As summer vacation season sets in, an important debate is taking place over the potential for the Securities and Exchange Commission (SEC) to require corporate disclosures on matters of sustainability. Contrary to what one might expect, this debate is taking place between investor coalitions themselves.
In a harsh letter addressed to the Sustainability Accounting Standards Board (SASB), the Investor Environmental Health Network (IEHN) identifies an uncomfortable tension that is plaguing investor coalitions seeking corporate sustainability disclosures: the need for single set of standards to legitimize corporate sustainability disclosure and the limitations that a dominant set of standards has on future innovation.
The SASB has taken the approach of advocating for a single standard for corporate sustainability disclosure, recognizing that many competing and conflicting sustainability reporting standards and definitions of materiality has undermined progress in this area thus far. Drawing an analogy to the evolution of financial reporting standards from a a collection of confusing and conflicting frameworks to a single recognized standard (FASB), the SASB implies that the same evolution in sustainability standards is necessary if sustainability is to be taken seriously.
But as the IEHN points out, the SASB approach relies on a narrow definition of what counts as material information for investors. Materiality as a legal concept is widely used to determine what information a corporation should disclose to its investors, and it is defined as “the information alters the total mix of information in a way that could alter the reasonable investor’s decisions.”
The SASB definition of materiality stops short at information that affects corporate valuation. In its letter to the SEC advocating for the adoption of SASB standards, SASB notes that “If financial materiality and the link to financial impact could not be demonstrated for a particular topic, the topic was not included in the standards.”
To be sure, some efforts are made to account for systemic and cross-cutting issues that affect whole industries, but as IEHN letter points out, this has been ad hoc and lacks transparency. Systemic risks are those that impact whole financial, social and environmental systems and may not be identified at individual or even portfolio level. Systemic risks interact with portfolios and corporate valuations in complex ways and future, particularly for universal owners such as pension funds and sovereign wealth funds, these risks are paramount.
If the SASB intends to be the standard setter for corporate sustainability disclosure, the SASB itself must be held to some standard of accountability. For example, the IEHN notes that SASB seems to have cherry picked climate change as an important systemic risk, but with no transparency over how this risk was selected and why other systemic risks were not.
“The practical reality is that as a market leader, SASB and its standards do not only provide information that investors seek – it effectively plays the role of advising investors as to the type of information that they should seek.” – IEHN, 2016
So on the one hand, the SASB offers up a tested and unambiguous framework that stands a good chance of earning widespread legitimacy if their standards are adopted by the SEC. But on the other hand, the approach that the SASB proposes is frustratingly similar to what conventional finance already does. As the IEHN argues:
“Sustainable accounting…standards as initiated by SASB are a necessary corrective to the failure of market forces and securities regulators to address environment, human rights, governance and other issues of great importance. The poor availability and inconsistency of this data is due in part to siloed economic decision-making; the SASB should not repeat this problem in its Conceptual Framework…”
How, then, are we to make meaningful (i.e. innovative) progress on corporate sustainability disclosures, while also avoiding the confusing and stalemate of multiple and conflicting frameworks vying to set the standard for what counts as relevant sustainability information?
The IEHN suggests that “multiple actions should be considered by the SEC that more adequately reflect the range of investor interest in sustainability disclosures and especially investors whose fiduciary duties necessitate attention to crosscutting and systemic risks.”
But I suspect that the SASB already recognizes the limitations. For example, a recent webinar co-hosted by the SASB, it is suggested that the SASB standards might be complemented by other frameworks, such as the Investment Integration Project, an initiative that aims to help investors identify the interdependence between risks within their portfolios and systems-level risks. And Founder Jean Roberts hints at how these frameworks might complement each other.
In other words, the SASB framework does not necessarily rule out the possibility of building diversified approaches that sees tangible progress on sustainability disclosures, while other ‘parallel’ frameworks continue to push the boundaries necessary for innovation. But if this is the case, then the SASB must make this possibility more explicit in its communications with the SEC and its stakeholders, and refrain from insinuating that the SASB should be the ONLY standard.
And SEC has its part to play in ensuring that on-going dialogue and deliberation over the merits and limitations of whichever sustainability standards are adopted is encouraged.