What next for ESG reporting? A cautious cheer for America’s SEC

By Claire Bodanis

Is the FT becoming the lefty paper? Last Tuesday’s key opinion piece debated whether the UK should change its listing rules to attract more overseas companies (tech, basically). ‘Adopt the free float and dual-class share structures of the US system and let the founders make a killing!’ cried the Yes camp. ‘Review yes, but make it a race to the top, not the bottom, and don’t sacrifice Britain’s high standards for the benefit of the few,’ was the rather more measured message from the No camp. No prizes for guessing where my loyalties lie.

Was it a coincidence, however, that the article was placed above another opinion piece – ‘Don’t let gig economy chiefs rewrite the law’? This reflected the previous week’s UK ruling against Uber that classified its drivers as employees, which stood in stark contrast to the California result in November. This changed the law to suit Uber, and was achieved by $200m spent on a campaign to persuade voters that it was in workers’ interests to be treated as self-employed. The message was clear: in the UK, companies, however big they are, don’t get to choose whether or not the law applies to them; in the US, the bigger they are the easier it is to get the law amended for their own gain.

This more buccaneering, caveat emptor approach favoured by the US is, I believe, reflected in its reporting regime too. A system like America's that’s essentially rules-based rather than principles-based is much easier to subvert to one’s own ends because, as I mentioned in FW’s February reporting blog, ‘all too often the annual report becomes a warehouse of “information that is true” rather than “the truth about our company”.’ Under the US system, a report’s readers are left to work out for themselves what the brain-frying mass of data that’s required for an SEC filing actually means. In the UK, the requirement for the directors to determine what is material to their business and their stakeholders and report on that is far more revealing, because it gives you real insight into what the directors are thinking. And what they don’t say is often as revealing as what they do say. In this context, the story can, counterintuitively perhaps, be more truthful than the facts.

The John and Janine show

So why am I cheering, albeit cautiously, the US Securities and Exchange Commission (SEC), and what’s it got to do with developments in ESG reporting? Last week I listened in to the International Institute of Finance’s US Climate Finance Summit (once I’d battled through their arcane registration system – now there’s a body that needs a tech revolution). I was particularly keen to hear the ‘New frontiers in Climate and ESG Disclosure’ panel discussion with John Coates of the SEC and Janine Guillot of the Sustainability Accounting Standards Board (SASB), of which I’ve long been a fan.

Initially alarmed by John’s opening, which staked the SEC’s claim to leading the development of a consistent, global set of standards for ESG reporting, I decided to hold my prejudices in check for the 30 minutes required of the session and actually listen to what he had to say before furiously bashing the comment button.

And in listening I heard some reassuring words: ‘continued, thoughtful engagement by trusted specialists looking for consensus about what’s useful’, and (music to my ears) ‘balancing principles and metrics’ in a debate about ‘how much industry standardisation can be achieved’. This was in the context of the 2020 modification by the SEC of regulation S-K, which, the facilitator mentioned, took requirements beyond the financial.

My ears pricked up – S-K? What’s that? Not wanting to miss a second of the discussion, a quick google gave me the answer (thank you legal eagles Jones Day): ‘The amended Regulation S-K rules reflect a shift toward a more principles-based disclosure framework and expand certain disclosure requirements relating to, among other things, human capital resources and government regulations.’

Goodness, I thought, am I going to have to amend my pro-UK, anti-US regulatory regime rhetoric?

Perhaps not quite yet, since John went on to say: ‘There are two common mistakes that people make about disclosure. We don’t currently have a rule that says you must disclose everything that is material.’ In picking my jaw up off the carpet, I’m afraid I missed the second mistake, but I managed to pull myself together quickly enough to take in a very important nuance in this debate, highlighted by Janine.

ESG – voluntary or mandatory? asked the facilitator. Not so fast, Janine replied; mandatory, like green, comes in many shades, and can mean everything from a principles-based, comply or explain type approach, to specific metrics for specific topics. John swore he and Janine hadn’t colluded beforehand, but his comment was very similar – noting, for example, that it is mandatory in the US for voluntary disclosures not to mislead the market (another slightly jaw-dropping moment there). And, he added, it is at this interplay between the voluntary and the mandatory where regulatory bodies such as the SEC can help.

I was also pleased to hear that, in promoting the SEC as a body that could lead in shaping a new ESG reporting regime, John echoed Janine’s message that such a regime must be global to meet the needs of global companies. That it must be allow ‘ample room for jurisdictional variation’. (To which I’d add Janine’s point, which SASB has been making for years, that any regime must allow for industry sector variation too, because non-financial metrics are not directly comparable or equally relevant to all companies in the way that in general, financial ones are.) And finally, he echoed, that any regime must be built through consensus, because the challenges inherent in such a project are numerous and contentious.

Consensus? Says who?

