Strong SEC climate risk disclosure rules are good for business, investors

The Securities and Exchange Commission (SEC) has prioritized the management of climate-related financial risk, gathering stakeholder input on climate risk disclosure in preparation for expected rulemaking in the fall.

Gabe Malek Coordinator, Sustainable Finance

Companies, trade associations, investors, and other stakeholders offered their perspectives through hundreds of public comments. As SEC Chair Gary Gensler noted, the overwhelming majority – from BlackRock to Chevron to FedEx to Walmart – welcomed SEC action.

This widespread support is a sign of the private sector’s growing acceptance and desire to address climate-related financial risk. Now it’s up to the SEC to follow this sign and develop a strong mandatory disclosure rule that produces comparable, specific, and decision-useful climate risk information.

Updated rulemaking is urgently needed given the immense risks climate change poses to companies, investors, and the American financial system.

Below are four elements essential to a robust rulemaking.

1. Address key climate risks as well as emissions

Companies have expressed widespread support for the public disclosure of greenhouse gas emissions. For example, Business Roundtable argued that companies should disclose their Scope 1 and 2 emissions, while Apple went an important step further, calling for Scope 1, 2, and 3 reporting.

But while verifiable emissions information is critical, it’s not enough for investors to effectively manage climate risk.

Not only do emissions data fail to capture the full scope of corporates’ contributions to climate change, they entirely neglect physical risk, a major blind spot for the financial system. For example, a company could have a relatively low emissions profile relative to its competitors but still be highly vulnerable to climate risk because of its facilities’ exposure to extreme weather.

Effective SEC disclosure rules must move beyond emissions reporting only. As a starting point, the Task Force on Climate-related Financial Disclosures (TCFD) provides 11 recommended disclosures, supported by the majority of companies, to guide companies in capturing their climate risk management practices and exposure to climate risk.

2. Require specific and comparable line-item disclosures

Despite its important role in driving progress on climate risk reporting, the TCFD framework as it stands does not elicit adequate climate disclosure. Past EDF analysis has shown that the TCFD’s high-level, voluntary principles often steer companies towards vague and unreliable disclosures.

The financial community needs the ability to conduct apples-to-apples comparisons of companies in and across sectors. Companies also benefit from benchmarking their own performance against their peers’.

As Calvert Research and Management noted, line-item metrics could include short-, medium-, and long-term emissions reduction targets and assets exposed to flooding, fire, and other forms of extreme weather.

These requirements would be not saddle companies with undue reporting burdens. With increasingly sophisticated risk analytics tools such as FutureProof and Jupiter, companies can more easily model the financial impact of extreme weather on their business.

Line-item disclosures that build on the TCFD framework can ensure that market participants have the specific and comparable information needed to reduce climate risk.

3. Include climate information in 10-Ks

The utility of disclosures will depend on the accuracy and precision of the climate information that companies provide. If companies disclose unreliable risk metrics, investors will make unreliable risk management decisions.

Climate risks are financial risks and thus belong in companies’ annual 10-K filings. Including climate information in 10-Ks – along with other financially relevant data – is essential to ensure credible reporting. Because they require sign-off from companies’ CEOs and CFOs and face targeted regulatory scrutiny, 10-Ks offer investors uniquely trustworthy information core to risk analysis.

Some companies have argued that climate information should appear in supplemental reports rather than 10-K filings, asserting that climate risk reporting involves too much uncertainty.

These companies’ statements underestimate the integrity of existing risk analysis tools. More importantly, reporting climate information outside of 10-Ks does nothing to improve data reliability, potentially giving companies a free pass to report misleading climate data.

Fortunately, not all companies share this view. Total Energies noted that climate risk information should be included in corporate 10-Ks because “climate change related company disclosures are important for investors to make informed investment decisions.” And major investors agreed, with firms including PIMCO and Invesco calling for equal treatment of climate and financial data.

4. Move quickly

Some companies that are supportive of SEC rulemaking have called for a gradual phase-in of climate disclosure standards. But with wildfires raging on the West Coast, storms flooding the East Coast, and temperatures rising around the globe, investors – and the planet – cannot afford to wait.

As climate change worsens, asset mispricing increases. This mispricing could lead to an economic shock that threatens investors, markets, and the American public, the very constituencies the SEC is mandated to serve.

Strong disclosure rules will fail to achieve maximum impact if they arrive too late. The SEC should forgo a gradual phase-in of new climate reporting standards and instead move quickly to compel robust disclosure that protects investors, companies, and the American public from the grave effects of climate change.

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