How effective are corporate disclosure regulations?

Governments of 38 of the largest 50 economies in the world have, or are developing, disclosure requirements for corporations covering environmental, social and governance issues.

The most common initiatives in our database are corporate reporting rules – over 200 relate to this. Some of these relate to a single issue. Examples include Saudi Arabia’s corporate governance rules, which require disclosure of management remuneration. South Korea’s green posting system requires listed companies to include greenhouse gas data and green technology certification in their annual reports. However, the vast majority of countries we analysed – 38 of the top 50 economies in the world – had, or were developing, some kind of government-led disclosure guidelines for corporations covering ESG issues. Most are voluntary or comply-or-explain, but they still play a role in raising awareness and offer a framework for structuring a disclosure.

The ongoing work of the Financial Stability Board’s (FSB) Task Force on Climate-related Financial Disclosures is likely to galvanise environmental disclosure in future years. Though voluntary, the task force recommendations can be seen as an opportunity for governments and accounting standard setters to develop disclosure policy referring to an internationally consistent set of reporting guidelines.

Government-led mandatory ESG reporting improves corporate risk management

Almost every country we analysed has some kind of company disclosure requirement. Only four countries don’t have any kind of government-led ESG disclosure and of these, two have no companies in the ACWI index. This meant there wasn’t enough data to test the effectiveness of these single-issue rules, so we focussed on rules covering E, S and G issues – designed to provide a broad overview of a company’s impact.

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Our analysis shows that companies in countries with mandatory, government-led comprehensive ESG reporting requirements have, on average, a 33% better MSCI ESG Rating score (figure 1) than those without. This score indicates better ESG risk management practices relative to risk exposure. We also tested the relationship between voluntary ESG disclosure requirements (figure 2). We found a small positive relationship (+11%), but far less significant than when we looked at mandatory regulations.

This relationship is stronger in developed markets (figures 3 and 4 – 36% and 24% respectively) compared to emerging markets (figures 5 and 6, respectively 8% and -6%). In both developed and emerging markets, companies subject to mandatory ESG disclosure regulations score better than those who are not.

Is better corporate disclosure enabling responsible investment?

Several factors could be contributing to these results.

The impact of regulation on corporate behaviour

Asking the right questions can enhance internal risk management processes and reduce a company fs overall exposure to risk.

Government attitude to regulation

Governments willing to regulate corporate disclosure may also take a more interventionist approach to ESG regulation in general. This could result in lower ESG risk exposure in that country.

Regulation formalising a tradition of corporate sustainability

Regulations sometimes follow, rather than lead, market practice. In practical terms, introducing a new disclosure rule is much harder without industry buy-in, and a body of voluntary market practice makes this process considerably easier. For example, the introduction of Article 173 of the French Energy Transition Law built on the existing strength of the SRI market and previous regulations.

Better data enabling investors to implement ESG incorporation and stewardship

Good quality disclosures enable investors to better analyse ESG-related risks and opportunities and engage with companies around long-term value creation strategies.

Through the interviews, we found that while disclosure is a good first step, to fundamentally change behaviour, incentives need to be aligned. Investors provide a significant part of those incentives through their investment decision making and stewardship activities.

Stock exchange and industry-led disclosure

In addition to government-led disclosures, 26 countries have or are developing reporting guidance led by stock exchanges or industry associations. One of the key drivers for new developments in stock exchanges is the Sustainable Stock Exchange (SSE) initiative’s Close the Guidance Gap campaign.

This is not the first analysis of stock exchange reporting. Analysis released in 2014 by Corporate Knights found that leading exchanges can contribute to better corporate reporting outcomes – but corporate reporting still regularly falls short of investor expectations. Stock exchanges with formal regulatory powers were included in the government analysis – the remainder are analysed here. Within this sample, only three stock exchanges –Toronto Stock Exchange (TSX)14, Kazakhstan Stock Exchange (KASE)15 and Pakistan Stock Exchange (PSX)16 – have mandatory ESG reporting requirements. Our sample size was therefore not large enough to replicate the analysis of the last section. Instead, we focussed on exchanges with ESG disclosure guidelines, irrespective of whether they are mandatory, voluntary or comply-or-explain.

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We found a negligible difference (+0.6%) in the MSCI ESG Rating scores of companies with stock exchange ESG reporting guidelines and without (figure 7). There is a very slight positive association in developed markets (figure 8, + 6%) and a very slight negative association in emerging and frontier markets (figure 9, -3%).

Voluntary disclosure as a stepping stone

This analysis comes at an early stage of stock exchange reporting. The Close the Guidance Gap campaign has commitments from 23 exchanges, but comprehensive disclosure guidelines are relatively recent and still developing.

When we analysed government-led reporting rules, we found that mandatory requirements were associated with considerably better ESG scores. This suggests that formal enforcement mechanisms strengthen implementation. Although the exchanges analysed here don’t have a formal regulatory mandate, they still have enforcement mechanisms. ESG disclosure requirements could be strengthened by systematically integrating them into listing rules – the key enforcement mechanism available to exchanges.

Voluntary disclosures are a useful stepping stone towards more formal rules and help to raise awareness in the market. Increasingly, we find exchanges are publishing voluntary guidance alongside a timetable for comply-or-explain or mandatory reporting.

“HKEX issued its ESG Reporting Guide in 2012, compliance with which was voluntary, but simultaneously announced that, subject to consultation, it would be updated to comply-or-explain in 2015. We put out a consultation in 2015, which received strong support from the market as well as from institutional investors.”

Ellie Pang, Vice President, Hong Kong Exchanges and Clearing Ltd (HKEX)