Top 10 Sustainability Developments in 2018

Investor, regulatory, and corporate interest in environmental, social and governance (ESG) issues seems to be growing by leaps and bounds. If securities lawyers haven’t been springing to attention already, then the arrival of a New Year, and a new proxy season, is a good time to start.

Here is a list of the top ten developments of 2018 that securities (and other) lawyers should find of interest.

1. Institutional investors are insisting on better sustainability

Large institutional investors are now firmly in the environmental, social and governance (or ESG) camp. Increasingly, ESG is viewed as an important risk factor for all investors in all types of companies and, accordingly, companies need to make better disclosures.

BlackRock, the world’s largest asset manager, has been particularly outspoken in this regard. In January 2018, the firm’s chief executive Larry Fink stated in his annual letter to CEOs that “a company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process.” On August 7, 2018, BlackRock announced plans to require that all of its fund managers consider ESG factors when they invest. And the firm’s 2018 U.S. proxy voting guidelines stated: “BlackRock expects companies to identify and report on the material, business-specific Environmental & Social risks and opportunities and to explain how these are managed.”

Other leading firms took similar steps. Vanguard’s guidance in its 2018 Investment Stewardship Annual Report stated that companies should provide “consistent, comparable, decision-useful disclosure on sustainability risks” that includes “both historical data and forward-looking information so that the market has context for what companies have done, what they plan to do, and how their governance structures enable the right decisions.” State Street’s guidance on providing meaningful climate-related disclosure expressed the view that “boards should regard climate change as they would any other significant risk to the business and ensure that a company’s assets and its long-term business strategy are resilient to the impacts of climate change.”

These views were evinced in proxy voting: in 2018, almost 29% of shares held by institutional investors were voted in favor of environmental and social shareholder proposals, up from 19% in 2014.

2. Investors are focusing on evidence of financial materiality.

Why the increased pressure for better ESG disclosure? Largely because there is a considerable body of academic research that supports the financial materiality of ESG factors, and this support grew in 2018.

For example, BlackRock issued a white paper in May, “Sustainable Investing: A ‘Why Not’ Moment”. Citing the evidence, the report stated: “Strong ESG performers tend to exhibit operational excellence and are more resilient to perils ranging from ethical lapses to climate risks…. we have moved from a ‘why’ to a ‘why not’ moment in sustainable investing.”

Further, the evidence on this point was well summarized in a report on ESG investing issued by the General Accountability Office, also in May:

“Academic research on the performance of investments incorporating ESG factors suggests that such factors can be a valid financial consideration, both in the aggregate and as individual factors. The vast majority (88 percent) of the scenarios in studies we reviewed that were published in peer reviewed academic journals between 2012 to 2017 reported finding a neutral or positive relationship between the use of ESG information in investment management and financial returns in comparison to otherwise similar investments. When considered independently, environmental, social, and governance factors were each found to have either a neutral or positive relationship with financial performance in over 90 percent of the scenarios.”

3. SASB publishes its codified ESG standards

Responding to investor demand, many companies are beginning to make more fulsome and specific disclosures about material ESG matters. One reason for this is the issuance of a set of standards released in November 2018 by the Sustainability Accounting Standards Board (full disclosure: as noted above, I work on a part-time basis as SASB’s Legal Director). The SASB standards were developed after nearly six years of work to provide a means for companies to make decision-useful and industry-specific information on ESG items that are likely to be financially material. This is a voluntary regime, and in 2018 SASB revised its view that the disclosures should only be made in a regulatory filing, stating that other forms of investor communication (annual reports, integrated reports, websites, sustainability reports, letters, and so on) were appropriate for disclosure—although, if the information is considered to be material, companies might well conclude that the disclosures should in fact be included in the MD&A or another portion of a 10-K or similar report. SASB does stress that companies should have in place internal controls and governance processes for these disclosures that are comparable to what are used for traditional financial information.

A number of large companies have already started to make disclosures using SASB standards, including General Motors, Diageo, Nike, Kellogg’s, and JetBlue.

The issuance of SASB’s standards may be reshaping the thinking behind corporate ESG disclosures. For example, a report issued in late 2018 by the Investor Responsibility Research Council described this as an element of the “next phase” in the evolution of sustainability reporting, noting “raised expectations for companies in ways that may not only change how companies report on sustainability, but also how they define their corporate identities and approach business in general.”

4. Standard-setters are focusing on complementary frameworks and better alignment

SASB is the only organization that has worked towards industry-specific, financially material ESG disclosures, but it is certainly not the only global body developing standards in this area. There are many others doing important work, most significantly the Global Reporting Initiative (GRI), which pioneered working in this space more than two decades ago. Unlike SASB, which focuses on how ESG factors might impact a company’s financial well-being, GRI looks at how a company’s activities might impact the world. So GRI’s standards are geared toward many interested parties or stakeholders, while SASB’s are focused solely on investors.

