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November 28, 2007

Environmental, Social and Governance Standards: Glass Half-Empty or Half-Full?
    by Bill Baue

The spread of voluntary and mandatory ESG disclosure and performance standards for business raises the question, how robust is implementation and enforcement? -- Standards for assessing and disclosing the environmental, social, and governance (ESG) impacts of business have been proliferating globally, a trend that brings a mix of applause and skepticism.

For example, last month the International Finance Corporation (IFC--the private sector arm of the World Bank Group) shepherded 30 development finance institutions (DFIs) around the world into signing its Approach Statement on Corporate Governance. Signatories include the Asian Development Bank, African Development Bank, Islamic Development Bank, Overseas Private Investment Corporation, and Norfund and Swedfund. By signing, “each institution agrees to help raise corporate governance to the level of environmental and social considerations,” according to the IFC press release.

Please support
our sponsorsGreat news, right? “Glass-half-full” folks say yes, welcoming this extension by DFIs (which, as the name suggests, provide financing to advance economic development in emerging markets) to explicitly cover ESG issues in due diligence. However, “glass-half-empty” folks charge that such standards amount to greenwash, using the socially responsible vernacular to paint a sheen on behavior that is in their opinion unsustainable.

“This amounts to a smokescreen justifying DFIs’ continued imposition of Friedmanesque religion to the detriment of unwilling converts,” said a well-known figure in the socially responsible investing field, referring to the free-market economist Milton Friedman who famously said, “the social responsibility of business is to increase its profits.” “The real question is not the DFIs’ ability to impose a ‘governance’ standard on companies operating in emerging markets, but when good governance can be imposed on the DFIs, forcing them to work for the benefit of humankind as opposed to investment banks.”

The spectrum of skepticism extends back several steps from this degree of cynicism. For example, the IFC press release implicitly suggests that DFIs already support positive environmental and social performance, an assumption that leaves itself open to question.

For example, the Asian Development Bank, the first of the 30 DFIs listed, invested in the Nam Theun 2 hydropower project in Laos, categorized as a “dodgy deal” by BankTrack, a consortium of NGOs that tracks the social and environmental impacts of global finance institutions.

“The Nam Theun 2 Hydropower project poses enormous social, environmental and economic risks to the people of Laos,” states BankTrack. BankTrack documents the forced displacement of over 6,000 Laotians to make way for the dam, which is flooding one of the largest remaining tropical forests in mainland Southeast Asia. Such is the “level” of social and environmental considerations to which the IFC Approach Statement on Corporate Governance seeks to “raise” corporate governance. IFC did not respond to’s commentary request.

BankTrack notes that this finance project falls under the umbrella of the Equator Principles, one of a growing number of voluntary ESG standards (such as the UN Global Compact, the Global Reporting Initiative, and the Aspen Principles) praised by glass-half-fullers as important steps in the right direction and criticized by glass-half-empty-ers for stalling necessary regulation.

Regulatory standards on corporate ESG disclosure and performance are on the rise as well. For example, the revised Companies Act as well as Accounts Modernization Directive, which mandate corporate ESG reporting, passed in the UK in 2006 (though the year before, then-Chancellor of the Exchequer Gordon Brown sacrificially slaughtered the Operating and Financial Review, a more robust ESG reporting regimen, on the altar of big business opposition). In July 2007, Indonesia adopted Article 74 requiring social and environmental responsibility programs for companies dealing in natural resources.

The US Securities and Exchange Commission (SEC) requires companies to disclose at least environmental (if not social) impacts.

“The SEC is committed to robust disclosure by companies of material environmental issues,” said SEC spokesperson John Nester. “The key requirement for triggering disclosure is that the impact or potential impact will be material to a company and is therefore material to investors.” Nester points to Regulation S-K, Items 101 (c)(xii), 103 (5), and 303 (Management’s Discussion and Analysis, or MD&A.)

On first blush, the SEC seems at a loss to find US companies to penalize for falling short on their obligation to report material environmental impacts.

“I’m not aware of any enforcement actions,” Nester told

“The last well-publicized enforcement case was Lee Pharmaceuticals back in 1998, where the SEC alleged that the company failed to provide reasonable estimates of environmental cleanup costs,” said Michelle Chan, coordinator of the Green Investments Program at Friends of the Earth. “However, the SEC generally views these kinds of enforcement orders as ‘last resorts.’”

“Normally, the Commission provides companies with the opportunity to correct apparent misstatements by issuing Comment Letters,” Chan told, praising the 2003 SEC report on Fortune 500 companies that provides guidance for environmental disclosures, pointing to SFAS 5, FIN 14, SOP 96-1 and SAB 92. “A quick EDGAR search reveals that in the past several years, the SEC has written scores--perhaps hundreds--of Comment Letters to companies asking them to provide clarification on various environmental issues.”

For example, in June 2006 the SEC sent a Comment Letter to Constellation Energy Resources LLC asking it to “inform us of your potential exposure to and the dollar amount of reserves established for exposure to environmental liabilities . . . [i]f material.”

“So, although the SEC hasn’t pursued many ‘hard’ environmental enforcement actions in the past several years, it has started to include environmental issues more in their regular reviews of company filings,” said Ms. Chan.

However, the SEC may be missing the forest for the trees, according to a recent petition filed by Ceres and Environmental Defense asking the Commission to require more robust disclosure on climate risks. The petitioners note the irony that ExxonMobil, the largest petroleum company in the world, “[m]entioned climate change in one perfunctory reference in the 126 pages of its 2006 10-K filing with the SEC, and otherwise did not mention global warming, greenhouse gases or carbon dioxide.”

A senior official at a federal regulatory agency noted action supporting improved ESG disclosure and performance by business across a broad spectrum of avenues globally. In addition to the initiatives listed earlier, CEOs are engaged, according to a recent McKinsey survey. Companies are increasingly issuing sustainability reports, most often using GRI guidelines. Stock exchanges in Brazil, South Africa, Israel, and Malaysia all require ESG disclosure.

Other voluntary initiatives abound, including the Voluntary Principles on Security and Human Rights, the Extractive Industries Transparency Initiative, and the Kimberly Process, among many others. The IFC has established new social and environmental sustainability performance standards (that underpin the Equator Principles.) The United Nations Environment Programme Finance Initiative (UNEP FI) program encouraging banks to integrate ESG factors into their investment decision-making has met with great success, with Goldman Sachs, Citi, Merrill Lynch, Deutsche Bank, and many others routinely doing so.

“The missing piece in this puzzle is Congress--Congressional committees should begin to hold regular hearings to evaluate progress and look at legislative options for requiring ESG reporting,” said the official, who applauded the Senate Banking Subcommittee on Securities, Insurance, and Investment for getting this ball rolling with a hearing on climate disclosure in late October.

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