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SEC’s Climate Risk Disclosure Proposal: A Good First Step

April 5, 2022, 8:00 AM

For too long, investors and other market participants have suffered from inconsistent, incomplete, and sometimes blatantly deceptive communications from businesses about how they are managing the risks of climate change.

For example, numerous banks continue to finance large-scale expansion of coal-fired power without reconciling this with their pledges to shareholders that they are working toward “net zero” greenhouse (GHG) emissions. Meanwhile, PG&E, California’s largest electricity utility, recently became the first Fortune 500 company to declare bankruptcy because of the impacts of burning coal and other fossil fuels.

Scientists say that much more economic calamity is heading our way if we don’t take climate risk more seriously. Leading financial institutions such as the Bank for International Settlements openly worry about a green swan event, where cascading climate-related business failures leads to rapid asset deflation and a global financial crisis.

Addressing Market Failures

Fortunately, the Securities and Exchange Commission is stepping in to address these market failures.

The SEC on March 21 issued its long-awaited proposal to require public companies to disclose their climate-related financial risks. Under the proposal, companies would be required to disclose: climate risks and their likely material impacts on strategies and expectations; governance and risk management processes; GHG emissions data; details about climate goals, targets and transition plans, including reliance on carbon offsets; and expenditures on transition plans and other key metrics in audited financial statements.

This approach makes sense. As we learned following the 1929 stock market crash, the 2000 Enron scandal, and the 2008 global financial crisis, mandatory disclosure is among the most straightforward ways that financial regulators can address market failures.

Thanks to the SEC, climate risk will soon be treated with the same seriousness in the C-suites as traditional financial risks. Investors and other market participants concerned about climate risk will finally have the reliable, actionable information from businesses that only a mandatory disclosure regime can provide.

Although initial responses to the proposal from investors have been favorable, a vocal minority of fossil fuel industry allies is strongly opposed, essentially arguing that climate risks are only a concern for environmentalists. Anyone not beholden to this high-risk, polluting industry sector can see that this is a false dichotomy.

Rising GHG emissions are increasingly threatening not just ecosystems, but businesses and livelihoods. Clean energy is now cost-effective and widely available, so averting this disaster is feasible if we act quickly.

SEC Carrying Out Its Mandate

What can the SEC offer at this moment of climate peril? It turns out that by fulfilling its three-part mandate—protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation—the SEC can help enormously.

The SEC’s proposal is aimed at protecting the wide array of investors concerned about businesses’ failure to prepare for the harmful impacts of climate change (“physical risks”) and the transition to a decarbonized economy (“transition risks”). In the absence of easily-accessible, decision-useful information, these investors face enormous costs and difficulties determining which companies are deserving of their capital.

For this reason, in October 2021, investors representing $52 trillion in assets under management (AUM)—more than half of total global AUM—united in a call for mandatory climate risk disclosure. Numerous other investors called for mandatory disclosure last summer in response to an SEC request for information.

The SEC is likewise aiming to achieve fair, orderly, and efficient markets in response to a dangerous surge of self-congratulatory hype about attention to climate risk. Over 2,000 multinational companies have now made pledges to reach net-zero GHG emissions by 2050 or established similar emissions targets, yet only a small handful have offered details on how they intend to reach those targets.

Many companies are purchasing cheap “offsets” (pledges by third parties to avoid emissions or store carbon) rather than cutting their own emissions. This approach is growing in popularity, with virtually no transparency, despite research showing that offsets are not delivering promised emissions reductions.

Facilitating Capital Formation

Finally, the SEC is facilitating capital formation. Perhaps the most exciting business trend today is the explosion of innovation and business creation in response to market demand for low-carbon and climate-resilient technologies. Providing capital to these businesses is a high priority for many investors, but they need reliable and comparable information to determine which are effectively turning climate risks into opportunities.

In an effort to minimize compliance costs, the SEC is proposing to allow companies to decide for themselves whether Scope 3 emissions (those released in the companies’ value chains) are material to investors. This is a mistake. These emissions are often the largest source of a company’s GHG emissions and therefore represent the largest part of its transition risk.

For example, 95% of Nestlé’s GHG emissions are Scope 3. Banks’ Scope 3 emissions from lending, investing, and underwriting are 700 times greater than emissions produced in their offices. Some companies acknowledge that Scope 3 emissions are a major source of climate risk and work with suppliers and customers on reducing them to improve profitability. Others are blind to this risk or claim it is out of their hands.

To help investors identify the forward-leaning companies, the SEC should make disclosure of these emissions mandatory for all large reporting companies.

The stakes are high with the SEC’s climate risk disclosure proposal. Proponents of fossil fuel expansion are putting forward a dark vision of our future, where business leaders act as if climate change is outside their scope.

The SEC’s proposal represents a different vision, where business leaders, investors, and other stakeholders work together on solutions to climate risks using a common set of facts. It is time for those of us who believe in this more optimistic and pragmatic vision to speak up.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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John Kostyack is principal at Kostyack Strategies, a consultancy helping mission-driven organizations achieve their climate change and clean energy policy goals. He previously led the National Whistleblower Center and Wind Solar Alliance and served as vice president at National Wildlife Federation.