There are many additional standard-setters with different approaches or narrower agendas than SASB—among these, the Task Force on Climate-Related Financial Disclosures (TCFD), the Climate Disclosure Standards Board, and others. In September 2018 the TCFD issued a status report on how much progress had been made since issuance of its recommendations a year earlier; the status report stated that “[m]ore than 500 public- and private-sector organizations have now indicated their support for our recommendations, including global companies, banks, insurers, asset managers, stock exchanges, and governments.”

The profusion of organizations in this area has caused confusion among many corporate issuers, who quite understandably say to themselves, we would like to do a better job of disclosing sustainability risks but how should that be done? And many institutional investors advocate for standardization of ESG disclosure. For example, Vanguard’s 2018 Investment Stewardship Annual Report stated that

“[t]hrough our support of such organizations as the Sustainability Accounting Standards Board, the Task Force on Climate-related Financial Disclosures, and the Principles for Responsible Investment, we hope to see issuers and investors coalesce around a standard set of reporting frameworks that meet the needs of all parties.”

Fortunately, steps are being taken towards harmonization. In 2017, the CDSB and SASB announced an “ongoing collaboration” in order “to establish a unified approach to climate-related financial disclosures”. And more recently, in late 2018, the leading international standards setters (including CDP, the CDSB, GRI, SASB, and the International Integrated Reporting Council), who are part of the Corporate Reporting Dialogue, announced a two-year Better Alignment project that will map the different approaches to achieve “better alignment in the corporate reporting landscape.” The group also intends to identify how “non-financial” metrics relate to financial outcomes and how this can be integrated into mainstream reports.

5. Corporate lawyers are devoting more attention to ESG disclosure

Several prominent corporate law firms showed that they are now paying close attention to ESG developments, emphasizing its importance to boards and management and urging better corporate disclosure. This increased in 2018.

For example, a Wachtell Lipton client memorandum for corporate boards stated: “Be aware that sustainability has become a major, mainstream governance topic that encompasses a wide range of issues, including a company’s long-term durability as a successful enterprise, climate change and other environmental risks and impacts, systemic financial stability, management of human capital, labor standards, resource management, and consumer and product safety, and consider how your company presents itself with respect to these matters.” The Wachtell lawyers advised:

“Management should periodically monitor the level of disclosure by competitors and market cap peers pursuant to disclosure standards organizations with significant industry backing (such as SASB, GRI and IIRC) and determine, in consultation with the board, the company’s disclosure posture with respect to these or other emerging approaches.”

Likewise, a memorandum from the Skadden Arps law firm said that this area is “more consequential than ever” and that it is “critical for the company to communicate, whether in annual reports, proxy statements, sustainability or corporate social responsibility reports, or other public statements, its approach to ESG matters as part of its overall business strategy.”

6. Disclosure risks are assessed

One of the most significant stumbling blocks to companies making substantial ESG disclosures is the advice often given to them by their lawyers—that is, “don’t disclose anything more than what is required by law.” Silence, it is thought, is the safest way to avoid being sued if something goes wrong.

There are a host of responses to this concern, which were explored in some detail by a group of leading securities scholars and practitioners at a SASB-sponsored symposium at the Harvard Law School in 2017 (a summary is available on SASB’s website). Among the many responses: many companies already make various sustainability-related disclosures but often couch those disclosures in boilerplate, even though “half-truths” can create liability risk.

This is still an uncertain area, with very little case law. A memorandum prepared in 2018 by the Gibson Dunn law firm concluded that there are liability risks and cautioned against making disclosures without necessary controls and governance processes in place. Perhaps more significantly, one particularly prominent securities law scholar, Georgetown Law Professor Donald Langevoort (who was also a participant at the Harvard/SASB symposium), looked carefully at this issue in a 2018 article. He focused in particular on SASB’s work and concluded that “using a common rubric with other similarly situated issuers reduces the risk that comes from being unique in what is said.” This is particularly true because, as SASB has stated, the standards have been developed to balance investor demand against the costs and risks related to disclosure and therefore reflect investor expectations as to what companies should likely disclose (although many companies will, of course, voluntarily continue to provide additional ESG information pursuant to other frameworks, such as GRI). Accordingly, Professor Langevoort concluded, “Adherence to the letter and spirit of high-quality voluntary sustainability disclosure is more likely to lessen the litigation risk than increase it.”

7. The accountants are increasingly working in this area

The accounting profession appears to be more interested in heightened ESG disclosure than does the legal profession. All of the major accounting firms have some type of sustainability practice, although sustainability reports are not generally subject to third-party assurance, and such assurance, when obtained, is most often provided by engineering or other consulting firms.

