Regulation S-K and ESG Disclosures: An Unsustainable Silence
Aug. 26, 2020
Let me start with a warm welcome to our newest colleague, Commissioner Crenshaw. She has been a tremendous asset to the Commission for many years, and I know that she will continue to serve the agency, investors, and the public with great distinction. I also want to thank the staff for their hard work on today’s rule. They’ve done exemplary work under trying circumstances, and I am, as always, grateful.
The final rule the majority adopts today, however, is silent on two critical subjects: diversity and climate risk disclosures. At the proposing stage for this rule, I was encouraged to see that it included the topic of human capital and hoped that heralded a commitment to a meaningful disclosure requirement on the subject. At the same time, I expressed concern that the proposal leaned too heavily on principles-based disclosures, both with respect to human capital and more broadly. I also expressed the concern that we failed to include, or even discuss whether to include, the crucial topic of climate risk.
Nevertheless, I voted to publish the proposal for comment, hopeful that investors—the consumers of this information—would weigh in regarding specific disclosures on human capital and climate risk, and help us get the balance right between principles-based and line-item disclosures. And that they did, in large numbers. We received thousands of comments seeking disclosure on workforce development, diversity, and climate risk. There were letters explaining why principles-based disclosure requirements, without at least some specifics, would not produce the disclosures investors need. Letters explaining what metrics were most important in terms of building long-term value for investors. Letters explaining what metrics cut across industries and what companies were already tracking. Commenters built a fulsome and persuasive record.
In addition to these comments, recent events have provided a real-time case study on the need for many of these disclosures. It has never been more clear that investors need information regarding, for example, how companies treat and value their workers, how they prioritize diversity in the face of profound racial injustice, and how their assets and business models are exposed to climate risk as the frequency and intensity of climate events increase. This year’s upheavals have driven home that ESG risks, like those associated with diversity and climate change, are strong predictors for resilience and for maximizing risk-adjusted returns.
And yet, the final rules today look largely like the proposal, ignoring both overwhelming investor comment and intervening events. We have declined to include even a discussion of climate risk in the release despite significant comment on this subject. And we have declined to go beyond merely introducing the topic of human capital generally, despite investors’ views that this is not nearly enough. I would have supported today’s final rule if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity. But we have declined to take even these modest steps.
Each of these omissions is objectionable, but I want to focus my remarks today on the particularly ill-advised omissions of diversity and climate risk. The final rule is silent on both. It is even silent on the very fact that there was a vast outpouring of comment letters on these subjects. I must respectfully dissent.
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Both diversity and climate risk generally fall under the rubric of Environmental, Social, and Governance or ESG risks. ESG investing is no longer just a matter of personal choice. Asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, stock exchanges—nearly all types of market participants—use ESG as a significant driver in decision-making, capital allocation, pricing, and value assessments. These factors have been integrated into traditional analyses designed to maximize risk-adjusted returns on investments of all types. A broad swath of investors find ESG risks to be as or more important in their decision-making process than financial statements, surpassing traditional metrics such as return on equity and earnings volatility.
In this release and elsewhere, however, the Commission takes the position that it does not need to require or specify these types of disclosures because our principles-based disclosure regime is on the job and will produce any disclosures on these topics that are material. Investors are asked to trust that each individual company has gauged materiality on these complex issues with flawless precision and objectivity.
On diversity then, should we assume that management at the hundreds (if not thousands) of companies that don’t provide data on workforce diversity have carefully and accurately determined that the information is not material to their business? That would be a questionable conclusion to make given the growing body of research showing the strong business case for diversity. In fact McKinsey & Company, which has been researching and analyzing the topic for years, released a study in May of this year showing that companies in the top quartile for ethnic diversity on executive teams outperformed those in the bottom quartile by 36 percent in profitability.
There is ever-growing recognition of the importance of diversity from all types of investors. Indeed, in one recent petition, investors representing $1.88 trillion in assets under management called for increased corporate transparency regarding workforce diversity. The recent proxy season has demonstrated this intensified shareholder focus on diversity. And large numbers of commenters on this rule proposal emphasized the need for specific diversity disclosure requirements.
What’s more, since this rule was proposed, we’ve seen protests regarding racial injustice that have brought about an unprecedented national conversation on this subject. Investors, corporations, and analysts have all taken note. Indeed, in July of this year, one large rating agency noted that “racial injustice is becoming a material issue that has the potential to change our ESG Evaluations and credit perspectives.”
I cannot think of a more timely topic for us to address, but we have declined to do so. The release is entirely silent on diversity and does not even explain why we chose not to include it.
