Since late February 2021, the SEC has issued several statements regarding Environmental, Social, and Corporate Governance (ESG) related risks facing businesses and their stakeholders. These risks are largely due to companies mislabeling ESG funds as being green, or intentionally promoting other funds as ESG products. As a result, Gary Gensler, Biden’s appointee to lead the SEC, has augmented expectations such that the agency will toughen its ESG oversight compared to the previous administration, and plans to stick with the same ESG focus as the Acting Chair, Allison Lee. Gensler has commented that the SEC hopes to instate mandates focused on standardizing sustainability reporting, with additional approaches being developed currently as the public comment period continues through June 13.
SEC on ESC Related Governance
So far this year, the SEC has issued a bulletin to educate investors about ESG funds in which they detailed key questions they should ask companies about ESG before investing. The commission also announced their plans to monitor voting proxy policies and practices to ensure that voting aligns with the best interest and expectations of investors given the intensifying physical risks companies are facing associated with climate change. They also announced the creation of a climate and ESG task force, dedicated to proactively identifying ESG misconduct among corporations. The initial focus of this task force will be to uncover gaps or misstatements in issuers’ disclosure of climate risks under existing rules. This was followed by a risk alert issued by the commission’s Division of Examinations, stating a high likelihood that investment advisors are wrongfully promoting funds as ESG products.
The SEC set out to evaluate whether companies were accurately disclosing their ESG investing approaches and behaving accordingly to their disclosures. Their examination metrics included portfolio management, performance advertising and marketing and compliance programs. They found that portfolio management practices, such as proxy voting decision making and the creation of marketing materials, were inconsistent with disclosures about ESG approaches. The examination also uncovered weaknesses in the policies and procedures governing the implementation and monitoring of ESG directives. Proxy voting was often inconsistent with the adviser’s stated approaches, and advisers frequently made unsubstantiated claims regarding substantial contributions to the development of specific ESG products when their roles were actually very limited or inconsequential.
ESG expectations are indeed becoming more ubiquitous, largely due to the establishment of global ESG standards by the World Economic Forum’s International Business council in September of 2020. In the PwC annual Corporate Director’s survey, however, only 51% of over six hundred companies said their board fully understands how ESG issues are impacting their company. Moreover, only 45% of directors say that ESG issues are a regular part of their board agenda.
So what can corporate boards do to improve their ESG oversight?
First, they can understand the importance of ESG issues to the success of their company. When surveyed by GreenBiz, 47% of directors said they believed ESG was important for brand equity and reputation, 24% mentioned customer and investor pressure, and 18% pointed to risk management and board pressure. Since board oversight includes advising the management team on the company strategy, the board must also understand how ESG issues can affect strategy and be in a position to address challenges and opportunities.
Boards should add ESG to their next meeting agenda. Even though investors and stakeholders demand that boards discuss ESG, less than half of company boards are addressing it currently. Corporate leaders who include meeting ESG demands in their long-term strategy will be in a better position to address new risks and opportunities.
As a board recruits new directors or replaces sitting directors, they ought to consider adding a director with ESG expertise. However, even with an expert in the mix, it is becoming increasingly necessary for the full board to understand ESG strategy and how risks are being mitigated.