As sure as there is going to be a hurricane season, mandatory climate-change disclosures of public companies, and perhaps private ones as well, are on their way. In March, the Securities and Exchange Commission (SEC) requested public input on what these new disclosures should be. In May, SEC Commissioner Allison Lee presented in a speech a legal analysis of the SEC’s authority to require such disclosures, even if the disclosures are not material to a reasonable investor. She based this analysis on wording found in the federal securities law that repeatedly states that the SEC has authority to require disclosures that are “in the public interest or for the protection of investors.” Such language implies broad powers in requiring disclosures. If Commissioner Lee is correct—and I believe that she is—the issue becomes: What, if any, limitations should the SEC impose on itself in terms of requiring climate-change disclosures?
It is easy to argue that the SEC should require disclosures that allow investors to evaluate how climate change affects the investment risk of the disclosing company, i.e., a public company’s climate risk. Moreover, even though it is probably not statutorily required, it is only common sense that some sort of materiality standard be applied. If not, company reporting and liability burdens may become onerous, and, most important, the costs to investors and the public of identifying the information that is truly important will be excessive.
Current SEC guidance already recommends a fair amount of such climate-risk disclosure. The following topics and how they affect the reporting company may require disclosure: the impact of climate-change legislation and regulation; international accords on climate change, such as the Paris Accord; indirect consequences of climate-change regulation, such as a reduction of demand for goods that create high levels of greenhouse gas emissions; and the physical impacts of climate change, such as severe weather, on the company’s operations.
In addition, I propose that the SEC require a company to disclose low-probability high-impact climate-change events as risk factors under Item 503(c) of Regulation S-K—for example, the possibility that a company may be significantly impacted by multiple freak winter storms that take down an entire state’s power grid for days. There are a lot of reasons that such risks are not already included in the price of a company’s stock, and Madison Condon provides those reasons in her recent law review article “Market Myopia’s Climate Bubble.” Once these risk factors are disclosed, investors can gauge just how well the company can adapt if such an event occurs. This is the key investor protection point in having such disclosures.
Beyond these investor protection disclosures, it is not at all clear what the parameters should be for general climate-change disclosures. That is, what climate-change mandatory disclosures would be in the “public interest”? My current thinking is that climate-change disclosures should be mandatory if they are proved to actually reduce the world’s climate risk—or, at least, have a good expectation of doing so. If they do not, what would be the public interest in having such disclosures?
For example, many have argued that the SEC should require standardized climate-change reporting data in order to facilitate the providing of ESG ratings and the setting up of ESG funds. Large investment advisers, rating agencies, and those lawyers and auditors in the compliance field will love this, but does requiring such mandatory one-size-fits-all information really do anything to mitigate climate change?
Not according to Tariq Fancy, BlackRock’s former chief investment officer for sustainable investing. In a recent op-ed, he states: “But doesn’t investing in sustainable mutual funds or ETFs increase funding to environmental and social causes? No, it doesn’t. While the investor may indirectly own more shares in companies with slightly higher ESG scores, those companies don’t receive the new funding. Instead, the money goes to the seller of the shares in the public market.” In sum, he thought it was unlikely that the creation of ESG funds was going to have any real-world impact on reducing carbon emissions.
Mr. Fancy also observed that “one lesson COVID-19 has hammered home is that systemic problems—such as a global pandemic or climate change—require systemic solutions. Only governments have the wide-ranging powers, resources and responsibilities that need to be brought to bear on the problem.” Moreover, he concluded that a focus on ESG investing harmed mitigation efforts “by creating a societal placebo that delayed overdue government reforms.” That is, this focus has reduced our sense of urgency to advocate for strong governmental actions that will have a real impact on mitigating climate change. Mr. Fancy refers to this as a “deadly distraction.”
Finally, it needs to be noted that the compliance bill for mandatory disclosures may be huge. For example, it has been reported that PricewaterhouseCoopers (PwC) is planning on hiring 100,000 new employees and investing $12 billion over the next five years in order to help meet its clients’ ESG reporting requirements. We can assume that this represents only the tip of the iceberg and probably does not even represent what public companies will actually pay to have the compliance work done.
Therefore, before the SEC tries to save the world from climate change and expose our companies to tens, if not hundreds, of billions of dollars per year in compliance costs, it needs to be very careful about the unintended consequences of the climate-change disclosures that it may require. We do not want mandatory disclosures to have the effect of making investors believe that they are helping mitigate climate change when, in reality, they are doing very little, creating another “deadly distraction.”
