On March 21st, 2022, the U.S. Securities Exchange Commission released a 500+ page proposed rule that would require publicly traded companies to include climate-related disclosures in their registration statements and report on certain standardized climate-related data in their quarterly and annual reports. Since that time, advocates and critics alike have voiced their opinions and have until June 17th to make their public comments known to the SEC before the agency revises and codifies the rule.
In summary, the proposed rule focuses on four issues related to climate data disclosure: risks, goals, governance, and carbon emissions. The rule would ask companies to report on:
I. Risks: Potential impact of climate related events on company performance both in the past and in the future
II. Goals: Potential impact of transition goals and transition related activities on company performance, including net-zero targets and transition targets
III. Governance: Disclosure of company governance practices around climate risks including individuals at the company responsible for climate-related oversight
IV. Carbon Emissions: Disclosure of company Greenhouse Gas Emissions
- a. All companies must disclose scope 1 and 2 emissions. Scope 1 includes a company’s direct greenhouse gas emissions and scope 2 encompasses indirect greenhouse gas emissions from electricity or other forms of energy purchased by the company.
- b. Some large companies must disclose scope 3 emissions, which includes all the greenhouse gas emissions from upstream and downstream activities in the company’s value chain.
Critics of the potential regulation note that the costs associated with implementing the new rule are untenable and that the added expense will end up hurting shareholders in the long run. Advocates, on the other hand, say that the new rule standardizes what many companies are already reporting on and gives investors a clearer view of the risks associated with certain investments. To help us understand how to think through this proposed rule as an investor, we asked our friends at Impax Asset Management to give their perspective, and they’ve graciously provided the content for the rest of this post.
From Impax SVP for Sustainable Investing, Julie Gorte:
Impax believes the proposed rule is wholly in line with the SEC’s historic mission, which includes assuring that investors have the information they need to decide which risks to take and how much to pay for taking them. We’ve had mandatory financial reporting for nearly a century and tend to take for granted that investors need certain financial information to make informed decisions about investments. It has been amply demonstrated that many elements not currently included within the scope of traditional financial reporting have significant consequences for financial performance, and that many of these elements can be anticipated, assigned probabilities, and priced. The SEC is right to see climate change as a set of foreseeable risks that, if investors have the appropriate information, can be evaluated and priced to assist with the orderly operation of financial markets.
Reporting on climate risks will take some effort and expense, but not having this information is also costly. It would mean a future of increasingly frequent and unpleasant surprises for investors should we lack the tools to anticipate and price climate risks. We have already experienced the first climate-related bankruptcy in the United States — electric utility Pacific Gas & Electric — and climate risks are already affecting the performance and competitiveness of companies across the globe. Plus, the prospect of future economic growth disruption is significant. The Federal Reserve recently noted, “climate change may increase the risk of very poor growth outcomes — which may lead to a variety of adverse impacts.” Facing a future without the disclosures, information, and tools so investors can assess this kind of risk is unacceptable.
As the impacts and costs of climate change continue to grow, not understanding the landscape of climate risk will be increasingly costly for companies as well as their investors, employees, and other stakeholders. For example, today, it’s possible to gather information on Scope 1 and 2 emissions for most large cap companies in developed country indices like the S&P 500, the Russell 1000, MSCI World, and even MSCI ACWI, and there are a few hundred large cap companies that report some Scope 3 emissions information. However, gaining access to that information is difficult. Investors must either scour company websites one by one or pay for data access through providers like MSCI, Sustainalytics, Refinitiv, Vigeo Eiris, and the Carbon Disclosure Project, which often involves substantial subscription fees.
Gathering information on vulnerability to physical risks is even more difficult. In late 2020, Impax, in partnership with a large state pension fund, reached out to companies in the S&P 500, asking that they disclose the locations of any company assets whose loss or damage could be a material event. Of the approximately 80 companies we engaged with on this issue, we found only three that appeared to have examined their physical risk profile and reported on actions designed to manage or adapt to such risks.
Many companies report very little on the locations of their operations, often mentioning only cities, countries, or regions. This information isn’t accurate enough for investors to effectively evaluate physical risk. For example, if a company only reports that it has operations in China, investors might have no choice but to assign every physical risk to the company, even if none of its facilities is particularly vulnerable to a specific type of event. Or if a company operates in a coastal city, vulnerability to sea level rise will be quite different for assets that are many meters above sea level compared to those whose properties are at the waterfront. Gathering data on the locations of facilities alone can take hundreds of hours just to assess a single portfolio, often because investors are seeking information that does not exist. That information is relatively straightforward for companies to disclose but laborious and time-consuming for investors to gather.
The SEC’s proposed rule would bring sunlight to the information investors need to understand a wide range of climate-related risks companies face, so they can make more informed decisions about which risks to take and how to value them.
- Michael T. Kiley, “Growth at Risk from Climate Change,” Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, DC, 2021–054.
- Julie Gorte and Matthew Wright, “Seeking Coordinates: A Unique Engagement on Physical Climate Risk,” Impax Asset Management, Oct. 25, 2021.