The same is true for climate risk. In 2010, the Commission issued guidance stating that issuers should include a discussion of climate risk in items 101 and 103—two of the provisions we amend today—to the extent it is material. Has that guidance fared so well that we need not revisit it at all as we purport to modernize these same rules a decade later, when we know much more about the implications of climate risk?
We know today that climate change poses a threat to economic stability that transcends typical financial risk and has the potential to disrupt health, food security, water supply—life—on our planet. Climate risk, writ large, cannot be diversified away, and implicates a systemic risk that threatens global financial stability. By some estimates, over 90% of U.S. equities by market capitalization are exposed to material financial impact from climate change. We are long past the point at which it can be credibly asserted that climate risk is not material.
We also know today that investors are not getting this material information. The world’s largest asset managers, the largest pension funds, the largest insurers, and every major systemic bank seek disclosure of climate related financial risk.  Just last month, investors representing in excess of $29 trillion in assets called on the SEC directly to issue rules requiring corporate climate risk disclosure. And, again, the recent proxy season reflects an increased shareholder focus on climate risk.
As for comments, from reading the release, one might think we received two or three isolated letters on the subject. In fact, we received thousands. This, coupled with an unprecedented and massive campaign to obtain voluntary climate-related disclosures from companies, speaks volumes regarding the deficiencies under the existing guidance and principles-based regime.
Nevertheless, today’s rule is silent on the topic of climate risk. It does not even explain or justify the decision to exclude it from the rule.
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There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed. It’s time for the SEC to lead a discussion—to bring all interested parties to the table and begin to work through how to get investors the standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.
 I would particularly like to thank Bill Hinman, Lisa Kohl, Johnny Gharib, Betsy Murphy, Felicia Kung, Sean Harrison, John Diamandis, and Sandra Hunter Berkheimer from the Division of Corporation Finance; Bryant Morris and Shaz Niazi from the Office of the General Counsel; and SP Kothari, Hari Phatak, and Vlad Ivanoff from the Division of Economic and Risk Analysis.
 See Comments on Proposed Rule: Modernization of Regulation S-K Items 101, 103, and 105, available at https://www.sec.gov/comments/s7-11-19/s71119.htm. The Commission has received nearly 3,000 comment letters on the proposal, including a campaign that generated the submission over 2,800 form letters cautioning against reliance exclusively on principles-based disclosure and asking for more disclosure on workforce development, climate, and diversity, and at least 97 unique letters.
 See, e.g., Letter from AFL-CIO (Oct. 22, 2019).
 See, e.g., Letter from California State Teachers’ Retirement System (Oct. 26, 2019).
 See, e.g., Letter from Service Employees International Union (Oct. 22, 2019).
 See, e.g., Letter from New York State Common Retirement Fund (Oct. 22, 2019).
 See Climate Change Indicators: Weather and Climate, U.S. Environmental Protection Agency https://www.epa.gov/climate-indicators/weather-climate (“Scientific studies indicate that extreme weather events such as heat waves and large storms are likely to become more frequent or more intense with human-induced climate change.”); see also Stephanie C. Herring, Nikolaos Christidis, et al., Explaining Extreme Events of 2018 from a Climate Perspective, Bull. Amer. Meteor. Soc. (2020) 101 (1): S1–S140 (analyzing extreme weather events and presenting evidence they were made more likely by human-caused climate change); Jeff Berardelli, “Climate chaos: Extreme heat, wildfires and record-setting storms suggest a frightening future is already here,” CBS News (Aug. 24, 2020).
 See, e.g., David C. Broadstock, Kalok Chan, Louis T.W. Chenga, Xiaowei Wang, The role of ESG performance during times of financial crisis: Evidence from COVID-19 in China, Finance Research Letters (2020) (finding that ESG performance mitigates financial risk during financial crisis).
 See, e.g., Oliver Schutzmann, “ESG stocks prove their value during Covid-19 crisis,” IR Magazine (Apr. 3, 2020); UBS Asset Management – Global, “How has COVID-19 impacted ESG investing?” https://www.ubs.com/global/en/asset-management/insights/panorama/mid-year/2020/covid-19-impacted-esg-investing.html (finding that “higher rated ESG funds fared better in the Covid-19 induced market downturn”).
 See Letter from Human Capital Management Coalition (Oct. 22, 2019) (an organization of 28 institutional investors representing over $4 trillion in assets under management advocating for universal disclosure of those four metrics).
