ESG Investing and Standards for Disclosure

by | Jul 22, 2016 | Economics

The Securities and Exchange Commission was recently looking for comment on “Business and Financial Disclosure Required by Regulation S-K”. Specifically on, inter alia, Environmental, Social, and Governance (ESG) disclosure. Most big companies publish a sustainability report. There is no one standard for measuring sustainability though. We at ii are all about standards and so we had a look.

The period for comments closed yesterday. The last review was back in the 1970s when Environmental and Social Governance investing was just getting up steam.

Here are my notes from reading the request for comments and the Sustainability Accounting Standards Board review:

  • Sustainability disclosure encompasses a range of topics, but can be summarized for disclosure purposes as environmental, social, or governance (“ESG”) issues.
  • There is a growing interest in ESG disclosure among investors. ESG investing is no longer a marginal but indeed is widespread.
  • Current corporate sustainability reporting is primarily voluntary. As such, the information made available to investors is inconsistent and incomplete. But that firms choose to provide sustainability information outside of their Commission filings suggests that it has value to some or all of: the companies, their shareholders, customers, and potential shareholders.
  • Sustainability issues are now material to an understanding of the company’s financial performance.
  • Because most ESG issues relate to future risks management’s judgment to determine when disclosure is required is more feasible than bright-line rule-based tests in evaluating materiality for purposes of disclosure.
  • Sustainability can be measured adequately for disclosure rules.
  • Rules on: a common set of metrics to value the economic, social and environmental benefits; a set of standard valuation methodologies; shadow price inputs; and a measure of the risk involved could elicit meaningful disclosure.

By not counting the full social, environmental and financial cost of building and infrastructure projects, engineering and architecture firms are unnecessarily increasing the financial risk of their firms and of their, and their clients’, infrastructure projects. Companies involved in building and infrastructure projects should take responsibility for their externalities. Investors should be made aware of the extent to which they are doing so, or not.

Many of the intangible costs and benefits encountered during infrastructure projects are related to sustainability. Project delays can be caused by not anticipating risks, regulatory delays, or stakeholders’ perceived negative consequences. If an Architecture, Engineering and Consulting (AEC) firm is designing an infrastructure project and has not developed a plan to deal with wetland loss it may have angry birders on its case. When peoples’ hackles are raised, environmental and social risks can quickly become project and financial risks with real dollar impacts. This is why so many companies in industries with active opponents or sensitive stakeholders are using Cost Benefit Analysis (CBA) to put prices on non-market goods and services.

CBA can be used to measure relative sustainability (relative to a building standard or a base case design) and has been standardized and can be embedded into engineering, architecture and design processes such as Building Information modelling (BIM).

Standardization of the data, methodologies, and output from CBA is required to make it accessible to AEC firms in their familiar planning, design, and construction processes. A standardized cost benefit framework that monetizes externalities allows AEC firms to respond rationally and in ways that are simultaneously defensible and transparent to all stakeholders. Using non-market or shadow prices, internalizing externalities, or valuing the environmental, social as well as the financial risks are all ways for AEC firms to address the obligation to fully assess the impacts and returns associated with their infrastructure project.

Rules on: a common set of metrics to value the economic, social and environmental benefits; a set of standard valuation methodologies; shadow price inputs; and a measure of the risk involved could elicit meaningful disclosure.

I have posted a longer review here.

The Sustainability Accounting Standards Board has responded – “today’s mainstream investors increasingly seek better disclosure of sustainability-related information. While Regulation S-K already requires the disclosure of material information, the resulting disclosure of sustainability-related information is insufficient. To make sustainability disclosure more cost-effective for companies and decision-useful for investors, we need a market standard. SASB was created to fill this need. … SASB standards are created by the market, specific to industry, and compatible with U.S. securities law. We encourage the SEC to acknowledge SASB standards as an acceptable disclosure framework for use by companies preparing their SEC filings.”

Cornerstone Capital advocated for “Integration of sustainability disclosures into financial reporting; A focus on material issues that may affect corporate performance over the long term; Principles-based rather than rules-based guidance, so that managements must exercise judgment about which issues matter for their business.

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