Climate change poses significant risks to all companies and their investors. To evaluate and protect shareholder value, investors need transparent and comprehensive disclosure of those risks. The most important source of information and assessment about those risks remains the annual reports (10-k reports) that publicly traded companies file with the Securities and Exchange Commission (SEC).
In 2010, the SEC recognized the potential financial impacts of climate change. It issued a Guidance on what constitutes a “material” climate-change related risk and should be reported in 10-K filings. Despite that, disclosure of climate change risk in most companies’ 10-k reports remains sketchy, incomplete, or non-existent.
A 2014 report by Ceres found that fully 41% of S&P 500 companies did not include any information on climate-related issues in their 10-ks. The general nature of the Guidance, and the SEC’s reluctance thus far to take any action on climate disclosures, may be at the heart of what’s making climate change disclosures seem more gratuitous than required.
But views (and requirements) toward reporting on both climate change and ESG (environment, social, and governance) factors may be getting a makeover.
Exhibit A: The Financial Stability Board – Climate Change Risks
The Financial Stability Board (FSB), an international body that promotes global financial stability by coordinating financial policies, has taken an important step in driving meaningful, specific disclosure of climate change risks in financial reporting. The FSB recently created a “Task Force on Climate-related Financial Disclosure.”
The Task Force will consider what constitutes climate change financial risk and, more importantly, what constitutes acceptable corporate financial disclosures regarding that risk. Its mission is to develop recommendations for consistent, comparable, reliable, clear, and efficient climate-related disclosures for companies to use when providing information to investors, lenders, insurers, and other stakeholders.
Why is this a big deal?
The FSB is a major force in international financial regulation. It monitors and advises on market and systemic developments, and their implications for regulatory policy. The fact that FSB sees climate change risk as significant market development means that the attention of the world’s investment community is focused on climate change risks.
The Task Force is chaired by Michael Bloomberg. Bloomberg is a strong force for change to address climate change. He already chairs the Sustainable Accounting Standards Board, which is developing specific, industry-based sustainability accounting standards. SASB’s work is similarly aimed at clarifying materiality within the context of public company sustainability reporting. Bloomberg also co-chairs (with Hank Paulson and Tom Steyer) the Risky Business Project, a collaboration of business and government leaders focused on quantifying and publicizing the financial impacts of climate change. His appointment as chair of the Task Force is another indicator of just how the FSB views the risks that climate change poses to the global financial stability.
At the April 14th Principles of Responsible Investment (PRI) 10th Anniversary celebration, when asked what worries him the most, Bloomberg said climate change was number 1 with nuclear war being number 2. He distinguished the two by saying that some species might survive a nuclear war.
- The Task Force includes representatives of many sustainability reporting organizations and users of financial disclosures. Its members hail from both financial and non-financial companies across a range of countries and relevant areas of expertise, including financial services leaders, stock exchange advisors, and corporate CFOs. Expertise in viewing financial risk through the sustainability lens is provided by individuals such as the chair of PRI and the founder of Generation Investment Capital.
As Bloomberg noted about the creation of the Task Force, “The breadth of experience the Task Force brings to this important work will be essential to our success. Managing climate-related risk is increasingly critical to financial stability, but it can't be done without effective disclosure. The recommendations from the Task Force will increase transparency and help to make markets more efficient, and economies more stable and resilient.”
The Task Force is currently finishing its scoping work, and aims to have its recommendations finalized by the end of 2016.
Exhibit B: The Disclosure Effectiveness Initiative – Reporting ESG Factors
The quest for information and transparency has lead to such a proliferation of disclosure requirements that many investors (and the SEC) question whether what’s truly material can be culled from the deluge of disclosure content. Some investors go as far as saying that this is a strategy companies use to make it more difficult to figure out what’s important for decision-making. Companies complain that disclosure requirements are too burdensome and widespread.
In response, a few years ago the SEC began a process for evaluating the effectiveness of disclosure requirements in producing decision-useful information for investors. The so-called Disclosure Effectiveness initiative has now resulted in the SEC issuing on April 13th a Concept Release seeking public comment about, among other things, sustainability or ESG disclosure requirements.
In announcing the Concept Release, the SEC made the following statement concerning its inquiry into ESG disclosure:
“Today, investors make their decisions based on an array of information, which goes beyond mere profit and loss. Many believe that the era of sustainability or impact investing has arrived. Sustainability disclosure differentiates companies and it may foster investor confidence, trust, and employee loyalty. More importantly for investors, companies that adopt certain environmental, social, and corporate governance or ESG measures may perform better than those that do not. Yet our current disclosure regime, and the current Concept Release, do not specifically address many of these ESG topics.”
In section F, starting on page 204 of the Concept Release, the SEC poses eight questions about ESG disclosure requirements (questions 116-223) for public comment. The questions are aimed at identifying core sustainability issues that fit within public policy constraints and are aligned with the SEC’s mandate to “protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.”
This is a starting point as the SEC considers how it will position itself in the global arena for sustainability reporting. Having considered itself a leader in the realm of disclosure requirements, it seems as though the SEC is now challenged in a game of catch up when it comes to ESG disclosures. On the international stage, pressure for ESG reporting has already resulted in action like the EU disclosure law that will take effect next year, and the FSB Task Force.
Look for some interesting developments as the SEC makes traverses its decision-making process and groups like the FSB Task Force weigh in and build the case for ESG disclosures in reporting. We will continue to track developments at both the Task Force and the SEC. In the meanwhile, if you would like to get your company rolling on a sustainability strategy, sign up for a webinar on how Sustrana platform can accelerate your journey toward having something positive to report.