Tim Mohin, chief sustainability officer at Persefoni, explains why investors and issuers should expect the Securities and Exchange Commission to act decisively.
We are still feeling the shock waves from the latest climate report released earlier this month by the Intergovernmental Panel on Climate Change (IPCC) — a body of more than 200 scientists convened by the United Nations. Although the UN called it a “code red for humanity”, outlining disastrous scenarios should our fight against climate change take a ‘business as usual’ approach, the report offered a glimpse of hope amidst its dire warning and urgent call to action.
The findings called for “unprecedented transformational change” in order to mitigate the worst impacts of climate change — the good news? This transformational change is already under way. One third of Fortune 500 companies have published net-zero climate goals and the Glasgow Financial Alliance for Net Zero (GFANZ) boasts US$88 trillion of combined assets under management. The business community is seeing their opportunity to take a meaningful stand against climate change, and despite political infighting, there are hopeful signs that governmental policy will too.
SEC is ready to act
In the seven months since President Biden’s inauguration, just about every department in the US government has gone through a top-to-bottom policy review. This cycle is normal with every change in administration, but rarely has it resulted in such a 180-degree shift in both leadership and agendas.
Case in point: in March, Allison Herren Lee, the Acting Chair of the US Securities and Exchange Commission (SEC), requested input on if and how the SEC should require climate-related disclosures for companies. This is a marked change from the previous administration, where a move like this would have been as likely as snow in the carbon-fueled heat of a DC summer.
Despite this notable shift in agenda-setting, this is not a new issue for the SEC as they issued guidance regarding disclosure related to climate change over a decade ago. The most recent request for commentary is an opportunity to hear from the public and private sectors about what the future of disclosure should look like as the threats of climate change grow increasingly dire and the IPCC report makes abundantly clear that the world will heat up by an average of 1.5 degrees Celsius in the next 30 years.
What did the SEC seek guidance on?
With people literally dying of the ‘heat domes’ in the western US, asking for opinions on whether to require climate disclosure seems quaint at best, dereliction at worst. After 90 days, the SEC received more than 550 comment letters (including a letter from Persefoni) responding to their 15 questions around climate-related disclosures ranging from what to disclose, when new mandates should go into effect and which reporting standards should be used. Their main question, to put it simply: should companies be required, by law, to report their carbon footprint?
The short answer to this question is an emphatic yes. SEC Chairman Gary Gensler framed the issue well in this statement when he said: “Investors are looking for consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs.”
Gensler went on to declare that “three out of every four of these responses [to the SEC request] support mandatory climate disclosure rules”. He also highlighted some recent data to demonstrate that carbon disclosure is, in fact, standard procedure already: “…nearly two-thirds of companies in the Russell 1000 Index, and 90% of the 500 largest companies in that index, published sustainability reports in 2019 using various third-party standards.”
How should the SEC move forward?
As the climate crisis deepens, it’s clear that investors are demanding climate-related financial disclosures. The SEC must play a role to define consistent, comparable and reliable reporting. Thankfully, some of the heavy lifting of defining standards and accounting procedures has already been developed. Now we just need the SEC to take action. Here are my top-line recommendations:
- What to disclose: Focus on climate for now and use the Task Force on Climate-related Financial Disclosures’ (TCFD) framework to guide which disclosures are required.
- When to disclose: Now. The Commission’s climate guidance has been available for more than 10 years and companies have had ample notice and time to prepare – there is no reason to delay any longer.
- Who should disclose: Audited and assured climate risk disclosure should be required from all ~4,300 companies listed on US exchanges, with assistance for smaller companies. Don’t get hung up on the “materiality” debate – the climate crisis is real and material for everyone on the planet. The marginal costs of potential regulatory overreach are far outweighed by the benefits of consistent, comparable and reliable information to address this global threat.
- What standards should be used?The SEC should endorse the International Sustainability Standards Board forming under the International Financial Reporting Standards Foundation (IFRS). The standards produced by IFRS are used by most countries in the world for financial disclosure. Endorsing these global standards will reduce confusion and reporting burden while increasing comparability across our connected economy.
The SEC has one job – do it
The role of the SEC is to protect investors. It does this by requiring information from companies that investors can rely upon to make decisions. Yet, because ESG information has historically been considered ‘non-financial,’ the SEC has kept its distance.
The arguments against climate-related disclosures were on full display when I testified at the House Finance Committee two years ago, which led to a memorable exchange with Wisconsin Representative Sean Duffy (an edited summary):
Rep Duffy: “How much money do you make Mr. Mohin?”
Me: “Well I don’t see how that’s relevant sir”
Rep Duffy: “Well, you are asking for more transparency, right? What’s next? Asking how many guns we own?”
Congressional hyperbole aside, I agree with the underlying sentiment of former Representative Duffy and his Republican colleagues. There should be a high bar to add new disclosure requirements for companies listed on US exchanges. Understandably, such mandates carry significant costs for companies to develop, monitor and report, therefore, before issuing a regulation, we must be certain that benefits of implementing such disclosures outweigh the costs. In the case of climate risk, the facts are now undeniable that we have reached this threshold. A few examples:
- In 2015, the Financial Stability Board of the G20 was concerned enough about the economically destabilising effect of climate change that it commissioned the Task Force on Climate-Related Financial Disclosures (TCFD). In the intervening years, the TCFD framework has been supported by thousands of companies and adopted into law in the UK and other nations.
- Each year, the head of the world’s largest asset manager – Larry Fink of Blackrock – pens a letter to the CEOs of the companies in their portfolios. Every edition of this letter is more strident and specific about Blackrock’s expectation for reliable climate risk disclosure. This year, Blackrock backed up the letter with a threat to vote against Boards who did not align – then this May they made good on their threat propelling three climate activists on to the Board of ExxonMobil.
- The leaders of Amazon, Facebook, Apple, Salesforce (as well as 80 other companies) have publicly called for mandatory climate disclosure. The collective valuation of these companies is only overshadowed by their influence.
These are just a few of the most recent facts that should push this issue to the top of the SEC priority list. With forecasts topping US$50 trillion invested in ESG strategies, there is more than ample evidence that sustainability has entered the mainstream of global commerce. But without regulation, ESG investing is still the wild west. Claims of ‘green’ or ‘sustainable’ investing strategies are largely undefined and unverified. Case in point: the investigation of Deutsche Bank’s sustainability claims. In other words, unless the SEC acts, anything goes.
Presumably, it will take the SEC some time to digest the comments received and formulate a proposal that will, in turn, be subject to additional comments, which will take time to complete. The good news is that Chairman Gensler has committed to a proposal in 2021.
While the wheels of the US government turn, Europe is not waiting. The European Commission has announced its intent to update its Non-Financial Reporting Directive (NFRD), to the renamed Corporate Sustainability Reporting Directive (CSRD). While the CSRD is not yet final, the proposal made it clear that certain such as climate risk will be required disclosures from every company doing business in Europe over a certain level.
Given their leadership, Europe is likely to set the tone on climate disclosure which could become the de-facto global standard as many US and global companies who operate across Europe must also observe these disclosures.
The take home message is that climate disclosure is all but certain to become a requirement for most companies whether it’s regulated in the US or Europe or demanded by investors. The dire warning of the IPCC report added even more justification for action. The question remains: are companies ready to embrace this unprecedented, transformational change?
After years of build-up to this moment, larger companies are well prepared, but there are thousands of others that have yet to measure or manage their carbon footprints. If you work for one of these companies, forward this article to your CEO and CFO right now.