ESG Disclosure Standards: Begin With Financially Value Relevant, Layer Other Objectives

Last week, US Securities and Exchange Commission (SEC) Chair Jay Clayton spoke on a webcast sponsored by FCLTGlobal. He discussed his views on environmental, social, and governance (ESG) disclosures and the SEC’s responsibilities to investors — rather than to all stakeholders. His remarks were consistent with the views CFA Institute recently expressed in a comment letter provided in response to the Accountancy Europe paper Interconnected Standard Setting for Corporate Reporting and with our questionnaire response to the European Commission consultation on the Nonfinancial Reporting Directive (EU NFRD).

Our responses highlight the need for a globally coordinated approach that: (1) starts with disclosures that are financially value relevant for investors and (2) layers disclosures for other stakeholders — and that does so in possibly different locations than the publicly available documents because of the offering of securities to investors.

In broad strokes, the Accountancy Europe paper proposes different methods of orchestrating convergence of disclosure standards over non-financial information by engaging the governance process of the International Financial Reporting Standards (IFRS) Foundation that sets accounting standards by way of the International Accounting Standards Board (IASB).

In our comment letter, we set forth, several key perspectives:

• Support Convergence Efforts. We support efforts to converge standards globally — just as we supported convergence of accounting standards — as this facilitates investment decision making.
• Oppose a Converged Standard-Setting Model That Removes Investor Primacy from IASB Mission.  We do not support any operating model that might alter the IASB’s focus on investors.
• Support Long-Term Value Creation and Integrated Reporting. We support sustainable business models and long-term value creation because it is foundational to the CFA® Program — not simply because of the current emphasis on ESG and sustainability reporting.
• Rebrand the Term “Nonfinancial Information.” To garner greater global support from investors, the term “nonfinancial information” may need clarification and rebranding to highlight the demonstrable link to financial performance and financial value creation.
• Specify Audience (Investors) and Communication Objectives (Financial Value Creation). It is essential to consider whom the information is prepared for and the objective of that information. The information must be material to investors’ investment decision-making process. The information needs of other stakeholders (i.e., including investors who invest based on values over value) must be considered separately. That is not to say they are mutually exclusive or less important, it is just to say that the discipline in making this distinction is important to be able to discern between financial value and return and values — should they fail to move in the same direction.
• Stress That Location of Information Matters. Publicly listed companies should not be required to provide disclosures that support values or civil society–based objectives — simply because they have a public reporting obligation to investors under securities laws. Doing so may penalize publicly listed companies and push companies out of the public market.
• Understand Funding. Before endorsing a proposal, we would need to understand how it would be funded.
• Define Materiality. The audience and the location of the reported information drive the purpose of the reporting — and the definition of materiality. Without a clear articulation of the intended use of the information — materiality cannot be defined and refined.
• Start with Value-Relevant Information for Investors, Layer Other Disclosures. Any global approach is best commenced with the financial value creation objective of investors. In this way, jurisdictions don’t dismiss the proposals based on the objectives or audience of the information, or its location. Information for other stakeholders would be an additional layer of disclosures. Investors are not a monolith and may want to invest, for themselves or for their clients, based on these civil society and policy objectives. Investors, however, need to understand the trade-off between value and values — should this decision need to be made. .

Accountancy Europe issued their follow-up paper, which cited our comment letter, as we went to print

Image Credit @ Getty Images/ Mark Wilson