By the time the Securities and Exchange Commission closed the comment period on the proposal to expand climate risk disclosures, it had received more than 400 responses. Many commenters advocated for a robust assessment and reporting framework for environmental, social, and governance (ESG) risks.

In speeches over the past few months, SEC Chair Gary Gensler has detailed some of the information the SEC framework could require from companies:

• Qualitative and quantitative details about how a company manages climate-related risks and opportunities in day-to-day operations and broad strategy
• Company-level metrics such as the financial impacts of climate change and the progress toward climate-related goals
• Disclosure of greenhouse gas emissions created by a company’s operations and, possibly, its entire value chain
• Reporting of scenario analyses on how climate change could affect business in the future
• Forward-looking statements that cover climate-change regulations, damage from severe weather, and damage from transitioning to a net-zero emissions business model
• Industry-specific ESG metrics, such as for banking, insurance, or transportation

“When it comes to disclosure, investors have told us what they want,” Gensler tweeted in early August. “It’s now time for the commission to take the baton.”

However, it would be practically impossible for the SEC to require all of the above-listed information in one expansive rule. In addition, though it might please climate change activists, it would alienate issuers and bring heaps of scorn from the business lobby. More importantly, though, it could violate a bedrock principle of SEC disclosure mandates: materiality.

Disclosures are material when they are reasonably likely to impact a company’s financial condition or operating performance. Therefore, they are the most important to investors, to use the definition of the Sustainability Accounting Standards Board.

SEC Commissioner Hester Pierce

In a July 20 speech to the Brookings Institution, SEC Commissioner Hester M. Pierce called materiality “an objective standard by which [the SEC] can exercise [its] statutory authority to decide what is necessary or appropriate in the public interest or for the protection of investors.”

One of the most important functions of materiality is filtering out irrelevant disclosures. It helps ensure that investors are not buried in an “avalanche of trivial information,” according to a 2015 discussion paper on materiality by the Business Roundtable.

Even the staunchest advocates of climate risk mitigation and sustainability standards admit that investors are drowning in ESG information from companies, some of which are irrelevant because there is no single standard or framework for what issuers should disclose.

On an early August U.S. Chamber of Commerce webcast, Jean Rogers, founder and former CEO of SASB, characterized sustainability disclosures as being in a state of “chaos, confusion, and conflict.”

In addition, said Pierce in her July 20 speech, asking issuers to provide information that is not material — that is, it does not contribute to assessing the prospect for investment returns — costs them in “bills for lawyers and consultants to prepare the disclosures; employee, management, and board time and attention; and potential litigation expenses.”

No Filter

But some ESG investors and climate change activists are pushing the SEC to make a blanket assumption that all potential ESG-related disclosures are material.

In June, the U.S. House of Representatives passed the Corporate Governance Improvement and Investor Protection Act. This bill requires issuers to annually disclose ESG metrics and their connection to a company’s long-term business strategy.

The text of the bill says, “It is the sense of Congress that ESG metrics, as such term is defined by the Commission . . . are de facto material for the purposes of disclosures . . .”

In the past, Congress has been accused of expanding the scope of required disclosures beyond the core concept of materiality.

Exhibit A in the Business Roundtable report on materiality is the 2010 Dodd-Frank conflict minerals disclosure rule. That rule required public companies, primarily manufacturers, to evaluate whether their supply chains contained even trace amounts of minerals linked to human rights abuses in the Democratic Republic of the Congo. Moreover, companies were required to reveal their findings regularly.

In 2014, though, a federal appeals court ruled part of the rule unconstitutional. That same year, the Republican head of the SEC labeled the rule “misguided.” Business groups have battled to repeal the law, saying it forces companies “to furnish politically charged information that is irrelevant to making investment decisions.”

The conflict minerals rule also failed on a practical basis. A GAO report in August 2015 found that two-thirds of public companies subject to the conflict minerals disclosure rule were unable to determine the origins of their conflict minerals.  In addition, the transparency effort seems to have had little effect on stemming human rights abuses.

Since the court decision, the SEC has failed to issue any re-formulation of the rule.

“Arbiters of Materiality”

Opposition to applying a strict materiality standard to ESG disclosures also exists within the SEC.

SEC Commissioner Allison Herren Lee

In public speeches, SEC Commissioner Allison Herren Lee has called investors the “arbiters of materiality” and said that they “have been overwhelmingly clear in their views that climate risk and other ESG matters are material to their investment and voting decisions.”

There is no doubt that “all manner of market participants embrace ESG factors as significant drivers of decision-making, risk assessment, and capital allocation precisely because of their relationship to firm value,” Lee said in a May 24 event hosted by the AICPA.

Lee also argues that the notion that SEC disclosure requirements must be strictly limited to material information is a myth.

The idea that the SEC must establish the materiality of each specific piece of information required to be disclosed in our rules is “legally incorrect,” she said in her May speech.

As an example, she pointed to Regulation S-K. It requires “periodic reports to include information that is important to investors,” but not every piece of information required is important in every instance, she said. Examples include disclosures of related-party transactions, environmental proceedings, share repurchases, and executive compensation.

“Double Materiality”

If the SEC wished to, it could circumvent the issue of materiality. In trying to formulate ESG disclosure rules, the European Financial Reporting Advisory Group adopted the concept of “double materiality” — that the materiality of an item can turn on its effects on the environment and society.

Some commenters to the SEC’s climate risk proposal would like the SEC to adopt an approach similar to double materiality that “focuses on outward effects, rather than effects on an issuer’s long-term financial value,” said Pierce.

Clearly, though, such an approach might carry the SEC far beyond its core mission, which is to maintain fair, orderly, and efficient markets; facilitate capital formation; and protect investors.

“To date, Congress has not granted authority to the SEC to address ESG issues for the purpose of promoting goals unrelated to the federal securities laws,” Commissioner Pierce has said.

On the early August Chamber of Commerce webcast, former SASB CEO Rogers and Granville Martin, head of U.S. public policy & outreach at the Value Reporting Foundation (formed from the merger of SASB with the International Integrated Reporting Council), agreed that materiality should be the anchor of any progress on ESG disclosure rules. (Though they did not provide their definition of materiality.)

ESG is “subjective,” which is why standards are needed, said Martin. “The focus on materiality is fundamental.”