Author: Lukas Herndl | UC Berkeley School of Law | LL.M. Candidate 2019 | Posted: January 8th, 2019 | Download PDF
An increasing number of companies disclose their ESG strategy and related risks to investors and to the public. These disclosures, commonly referred to as sustainability reports, follow a rising demand by investors who see ESG as an important factor influencing the long-term performance of businesses. But since disclosure is not mandatory, a significant number of companies does not report. And absent common guidelines, voluntary sustainability reports are hard to compare and thus have less value for investors.
This October, law professors Cynthia A. Williams of Osgoode Hall Law School, and Jill E. Fisch of University of Pennsylvania Law School filed a petition with the Securities and Exchange Commission (SEC) calling the Commission to establish a clear and consistent reporting framework that requires public companies to disclose their ESG related risks and strategies. The petitioners argue that ESG data is financially material information that reasonable shareholders consider in their voting strategy. They point to the fact that several major institutional investors use ESG related data in planning their investment strategy. Recently, a significant number of capital market participants including the world’s largest asset manager BlackRock have demanded mandatory ESG disclosure. This was mainly driven by the weaknesses of existing voluntary sustainability reports, the petitioners argue: absent a general regulatory framework, the information is often incomplete, inconsistent, and not comparable between companies. In contrast, mandatory ESG disclosure would establish clear standards, make reporting consistent and comparable, and thus, meet the needs of investors.
If the SEC follows the market’s demand for a rule on ESG disclosure, a main issue will be to define the content that has to be reported. A model might be found in the European Union law: The Non-Financial Reporting Directive requires member states to enforce ESG disclosure by certain large companies beginning with financial years that started in 2017.
The EU’s lawmaking was driven by reasons very similar to those stated in the petition to the SEC: The European Parliament deemed disclosure of non-financial information vital for combining long-term profitability with social justice and environmental protection because it helps to measure, monitor and manage companies’ performance and impact. The main objective of the directive is to establish consistent and comparable reporting of relevant ESG information throughout the Common Market in the interest of companies, shareholders and other stakeholders.
Specifically, the directive sets reporting standards for large public-interest companies with more than 500 employees, although member states are free to expand the scope to other businesses. These companies are required to include in their mandatory management report the information necessary to understand the company’s development, performance, position and impact, relating to environmental, social and employee matters, to the respect for human rights, to anti-corruption and bribery. The report must include descriptions of the company’s business model, its ESG policies and their outcome; the risks related to ESG matters and how the company manages those risks; and non-financial key performance indicators relevant to the business. Where the company does not have a policy addressing one of these matters, it must provide an explanation for not having one. Further, the management report has to contain a description of the company’s diversity policy concerning its administrative, management and supervisory bodies with regard to aspects like age, gender, or educational and professional backgrounds. If no such policy is applied, the statement must explain the reason. The management report containing these disclosures underlies the general publication requirement stated in the EU Accounting Directive.
The strength of the EU model clearly lies in the broad scope of ESG related topics to be disclosed, the detailed information required, and the obligation to explain the reason for not having a policy addressing an ESG matter. Thus, the directive might serve as a suitable model for the content of disclosure required by an SEC rule.
The main weakness of the EU law is one it would likely share with a future SEC rule: The Non-Financial Reporting Directive does not set binding standards for most private companies. Likewise, the SEC has only broad authority to regulate the public market. An ESG disclosure rule would not apply to private businesses, including large, globally operating enterprises like Airbnb and Uber.Still, that does not imply that an SEC rule would not influence these parts of the market at all. Once a clear standard is set for the public sector, private companies might adapt their voluntary sustainability reports in order to provide comparable information. Most likely, shareholders and prospective investors would heavily demand that. In conclusion, an SEC rule – modeled, for example, after the EU Non-Financial Reporting Directive, would most likely be a major improvement for investors that care about companies’ ESG strategy and risks.
 Environmental, social and governance.
 Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups.
 Id., Recital 3.
 Id., Recitals 4, 6, 21.
 See Directive 2013/34/EU (EU Accounting Directive), Art 3.4: Large undertakings are companies that exceed at least two of the following three criteria: EUR 20,000,000 balance sheet total; EUR 40,000,000 net turnover; 250 employees on average during fiscal year.
 See id., Art 2 (1): Public-interest entities are companies that are designated by a member state as such, public companies, credit institutions, and insurance companies.
 Directive 2014/95/EU, Recital 14.
 See Directive 2013/34/EU, Art 19.
 Directive 2014/95/EU, Art 1 (1).
 Directive 2014/95/EU, Art 1 (2)(a).
 Directive 2013/34/EU, Art 30.
 Directive 2014/95/EU, Art 1 (1): Disclosure is mandatory for public-interest entities in the meaning of Directive 2013/34/EU, Art 2 (1). See also FN 7.