It was refreshing to hear the US talking about a global consensus on ESG reporting, and there certainly seems to be agreement for the idea of a global framework. I asked Andy Griffiths, luminary of the UK investor scene in his role heading up The Investor Forum, for his thoughts: “It is encouraging to see such a constructive debate and a genuine appetite to collaborate in pursuit of a global framework for ESG reporting,” he said. But, he warned, while “the direction of travel is clear, the journey to widely accepted standards will be long and arduous. The best companies around the world are already meaningfully enhancing their reporting to address a wide range of material issues – and the leaders will continue to move at pace to ensure their stakeholders have clear insights into, and evidence of, their ESG credentials. Investors and society will demand no less.”

And how about the UK regulatory perspective? As ever, the friendly folk at the UK Financial Reporting Council could be relied on for a constructive approach. Mark Babington, Executive Director of Regulatory Standards said: “High quality ESG reporting is recognised for having a major impact on how companies are run and the information that flows through to investors and other stakeholders. 2020 represented a major step change in the ESG debate and it is clear that momentum is growing for consolidated international standards, to support the delivery of consistent and comparable high-quality information. This will only continue to grow in the run up to COP 26. The FRC supports the introduction of global non-financial reporting standards and strongly encourages public interest entities to report against the TFCD’s recommended disclosures and the Sustainability Accounting Standards Board metrics for their sector.” He also said: “The UK is rightly heralded as an international leader in setting high standards of corporate governance and stewardship.” I’d add – for now...

Placing my bets on the IFRS

But let’s be optimistic. I hope the nice people at the FRC will be just as vociferous as those at the SEC in making their views known – there are many contenders battling for the standardisation of ESG reporting crown, and it’s essential that the right one wins. And who should that be?

Both John and Janine concluded that the best option on the table right now is the IFRS Foundation’s proposal, which also has the support of a growing number of pension funds and institutional investors. The Foundation is proposing a new, collaborative Sustainability Standards Board (SSB) which would set global non-financial reporting standards, and operate alongside the existing International Accounting Standards Board which sets the IFRS standards. It’s where I’d put my money too, although there’s a lot of horse-trading to be done. The EU is working on its own ESG standards in its Taxonomy and Non-Financial Reporting Directive; then there’s the question of whether the needs of stakeholders beyond investors should be included, which the SSB would need to sort out.

Why do I support the IFRS approach? IFRS has proved its usefulness as a set of global financial reporting standards (although we’re still waiting for the US to come on board!). In doing so, it hasn’t done away with the narrative, principles-based reporting approach I so favour in the UK. I am hopeful, therefore, that any non-financial standards proposed by the same body would walk that careful – but so essential – line between a mandated list of disclosures and the flexibility of the narrative ‘comply or explain’ approach. Any dilution of the UK’s requirement for directors to determine what is material to the business and report on that – namely, to tell their story truthfully – would, in my mind, be a catastrophe for reporting, and by extension for business and society. We’ve all seen what happens when falsehood is allowed to masquerade as truth, which makes it more important than ever that those called upon to report information do indeed tell the truth.

Back to the SEC, and I was delighted by John’s overarching comment that any policy or approach from the SEC will ‘respect science, evidence, and reality’. It’s just a shame that he felt it necessary to say so. There’s no doubt that for global standards to be effective, they must have US input and support, even leadership. But they must also have a far greater and more rigorous requirement for truth-telling than the current US system requires. Truth-telling that is intelligible to all stakeholders, not just those professionals who know their way around a 300-page, densely packed, gobbledegook Form 10K or 20-F. And that’s why I give the SEC’s proposed leadership role a cautious, single cheer, but not quite an all-out hat trick just yet – although I am encouraged by the SEC’s changes to the S-K, and its reference to principles, because it suggests better things to come.

And finally… Bob Eccles reads the runes

However, I’m not great at reading the runes in the US, so I thought I’d do a bit of digging from someone who is. And who better than Robert Eccles, a professor at the Saïd Business School at Oxford, and Founding Chairman of SASB, who’s been tilling the fields of ESG reporting standards since back in the day when it was still called philanthropy. After a mutual moan about the IIF’s registration system, Bob said: “While your caution is understandable, these steps that may seem small are actually pretty significant. For the last four years, you couldn’t use the word ‘climate’ at the SEC – but John has. And, while there were few corporate US responses to the IFRS Foundation’s consultation for the SSB there were many investor ones. And we now have an important voice at the SEC gently signalling that the US would support a global set of standards for non-financial reporting and wants to play a major role in making that happen. I’ve been dreaming about this for 30 years! For it to happen, the US must step up and the EU must exercise its leadership to support the SSB. And if they can do that, I don’t see why all other jurisdictions wouldn’t get on board. Not too long from now, we may look back on John’s comments as the first smoke signal by the US of the game-changing move that the capital markets and the world at large so desperately need.”

Well, that was good to hear! Perhaps I’ll give the SEC two cheers after all. Not least because better things to come from the US might just help us back in London fend off the rather worrying voices calling for a dilution of the high standards of governance and probity, and the integrity of our legal system, that gave us reason to be proud to be British in the first place. None of us can afford to be complacent.

Lefties of the FT, unite