A Familiar Starting Point
Last week’s hearing in the U.S. House Committee on Financial Services brought together a broad and, at times, classically divisive group of viewpoints around topics like climate change and stakeholder capitalism. These are hot button issues sure to draw strong dividing lines around familiar political ideologies.
There was an uncontestable understanding that regulations around climate change disclosures are coming. That they likely would benefit investors, companies, and American communities. And that some individuals will protest them anyways.
Disclosures are Political Flashpoints
On the one hand, you have the viewpoint of Rep. Bill Huizenga, a ranking member of the committee. He argues that disclosures only serve to “name and shame” bad actors in service of a trendy corporate villainization. In his view, it is not the mandate of the SEC to fight social justice battles.
The SEC has a tripartite responsibility to protect investors, maintain orderly markets, and facilitate capital formation. Rep. Huizinga capped off his opening remarks with the statement, “To date, there is very little concrete evidence that over the long term, ESG investing outperforms broad market indexes.”
However, the above statements actually leave open the door for some really excellent reasoning on corporate disclosures around Climate Change, and additionally, around Human Capital Management. For instance, “very little” is undoubtedly more than none. And that evidence is only likely to grow.
Disclosures are Already Happening, Just not Very Well (Yet)
At the present moment, so much disclosure around climate change and human capital are voluntary. Veena Ramani points out that investor demand can only take voluntary disclosure so far. The federal reserve and all major regulatory bodies have already begun to treat climate change as a systemic risk.
The irony is that the disclosures have lagged so far behind when so much of the community is in complete agreement about their necessity. Ramani also notes that “Investors have known about physical and transitional effects for years.”
There is no doubt that companies have internally tracked risks to their businesses that are climate related. Whether or not they have provided them to the market is now only part of the issue. Investors and regulators are still not getting decision-useful insights due to poor quality, divergent reporting methodologies, and lack of consistent data.
Decisive action is needed by the SEC because this is fundamental to the success of companies, investors, and regulators. Veena Ramani, Ceres
Ramani suggests that the SEC follow the other standards bodies and “robustly enforce the existing interpretive guidance on climate change.”
ESG Portfolios can Generate Alpha
The overarching criticism of a lack of data on the alpha generation of ESG positive portfolios has been disproven. The negative side is easy – as James Andrus of CalPERS points out, a mismanaged workforce represents an obvious risk to a company’s future growth. Stability and sustainable growth require a motivated and engaged workforce.
On the side of alpha generation, Andrus argues that the data shows diverse boards are a reliable indicator of portfolio outperformance over time, not least because a board that lacks diversity could easily mishandle a social issue that materially affects the business. But also because leadership requires bringing all viewpoints to the table for a better understanding of key issues.
These kinds of risks are being analyzed by the market and priced in. Are they being priced efficiently? That is unlikely, given that such data is not readily available at scale. The volume of data is increasing, which means that the qualitative information that justifies these data is growing as well.
Transparency is the Key to Better Understanding
Andrus reads a powerful quote from Justice Kennedy that contains the phrase, "transparency enables the electorate to make informed decisions." There is a baseline obviousness to that statement that somehow gets left out in ESG disclosure discussions.
Transparency is essential. A lack of transparency does not denote a lack of risk. The opposite is commonly true. What companies choose to disclose in the unregulated space of ESG information can be telling, but a lack of guidance can also be revealing. There is a dent in the efficiency of capital formation when the decision-relevant information is not easily provided.
There is also an impact on the "invisible investor," a strong turn of phrase introduced into Heather McTeer Toney's proceeding. She related personal experience with climate-influenced weather events. She explained that her city's most prominent business was committed to disclosing climate-related risks to the public sphere. This allowed for coordination between the government and the business to ensure that citizens, the taxpayers who invest in American infrastructure, were protected from the worst outcomes.
Protecting the Investor, the Functioning of the Markets, and Facilitating Capital Formation
ESG data and research are essential to fulfilling the tripartite responsibility of the SEC. Without accurate data about contributions to climate change and the risks that we face as a society, it is impossible to facilitate a smoothly functioning market that efficiently allows for capital formation along sustainable lines.
Old arguments around tired political lines like regulations being cumbersome for business because they are costly don't hold as much weight today.
The proper regulations can actually reduce the burden for everyone involved. Corporations get clear guidance on the competitive rules of the game. Investors get scalable data to fuel their decisions. Stakeholders can flex their internet-era muscle and leverage social media to influence outcomes.
ESG Data Can and SHOULD Be Transparent
Though a genuinely normative taxonomy for ESG reporting may be a long way away, some key features of a solid research effort are available today.
The SEC filings can already provide scalable quantitative information on board composition, CEO pay ratio, human capital management, and other ESG-related KPIs.
A searchable database of corporate disclosure based on focused themes or risks combined with research tools can curate data from millions of documents and provide the relevant texts in a useful, decision-meaningful format.
At idaciti, acknowledging the state of affairs does not mean limiting ourselves to places where structure already exists and the problems of a sustainable tomorrow are all already fixed.
We have taken our collective expertise in XBRL structure to a new level. With our extensible XBRL framework, we can help make any ESG research topic withstand the rigor necessary in decision-making.
What is Available Today
Today in real-time, we monitor companies’ response to the Reg S-K requirements on human capital disclosure from the SEC. These requirements have a positive impact on the ESG research space, right now, today, in real-time.
The dataset we are generating is integrated into the source disclosures themselves. Rather than separate the data from the company's financial disclosures, our technology helps connect the dots, putting the self-describing metadata into the documents themselves. Traceback and transparency together create a strong foundation for the best research practices of tomorrow.
To learn more about idaciti solutions for structured ESG data, please visit our website at: Demo - idaciti