Two Sides of the ESG Debate Are Closer Than They Think
In July, G–20 finance ministers and central bank governors “welcome[d] the work programme of the International Financial Reporting Standards (IFRS) Foundation to develop a baseline global reporting standard” for climate-related risks through the establishment of an International Sustainability Standards Board (ISSB). Judging from other high-profile statements—and related media coverage—this consensus may not appear to be widely shared among participants in US capital markets. Investors and at least one Securities and Exchange Commission (SEC or the Commission) commissioner appear largely supportive, whereas many US corporations and at least one other SEC commissioner look to be steadfastly opposed.
Appearances, however, can be misleading. The viewpoints expressed have made valuable contributions to a long-overdue market dialogue. We have found important common ground: a shared conviction that US regulatory requirements for climate-related disclosures should focus on providing investors with information that is material to their capital allocation decisions.
Talking Past Each Other
Interestingly, much of the pushback—including many of the points made in SEC Commissioner Hester Peirce’s recent letter to the IFRS Foundation—appears to be rooted in the misperception that sustainability standards are “not fundamentally about economic decision making,” but rather are “intentionally laden with judgments about where capital should flow.”
Coincidentally, just days before Commissioner Peirce’s letter, Erkki Liikanen, chair of the IFRS Foundation Trustees, noted that the ISSB will be focused on sustainability disclosures as instruments of economic decision making—and not on establishing thresholds for sustainability performance. At the CFA Institute Financial Regulatory Symposium, Chair Liikanen, outlined how the IFRS Foundation has established a few “first principles” for its sustainability efforts. These principles ensure that efforts are investor centric, are focused on the creation of enterprise value, and establish a global baseline that enables a “building blocks” approach to balance international consistency with jurisdictional specificity. All of these principles are explicitly intended to facilitate economic decision making.
Investor-Focused Disclosure: The Common Ground
Consistent, comparable, reliable information is the lifeblood of investment analysis. Corporate valuations increasingly are driven by risks and opportunities that are not captured by traditional financial reporting. This is why investors have advocated for sustainability disclosure standards. And this is why, like traditional financial disclosure standards, they need to be designed with a specific user and objective in mind.
The ISSB’s proposed approach is premised on the idea that when markets have access to comparable information about the sustainability issues that affect financial performance and enterprise value, investors can better exercise their professional judgment in evaluating performance and markets can more efficiently price risk.
Why We Support the ISSB
We support the formation of an ISSB because its “first principles” are important to the investment community and because we welcome its commitment to address the full range of sustainability factors (i.e., beyond climate change alone) through which investors assess business performance. Crucially, the ISSB also would establish a global sustainability disclosure baseline, bringing coherence to a fragmented ecosystem in which investors have been forced to be multilingual.
That said, our support is not categorial. How the ISSB is implemented is of critical importance. You get what you build, and we believe the ISSB should be built with the following in mind:
- Appropriate governance, organizational, and independent funding models;
- A conceptual framework and due process;
- A mix of quantitative and qualitative information;
- Both industry-specific and cross-industry metrics;
- An appropriate leveraging of assets and expertise from existing standard setters; and
- Significant investor representation.
To achieve these aims, the SEC must play a significant role.
The SEC Must Stay at the Table
The Commission, until recently, has had little to say about sustainability-related disclosure since its 2010 guidance on climate change. Today, however, this issue is at or near the top of the agenda for policy makers and regulators around the world, including the SEC. US markets must be engaged in the international landscape, or global norms will be established without US input.
The legitimate concerns raised by commissioners can best be addressed not through withdrawal but through active engagement, including directly with the ISSB process, through the IFRS Monitoring Board, and through the International Organization of Securities Commissions technical experts group. On the latter, we are encouraged to see the SEC taking a leadership role.
Specifically, the Commission’s involvement can help ensure an ISSB due process that sticks to the “first principles” and focuses on meeting investor needs for decision-useful information, enabling market transparency and efficiency. The SEC’s important role is why companies and investors must engage in the IFRS Foundation’s ongoing consultations and encourage the SEC to stay at table to help shape what comes next.
We agree with Commissioner Peirce that “strong financial reporting standards are the bedrock of our capital markets.” But financial reporting standards are not static, and they have evolved through the years along with the markets they serve. As investors increasingly believe certain sustainability information is value relevant and actively use this information to inform investment decisions, disclosure standards must adapt accordingly.
Photo Credit @ Getty Images / Galeanu Mihai