 I would have supported a final rule that included even the introduction of the topic of climate risk. This rulemaking updates two of the disclosure items that the Commission identified in its 2010 guidance as potentially appropriate locations for climate disclosure, yet we purport to modernize the rule a decade later, as the climate crisis intensifies, without even mentioning this pressing issue.
 See Mark Carney, Governor of the Bank of England, “The Road to Glasgow” (Feb. 27, 2020) (“Every major systemic bank, the world’s largest insurers, its biggest pension funds and top asset managers are calling for the disclosure of climate-related financial risk through their support of the Task Force for Climate-related Financial Disclosures (TCFD)”); TCFD Supporters, https://www.fsb-tcfd.org/tcfd-supporters/ (representing a market capitalization of over $12 trillion and including issuers, credit rating agencies, and index providers as well); Principles for Responsible Investment (PRI), https://www.unpri.org/pri-blogs/pri-welcomes-500th-asset-owner-signatory/5367.article (representing over $90 trillion in assets under management); see also Blackrock, Toward a Common Language for Sustainable Investment (Jan. 2020) (“Our investment conviction is that sustainability-integrated portfolios – composed of more sustainable building-block products – can provide better risk-adjusted returns to investors. With the impact of sustainability on investment returns increasing, we believe that sustainable investment will be a critical foundation for client portfolios going forward.”); Fitch Ratings, “Fitch Ratings Launches ESG Relevance Scores to Show Impact of ESG on Credit” (Jan. 9, 2019); Hazel Bradford, “ESG initiatives by exchanges on the rise, survey says” Pensions & Investments (Apr. 23, 2019).
 See Emirhan Ilhan, et al., Institutional Investors’ Views and Preferences on Climate Risk Disclosure, European Corporate Governance Institute, Working Paper No. 661/2020 (Feb. 2020), https://ecgi.global/sites/default/files/working_papers/documents/ilhankreugersautnerstarksfinal.pdf (“51% of respondents believe that climate risk reporting is as important as traditional financial reporting, and almost one-third considers it to be more important.”).
 See Bank of America/Merrill Lynch, Equity Strategy Focus Point, ESG Part II: a deeper dive (June 15, 2017), https://www.iccr.org/sites/default/files/page_attachments/esg_part_2_deeper_dive_bof_of_a_june_2017.pdf (“Prior to our work on ESG, we found scant evidence of fundamental measures reliably predicting earnings quality. If anything, high quality stocks based on measures like Return on Equity (ROE) or earnings stability tended to deteriorate in quality, and low quality stocks tended to improve just on the principle of mean reversion. But ESG appears to isolate non-fundamental attributes that have real earnings impact: these attributes have been a better signal of future earnings volatility than any other measure we have found.”).
 See McKinsey & Co., Diversity Wins, How inclusion matters (May 2020), https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/Diversity%20and%20Inclusion/Diversity%20wins%20How%20inclusion%20matters/Diversity-wins-How-inclusion-matters-vF.pdf. The same report found that companies with more than 30 percent women on their executive teams are significantly more likely to outperform those with between 10 and 30 percent women, and these companies in turn are more likely to outperform those with fewer or no women executives.
 See As You Sow, Workplace Equity Disclosure Statement, https://www.asyousow.org/our-work/gender-workplace-equity-disclosure-statement.
 See Hannah Orowitz and Brigid Rosati, “An Early Look at the 2020 Proxy Season” (June 10, 2020), https://corpgov.law.harvard.edu/2020/06/10/an-early-look-at-the-2020-proxy-season/ (“[A]n examination of environmental and social (E&S) shareholder proposals generally shows that diversity-focused proposals are also garnering significant shareholder support this season.”).
 See S&P Global Rankings, Why Corporations’ Responses To George Floyd Protests Matter (July 23, 2020), https://www.spglobal.com/ratings/en/research/articles/200723-environmental-social-and-governance-why-corporations-responses-to-george-floyd-protests-matter-11568216.
 See Intergovernmental Panel on Climate Change, Special Report on Global Warming of 1.5°C (Oct. 2018) (finding global warming is likely to reach 1.5 degrees Celsius between 2030 and 2052 if it continues to increase at the current rate, and discussing climate-related risks to health, livelihoods, food security, water supply, human security, and economic growth).
 See Network for Greening the Financial System, The Macroeconomic and Financial Stability Impacts of Climate Change, Research Priorities (June 2020), https://www.ngfs.net/sites/default/files/medias/documents/ngfs_research_priorities_final.pdf (“More frequent or severe extreme weather events and/or a late and abrupt transition to a low-carbon economy could have significant impacts on the financial system, with potential systemic consequences.”); see also Gregg Gelzinis and Graham Steele, Center for American Progress, “Climate Change Threatens the Stability of the Financial System” (Nov. 21, 2019).
