Planning Ahead: Integrating ESG into Your Next Proxy and 10-K

Originally published at https://www.consultqb.com on July 14, 2021.

ESG disclosures are no longer aspirational- the U.S. Securities and Exchange Commission’s (SEC) proposed regulations make them a reality.

When the public comment period for enhanced ESG disclosure closed last month, it was clear that not everyone is on board; at least 10 companies asked the SEC for more flexibility. Required disclosure filings increase a company’s legal liability for omitting or misstating information. Those opposed to the regulations link liability to the innate uncertainty of measuring climate-related topics.

The forthcoming regulations come amid growing investor interest in SEC submissions that contain ESG disclosures. Companies in favor of the regulations cite benefits like better comparability and efficiency if disclosure frameworks like TCFD and SASB are integrated into the SEC’s system.

Here’s what you need to know if you’re being asked to integrate ESG disclosures in your company’s Proxy or 10K for the first time:

1. ESG communications are not all made equal

There’s no time like now to learn best practices for integrating your company’s environmental, social, and governance information into annual proxy statements and Form 10-Ks.

The Center for Audit Quality’s 2021 roadmap emphasizes that ESG communications must be:

• Consistent: an established, external disclosure framework- like that of SASB, TCFD, or GRI- should be referenced in communications and reports that are released at a determined frequency.
• Comparable: strive to make your communications and reporting fit (or better yet, stand out) over time amongst your peers or industry group.
• Comprehensive: from a risk perspective, selective ESG metrics that put a company in the best light do not accurately reflect its performance. An ESG journey can become a legal liability if transparency takes a backseat in SEC submissions,

2. We’re facing an uncertain climate

Climate-related ESG risks are typically categorized as physical (from exposure to the damage of our changing natural environment) or transition-based (related to financial impacts on assets as we move towards a low-carbon economy). Under the current disclosure framework, companies are free to choose whether to disclose one, none, or a mix of climate risks from these categories.

Through required disclosures, the SEC hopes to make climate information more comprehensive. Given the vast array of corporate commitments and work in this area, SEC Chair Gary Gensler’s ESG Task Force plans to analyze existing forward-looking corporate climate statements, as well as how companies’ multinational operations comply with current climate policies in locations abroad.

Disclosure uniformity is also meant to help companies share how their ESG information and progress shape long-term business strategy. Embedding disclosures in annual filings addresses the consistency that grounds best practices in this space.

“Investors representing literally tens of trillions of dollars of assets under management are looking for consistent, comparable, decision-useful information to determine whether to invest, sell, or make a proxy vote one way or another.”

- SEC Chairman Gary Gensler at London City Week, 06.23.21

3. The S in Social capital is Swelling

Social capital carries more weight now than ever. We are emerging from a pandemic that saw community hardships and chronic injustice resonate and rise to the national discourse. This means where companies operate and who they touch along the way.

Social disclosures have all the momentum, and environmental justice is among the slate of material issues facing corporate stakeholders. Legal experts urge companies to take notice strategically by addressing the operational impacts of environmental justice on access to markets, compliance, and reputational risk.

Proxy statements, where ESG is used to communicate with stakeholders most broadly, are blooming with increased social capital proposals.

The 2021 proxy season saw more shareholder proposals on lobbying, safety, and climate mitigation planning across the value chain.

Beyond social capital, proxy references to carbon emissions, organizational ESG oversight, and workforce and Board diversity were also encouraged.

4. Your people belong in your 10-K

Companies can also utilize the Form 10-K document to make ESG disclosures. Per the Center for Audit Quality, the 10-K’s Item I (Business) section can communicate about a company’s historical ESG performance and related factual information. The Management, Discussion, and Analysis (MD&A) section of the 10-K should be used for describing trends in ESG progress, along with related estimates and uncertainties.

In 2020, the SEC mandated increased disclosure of corporate human capital measures, goals, and resources in 10-K filings. An analysis by EY of the first 10-K submissions under the mandate found disclosure themes related to employee benefits, safety, learning and development, and executive compensation. This year, Gensler’s Task Force will also respond to investor interest in understanding human assets by potentially mandating disclosure metrics that build on the 2020 move.

Additionally, a 2021 report from Stanford University’s Rock Center for Corporate Governance examined human capital management (HCM) disclosure themes in a sample of recent 10-Ks. The researchers found that diversity and inclusion (D&I) disclosures were the most common throughout the sample. On the other hand, company efforts on mental health and pay equity were only found in 7% and 5% of the sample, respectively. With mental health advocacy and compensation gaps continuing to make headlines, there is reason for corporate data collection and disclosures in these areas to develop accordingly.

Most importantly, the Rock Center team points out that “companies tend to cherry pick the categories of HCM that they disclose, and disclosure is rarely detailed and quantitative”. This conclusion speaks more broadly to the current state of ESG disclosures: it’s also fuel for the SEC’s pending regulations.