Saturday, May 22, 2021

Get Your ESG House in Order

Here Come the Regulators.

Author: David Schwartz J.D. CPA

Environmental, social, and governance (ESG) investing has taken global financial markets by storm over the last few years. Post-pandemic, the demand for ESG investments has only intensified and has proven to be much more durable than a fad. However, lack of consistency and transparency threatens the trustworthiness of ESG as a category, and has led to accusations of 'greenwashing.' 


As a result, US regulators and their counterparts in the EU and UK have begun building regulatory and enforcement momentum, focusing on the quality and accuracy of ESG disclosures by asset managers and investment funds. Accounting and other standard setters have joined their regulatory brethren in calling for consistency in financial and non-financial ESG reporting.


Up until now, non-governmental organizations (NGOs) and industry associations have set ESG standards and benchmarks, with no single accepted framework for evaluating and comparing assets emerging as even an unofficial norm. The industry has also relied on often opaque scoring systems in assessing the ESG credentials of companies.


This, however, is beginning to change as regulators focus more on ESG.  In Europe, the European Securities and Markets Authority (ESMA) has taken steps toward standardizing ESG disclosure and investment practices. Meanwhile, in the US, the Securities and Exchange Commission (SEC) has published initial guidance to improve transparency for investors and credibility for the industry. For example, it has recommended that asset managers should document the processes used to generate scores, perform proxy voting, and notify the board of any disagreement with a decision. More importantly, the SEC has made clear an ESG disclosure framework is coming and has opened a comment period on potential climate change disclosures.


The prospect of more prescriptive ESG disclosure requirements raises questions about how financial firms collect, aggregate, and contextualize their ESG data. Above all else, they will need to marshal appropriate resources and data to demonstrate in their reports to regulators and shareholders that they describe their ESG activities accurately and appropriately and live up to their commitment to investors. Failures on this front could be costly. Regulators like the SEC have already made clear that they intend to focus on potential deficiencies in ESG disclosures. Firms ultimately cited and penalized by the SEC for greenwashing open themselves up to painful and protracted litigation from classes of disappointed investors. 


Now is the time to get your ESG house in order. As we wait for the inevitable rules, now is the time to assemble your data and make sure the linkages between your disclosures and activities are meaningful and accurate and ensuring the compliance structure is in place to collect the data you will need to satisfy the SEC examiners or take to the courthouse.