- Several global regulators moved ahead in 2021 to establish new public reporting requirements relative to the governance and climate policies and practices among security issuers.
- Regulations related to enhanced ESG disclosure are being discussed and examined in the U.S. as well as the European Union.
- Changes will have implications for asset managers, investors, regulators, and consumers.
Members of Breckinridge’s corporate bond research team, who monitor reporting requirements, recently offered their perspectives regulatory developments during 2021 intended to standardize disclosure. A companion article touches on recent developments by non-governmental organizations to advance ESG disclosure.
In the U.S., the Securities and Exchange Commission (SEC) rulemaking on governance issues.
Director, ESG Research Rob Fernandez: The SEC published its rulemaking plan related to disclosures regarding diversity and human capital—both are key corporate governance matters. This is in addition to proposed reporting requirements for climate risks. It is possible the SEC will share the proposed standards in early 2022, allowing for comments from market participants. Publication of final rules will follow sometime after that.
Co-Head, Research Nick Elfner: Reporting disclosures are a significant issue in the SEC’s history going back to the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010. Those were primarily focused on audit and financial reporting standards rather than the human capital and climate matters that some of the SEC’s 2021 proposals seek to address. The efforts are consistent with our belief that ESG factors require more transparency, as they are key drivers of sustainable growth and long-term value creation.
Considerations regarding the materiality of key human capital and workforce diversity issues.
Senior Research Analyst Abigail Ingalls: Related to human capital, the SEC is weighing whether to require disclosure of metrics on workforce turnover, skills and development training, compensation, benefits, workforce demographics, and health and safety considerations.
Some contend these are issues for human resources management reporting more than SEC periodic reports. Others, including Breckinridge, point out that inadequate or ineffective policies and practices in these areas represent material risks to an issuer’s financial performance.
Senior Research Analyst Josh Perez: In risk areas like fraud, employee health and safety, and illegal operations, the links are clear between effective policies and better overall long-term corporate performance. For other areas, such as board member or management diversity, the linkage between effective policies and performance may be less clear, but they do exist nonetheless.
There are studies that support these principles. A 2018 McKinsey Global Institute study found that company executive teams with great ethnic and cultural diversity were 33 percent more likely to have industry leading profitability.
For more than five years, McKinsey has explored the role of women in business and noted those companies that lead in gender diversity also often lead their sectors in performance over time.
AI: There is also evidence1 that comprising a workforce that demographically is representative of a company’s clientele can help support revenue expansion. Similarly, ongoing training and education can enhance the skillset of the workforce for the benefit of the company and its clients.
Legislative efforts in 2021 targeted ESG disclosures.
Senior Research Analyst Brian Garcia: In addition to the SEC in the U.S., Congress is looking at ESG disclosure. In June, the U.S. House of Representatives passed H.R. 1187—the ESG Disclosure Simplification Act of 2021.
Specifically, it would mandate that public companies listed with the SEC disclose to shareholders a description of management’s view of the link between ESG metrics—like those based on governance practices—and the long-term business strategy of the company. That disclosure would also cover processes used to determine the impact of ESG metrics in the long-term.
Senior Research Analyst Josh Perez: H.R. 1187 was drafted by the House Financial Services Committee. It also includes proposed reporting requirements on corporate governance matters including executive pay and political spending.
While it may not ultimately become law, H.R. 1187’s provisions are consistent with trends among a growing number of shareholders and consumers who expect companies to meet corporate responsibilities described in the U.N. Guiding Principles on Business and Human Rights.
Disclosure proposals in the U.S. similar to efforts globally that target ESG disclosures.
RF: A United Nations Principles for Responsible Investment (PRI) survey of U.S. PRI signatories, found that 87.5 percent of respondents want the SEC to establish mandatory baseline ESG disclosure requirements that provide consistent, comparable data needed to fully consider ESG-related risks and opportunities in investment decisions.
The disclosures we are discussing—specifically reporting on ESG metrics and their effect on long-term business strategy—are similar in many respects to requirements in the European Union’s (EU) Sustainable Finance Disclosure Regulation (SFDR).
Senior Research Analyst Evan Lassow: The EU Commission took a substantial step to standardize important aspects of sustainable operations in December 2019. It introduced the EU Taxonomy. (See Setting the Rules of the Road for Sustainable Markets.)
The EU’s Non-Financial Reporting Directive, which is being revised and will be renamed the Corporate Sustainability Reporting Directive, and the SFDR, in combination with the EU taxonomy, create one reporting framework.
Reflecting the EU’s commitment under the Paris Agreement to achieve carbon neutrality by 2050, the Taxonomy Regulation and technical screening criteria initially focuses on climate change issues. The Taxonomy’s climate mitigation and climate adaptation requirements will apply to reporting on January 1, 2022, according to S&P Global.2
Senior Research Analyst Josh Stein: The SEC and the Biden administration are pushing for international collaboration on ESG transparency requirements. Just a few days ahead of the COP26 climate conference in November, the UK government announced plans to introduce legislation requiring mandatory climate-related disclosure by companies and financial institutions. That legislation is expected to become law in April 2022. If it does, the UK’s largest publicly listed companies and financial institutions will be required by law to provide reporting in line with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD).
Breckinridge responds to SEC rulemaking efforts on climate risk.
RF: Breckinridge responded to the SEC’s request for public comment in June 2021. We also had the opportunity to participate in a constructive SEC staff listening session on climate disclosure with other institutional investors. The SEC was receptive to investor input while investors on the call had a lot of ideas for ways that companies could more clearly articulate their exposure to physical as well as transition risks.
NE: Overall, we support the attention being paid to ESG disclosure from regulators and legislators. The point is that improved disclosures and reporting standards across ESG matters—including human capital management, climate, and governance policies and practices—can improve our ability as investors to gauge management’s accountability, transparency, responsibility, fairness, and, we believe, prospects for long-term sustainable success.
We will monitor the progress in the U.S. of legislation like H.R. 1187 and the SEC’s rulemaking, as well as the global implementation of the EU Taxonomy and the SFDR throughout 2022.
 “Creating a Culture of Diversity Can Help Your Business Grow and Thrive,” Career Attraction, 2021, Kermes, Kevin.
 “EU Taxonomy Timeline,” EU Taxonomy Info, December 7, 2021.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions.
While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will provide improved risk-adjusted returns over any specific time period.
Some information has been taken directly from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness.