Discover the limitations of voluntary sustainability reports and ESG ratings, driven by market forces, in providing complete and comparable climate-related disclosures. Understand the role of the SEC rule in enhancing disclosure consistency and promoting fair access to crucial information.
Now, you might be saying, “but what about sustainability reports - don’t those meet the need?”. Well, yes and no. About 90% of S&P 500 companies do, in fact, publish voluntary sustainability reports, but only 16% include any reference to ESG factors in their SEC filings.
Because sustainability reports are voluntary, there are no enforceable standards for what these reports contain, giving rise to a near-infinite set of approaches regarding the disclosures, data methodologies, and forward-looking statements these reports are composed of.
There is also ample room for greenwashing bias as sustainability reports are generally published with the primary intent of boosting a company’s reputation in the market, and thus are likely to shy away from disclosing potentially negative climate impacts.
The result, of course, is an incomplete picture of a company’s true exposure to climate and financial risks, and beyond that, one that is not directly comparable across companies.
These incomplete and/or incomparable voluntary reports inspire a call back to the second tenet of the SEC’s mission: maintaining fair, orderly, and efficient markets.
In the absence of an enforceable standard, many larger investors are now looking beyond sustainability reports and seeking additional external assessments of a company’s financial exposure to climate impacts and their strategies in place to deal with them. This has quite naturally created an industry of external ESG ratings firms that compile this information and provide a more comprehensive picture to investors.
While these ratings firms can provide useful information to the market, without uniform disclosure by companies, there is a risk that the ratings promote asymmetric information favoring larger investors who can afford access. As a result, an inefficient market is created.
In summary, sustainability reports and ESG ratings are market-driven tools that have fostered progress in the exchange of climate-related disclosures. The SEC rule now seeks to further those activities in service of high-fidelity disclosure and equal access to information.