The push for sustainability disclosure by investors is alive and well.
In late May, the Securities and Exchange Commission’s Investor Advisory Committee urged the agency to take the global lead in requiring environmental social and governance (ESG) disclosures. A week later, a second SEC body, the Asset Management Advisory Committee, discussed plans to make recommendations on ESG disclosures by the end of the year that could be even more aggressive than the IAC.
These calls are timely. Even as our economy is working to get back on its feet after the Covid-19 shutdown, the nearly daily headlines we’re seeing about extreme weather events like the catastrophic flooding this spring in Michigan or forecasts of a busier than usual hurricane season send a clear message: We cannot wait to address climate change. And in fact, the pandemic has made our economy and communities more vulnerable than ever to the inevitable economic shocks of a warming planet.
Alarm around the climate crisis is at a point where the discussion is no longer about whether climate change has financial impacts or whether those impacts could be material. The growing consensus is that climate change is a systemic risk affecting our financial markets—which means that it affects all institutions irrespective of industry.
Climate Change Is Creating Systemic Risks
A new report from Ceres, a sustainability nonprofit that works with investors and companies, outlines this reality. Climate fueled events, including storms, droughts, wildfires, rising sea levels and changing ecosystems, aren’t just increasing in frequency and intensity. They’re combining in devastating ways to create systemic risks to our financial systems, impacting asset valuations, health and productivity, the predictability of supply chains and even where people can live and companies do business. And the nonlinear and unpredictable nature of these risks means their impact could be even more severe than the most alarming financial models predict.
Major investors, including CalPERS and BlackRock, have been among the avant garde in noting the systemic nature of climate risks. Research from Mercer and other groups has underscored that climate change poses significant impacts to investor portfolios across all asset classes. These threats are what prompted some of the largest financial firms, investors and companies to work together on the climate risk disclosure guidelines released by the Financial Stability Board’s Taskforce on Climate-Related Financial Disclosures (TTCFD) in 2017.
In response to this investor momentum, SEC Commissioner Allison Herren Lee in January criticized the SEC’s failure to address climate issues as part of its recent efforts to modernize Regulation S-K. “We purport to modernize, without mentioning what may be the single most momentous risk to face markets since the financial crisis. Where we should be showing leadership, we are conspicuously silent. In so doing, we risk falling behind international efforts and putting U.S. companies at a competitive disadvantage globally.”
Key Steps for SEC
Given the risks that the climate crisis poses to securities markets, Ceres calls on the SEC to address climate change across its mandate through a few key actions:
1) Economic and Policy Research
The first step is for the SEC to analyze climate risk impacts on the securities markets and its own mandate. The role of the SEC’s Division of Economic and Risk Analysis is to conduct economic and risk analyses on market-wide, systemic risks to inform SEC policymaking, rulemaking and enforcement.
By conducting its own research into the nature of climate impacts, the SEC can do a better job of integrating the consideration of climate risk into its core functions, including policy decisions and rulemaking. Building on that analysis, the SEC could establish an internal, cross-divisional task force that can coordinate responses, similar to the approach it took to address Y2K risks.
2) Investor Fiduciary Duty
The SEC should make clear that climate risk is part of investor fiduciary duty. Major investors are continuing to integrate material ESG issues and climate-related risks more tightly into their investment decision-making processes. Climate change was a key topic area for investors during the current proxy season.
For example, BlackRock in May voted against Exxon Mobile’s board as part of its expectation for more disclosure and urgency on climate risks on the part of the board. Clarity from the SEC on investor fiduciary duty will affirm the notion that fiduciary duty is a dynamic concept that should accommodate the evolving understanding of the financial impacts of climate risk.
It would also support the ability of investors, financial advisers, asset managers, and other fiduciaries to address material climate risks in their portfolios with all the tools available to them, including engaging with their portfolio companies on climate risks through shareholder resolutions.
The SEC should issue rules mandating consistent, comparable, reliable and decision-useful climate risk disclosure from companies and financial intermediaries, building on the TCFD’s disclosure framework. In the short term, the SEC should more fully enforce its existing regulations and guidance. Investors and other capital market actors simply cannot make smart decisions on the material climate risks they face without the right information.
Though the SEC issued guidance on climate risk disclosure in 2010, the quality of climate change disclosure in financial filings is still spotty and inconsistent, preventing investors and regulators from making informed decisions. By reinvigorating its own guidance and pulling from the TCFD’s disclosure guidelines, the SEC will create a strong disclosure framework it can adapt as needed.
4) Collaboration and Consistency
The SEC should collaborate and share findings with other federal regulatory agencies to better understand the intersecting ways climate change relates to their mandates. For instance, the SEC could coordinate with the Fed and other regulatory agencies to require that financial institutions provide robust climate change disclosure, including assessing and disclosing carbon emissions from their lending and investment activities.
Additionally, the SEC will need to work with the Public Company Accounting Oversight Board (PCAOB), the Financial Accounting Standards Board (FASB), and credit raters to drive consistency in how climate risk is being audited, how disclosures are being integrated into financial statements and how climate impacts are being taken into account in credit ratings.
All these recommendations fall within the existing mandate of the SEC. They are ones that investors, securities regulators and stock exchanges around the globe are calling for or have implemented. The most recent example: Canada linking its pandemic recovery aid to a requirement that recipient companies publish annual climate-related disclosure reports consistent with the TCFD.
Despite the coronavirus’ blow to our financial systems, investors continue to expect companies to focus on climate change—as we saw during the recent proxy season. It’s time for the SEC to build on this call by the community they are charged with representing—and address climate across their mandate.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Veena Ramani is senior program director for capital market systems at Ceres. She leads Ceres’ initiatives on regulating climate as a systemic risk and board governance for a sustainable future for the Ceres’ Accelerator for Sustainable Capital Markets.