance, and human capital disclosure reform, and is the first to detail specifically how the current reporting rules under Regulation S-K of the US Securities and Exchange Act of 1934 would need to be amended to implement the reporting guidance of the TCFD and the SASB/Value Reporting Foundation disclosure standards, which are the foundation of the ISSB prototypes.
In general, I argue that this will require new prescriptive, sector-specific rules, especially in light of the need for more standardized, metrics-based disclosure. And, while I have previously argued that SEC rulemaking might be more likely to survive legal challenge if it were done on a comply-or-explain basis, comply-or-explain reporting will not achieve the level of comparability and consistency that is needed at present, particularly for climate-related financial risk. My article therefore argues that comply-or-explain reporting should be used only for additional reporting beyond the core requirements where more flexibility may be needed, for instance, with respect to assurance, ESG risk mitigation, or climate risk scenario analysis, or where reporting measures are rapidly evolving.
Prospects for Harmonization?
On the broader question of what approach the US will take, a key factor that bodes well for greater international harmonization is its timing, since the ISSB’s proposals coincide with new momentum on ESG disclosure by the SEC. After over a decade of inaction on climate disclosure, the SEC sought public input in March 2021 on the need for climate-related disclosure reform and ultimately announced it would work on proposed reporting rules for climate-related financial risk, board diversity, and cybersecurity risk, as well as possible rule changes to its recently adopted ‘human capital’ (ie workforce-related) disclosure rules. Other US regulators, including the Commodity Futures Trading Commission, the Financial Stability Board, and the US Treasury Department’s Financial Stability Oversight Council, have also called for a coordinated regulatory response to the systemic threat that climate risk poses to the financial system, and in 2021 the US House of Representatives also passed a bill that would, if it became law, give the SEC broader authority to tackle ESG disclosure.
Given these important developments, the ISSB’s announcement of the new prototypes is likely to shape how the SEC responds to the calls for better information on climate-related financial risk and to rising demand from investors for more standardized ESG disclosure.
ESG Reform Challenges
At the same time, any SEC effort to mandate ESG reporting faces clear challenges that could keep the SEC from endorsing the ISSB’s approach and could slow implementation of any new reporting rules. My article offers a response to these challenges, some of which can best be resolved by Congressional action:
- The Authority of the SEC.
One major question is whether adopting ESG disclosure reform falls with the SEC’s existing authority to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Under the prototypes, companies must assess the materiality of their impacts on ‘society and the environment’ and to report on such impacts if they ‘could reasonably be expected to affect the entity’s future cash flows’.
I argue that the systemic risk effects of climate change justify the SEC’s requiring companies to disclose climate-related financial risk to the reporting company itself, but also corporate climate impacts. But a broader stakeholder-oriented materiality standard may be difficult to harmonize with the narrower investor- and market-oriented scope of the US securities laws without specific authorization from Congress. On the other hand, if the US adopts a narrower approach, it may prove ineffective in pushing companies to reduce their carbon footprints and change their operations to address environmental and social harms.
- Scope of Disclosure & Litigation Risk.
In contrast to the current law governing US reporting, which only requires companies to report information specifically required by the disclosure rules or that is necessary to make the required disclosures not misleading, the ISSB prototypes require reporting companies to disclose all material sustainability-related financial information. Following this approach is certain to raise serious concerns about securities fraud litigation risk exposure for US companies.
- Negative Information & ‘Compelled Speech’ Concerns
Also, under both the TCFD guidelines and the ISSB prototypes, companies may have to report negative information, such as inadequate climate risk mitigation or a failure to meet an identified sustainability performance target. But rules like this may face constitutional challenge in the US on ‘compelled speech’ grounds. My article therefore urges the US Congress to go beyond past legislative proposals and give the SEC a clear mandate to adopt ESG disclosure reform in alignment with current and emerging international reporting standards. Congress should, I argue, also make clear that the SEC is not required to justify new rulemaking with particularized empirical evidence of the materiality of the information it is requiring be disclosed.
This article concludes by outlining more ambitious reform proposals that Congress could take to reach large private companies and to allow sustainability information to be integrated across the financial system as part of the groundwork for a post-carbon transition.
Virginia Harper Ho is a Professor of Law at the City University of Hong Kong and a former Earl B. Shurtz Research Professor at the University of Kansas School of Law. The post is based on her recent article ‘Modernizing ESG Disclosure’, which is forthcoming in the University of Illinois Law Review.
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