 See Sustainability Accounting Standards Board (SASB), Climate Risk Technical Bulletin (Oct. 2016), https://www.sasb.org/wp-content/uploads/2019/08/Climate-Risk-Technical-Bulletin-web.pdf (“SASB research demonstrates that 72 out of 79 Sustainable Industry Classification System (SICS) industries are significantly affected in some way by climate risk. This equates to $27.5 trillion, or 93 percent of U.S. equities by market capitalization.”).
 See Carney, supra note 12.
 See Ceres letter to federal financial regulators (July 21, 2020), https://www.ceres.org/sites/default/files/Federal%20Regulators%20Letter.pdf; see also Ceres, Addressing Climate as a Systemic Risk: A call to action for U.S. financial regulators (June 1, 2020), https://www.ceres.org/resources/reports/addressing-climate-systemic-risk.
 See Orowitz and Rosati, supra note 17.
 See, e.g., Climate Action 100+, an investor initiative with 375 signatories representing over $35 trillion in assets under management seeking improved climate performance and transparent disclosure from the world’s largest greenhouse gas emitters. See also State Street Global Advisors, The ESG Data Challenge (Mar. 2019) (“Asset owners and their investment managers seek solutions to the challenges posed by a lack of consistent, comparable, and material information. Investors increasingly view material ESG factors as being critical drivers of a company’s ability to generate sustainable long-term performance. In turn, ESG data has increasing importance for investors’ ability to allocate capital most effectively.”); Letter from Larry Fink, Chairman & CEO, BlackRock to CEOs (Jan. 14, 2020) (“Investors are increasingly reckoning with these questions and recognizing that climate risk is investment risk. Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock … .They are seeking to understand both the physical risks associated with climate change as well as the ways that climate policy will impact prices, costs, and demand across the entire economy. These questions are driving a profound reassessment of risk and asset values.”).
 Indeed, a report by the Governmental Accountability Office from 2018 found significant inconsistencies in climate disclosures—variations among definitions, metrics, and methodologies. See Government Accountability Office, Climate-Related Disclosures, SEC Has Taken Steps to Clarify Disclosure (Feb. 2018) (“[C]ompanies may report similar climate-related disclosures in different sections of the filings, and climate-related disclosures in some filings contain disclosures using generic language, not tailored to the company, and do not include quantitative metrics. When companies report climate-related disclosures in varying formats and specificity, SEC reviewers and investors may find it difficult to compare and analyze related disclosures across companies’ filings.”). These disclosures are not standardized even within industries, they are not consistent period to period, they are not reliable, and they are not comparable. I note also a lack of staff comment letters on climate-related disclosure. See Mindy Lubber, CEO and President of Ceres, Comments on the Climate Risk Disclosure Act of 2019 (July 18, 2019) (“A search for SEC comment letters asking issuers to improve their climate-related disclosure in Commission filings reveals only one such letter from January 2017 to [July 2019].”). Reliance on principles-based disclosure rules alone can only work when regulators have the requisite resources, information, expertise, skepticism, and independence from industry. See Cristie Ford, “Principles-based Securities Regulation in the Wake of the Global Financial Crisis,” 55 McGill Law Journal, Vol. 55 (2010).
 As I have said before, through our continued failure to even engage in the discussion about this momentous risk to the financial system, we risk falling behind international efforts and putting US companies at a competitive disadvantage globally. Our international counterparts are moving forward with a number of thoughtful initiatives, and this challenge requires a global effort. The European Commission, the UK, China, Hong Kong, Singapore, Japan, Australia, Canada, and Mexico have all taken aim at improving sustainability disclosures. See Blackrock, supra note 12 (summarizing international developments). There is now an extensive network of disclosure approaches, both voluntary and mandatory, put in place by governments, exchanges, index providers, and non-governmental organizations. See Recommendations of the Task Force on Climate-related Financial Disclosures, at Tables A4.1, A4.2 and A4.2 (June 2017) (summarizing both voluntary and mandatory regimes); see also Network for Greening the Financial System, A call for action: Climate change as a source of financial risk (Apr. 2019) (recognition by a network of, at the time of the report, 34 central banks and financial supervisors, that “[c]limate-related risks are a source of financial risk and it therefore falls squarely within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks.”).
 We should partner with and leverage the great work that has already been done by private standard setters and others on many of these issues. See, e.g., SASB, TCFD, PRI, Global Reporting Initiative, International Integrated Reporting Council, and Partnership for Carbon Accounting Financials.