But the firms are reporting that these practice areas are growing. The AICPA has a Sustainability Assurance and Advisory Task Force that is active in this area. Also, on an international level, the International Audit and Assurance Standards Board moved forward in 2018 with its “Emerging Forms of External Reporting” project, intended to develop guidance for “integrated reporting, sustainability reporting and non-financial reporting about environmental, social and governance matters.” This may well lead to more assurance engagements on an international level.

In addition, in October the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and the World Business Council for Sustainable Development (WBCSD) issued “Guidance for Applying Enterprise Risk Management (ERM) to Environmental, Social and Governance (ESG)-related Risks.” The report is designed to integrate ESG-related risks into ERM.

8. Some legislators express interest in better disclosure

The SEC’s 2016 Concept Release on Regulation S-K dealt with numerous issues, with mention of possible need for better ESG disclosure. That led to a torrent of comment letters urging that the SEC take steps leading to improved ESG disclosures. But the SEC has not acted, and it has given no indication that it will do anything in response. Nor has the SEC acted on either of two rulemaking requests, one seeking rulemaking that would require better disclosure about human capital and another, filed in 2018, asking for a rule that would require improved ESG disclosures generally.

On the other hand, there has been some pressure from Capitol Hill for the SEC to do something; thus far this hasn’t amounted to much, but the level of activity seems likely to increase with the change in party control of the House of Representatives.

In July, Senator Warner wrote SEC Chairman Jay Clayton asking that more qualitative and quantitative human capital management disclosures be required of public companies, also under Regulation S-K. Warner argued that a need for human capital metrics is evidenced by growing interest in ESG more generally and he notes that 1,500 investors representing $62 trillion in assets under management have signed the U.N.-based Principles for Responsible Investment. Also, Senator Elizabeth Warren introduced the Climate Risk Disclosure Act to require public companies to disclose critical information about their exposure to climate-related risks.

Other activity took place on the state level. In May the Delaware legislature approved a bill called “The Certification of Adoption of Sustainability and Transparency Standards Act,” pursuant to which Delaware corporations can obtain from the Delaware Secretary of State a “certificate of adoption” upon a showing that the company is using a set of third-party developed for disclosure of “the impact of their business and operations on issues of social and environmental impact.” It is too soon to determine whether this new law will have any traction.

9. The rest of the world takes steps towards better sustainability disclosure

Developments outside of the US in 2018 on corporate ESG disclosure were broad and diverse. Concerns about sustainability elements such as climate change, water usage and others tend to be much widespread in Europe and elsewhere, and non-US companies typically make more extensive disclosures, often because of regulatory mandates. At some point, if only for reasons of potential competitive disadvantages, US companies may feel compelled to catch up even without regulatory pressure.

Most recently, the EU’s Non-Financial Reporting Directive (NFRD) took effect in 2018. The NFRD applies to large public-interest companies with more than 500 employees, or approximately 6 000 large companies and groups across the EU, including listed companies, banks, insurance companies, and other companies designated by national authorities as public-interest entities. The law requires those companies to disclose certain information on the way they operate and manage social and environmental challenges.

As noted above, many European companies are also meeting the requirements of the TCFD, which recommended voluntary disclosures by businesses. There are also reports of significant and growing interest in how businesses are contributing to the UN’s Sustainable Development Goals (SDGs).

In this regard and of interest to securities lawyers, the UN’s Sustainable Stock Exchange Initiative issued a report in November on how securities regulators can support the SDG’s. The authors recommend that securities regulators support the ongoing efforts to develop voluntary reporting guidelines; integrate sustainability reporting guidance into listing requirements; and work with their counterparts in other jurisdictions, and with relevant international organizations such as IOSCO, to encourage internationally consistent and comparable disclosures of financially material sustainability-related information.

10. Concerns about climate change and cyber security greatly increase:

A Top Ten list in this area shouldn’t omit the big picture: the growing worldwide attention being given to sustainability issues such as climate change and cybersecurity. Volumes have been written on these topics, such as increasingly dire scientific analyses of climate change and massive cybersecurity breaches. The attention given these issues is certain to increase. (Here is an illuminative, unrecognized fact: during the Trump-Clinton presidential debates in 2016 not even one question was asked about climate change, while many were posed about the candidates’ emails and tax returns. It is hard to see that happening again.)

So this space deserves watching. ESG disclosure is something securities lawyers need to be familiar with in order to advise their clients. There are a lot of developing issues—for instance, where to disclose, what to disclose, what internal controls and governance processes need to put in place, what are the regulatory requirements, whether to involve your auditor and what risks exist—that will (and should) be the subject of continued discussion and legal analysis.