Recently, when asked about how all of the U.S. agencies coordinate on climate issues, SEC Commissioner Allison Herren Lee observed that one way agencies coordinate is through the Financial Stability Oversight Council. The FSOC, which is chaired by U.S. Treasury Secretary Janet Yellen and includes SEC Chair Gary Gensler as a member, has just issued a new report on climate-related financial risk. The report concludes that climate-related financial risk is “an emerging threat to the financial stability of the United States.” Some of the discussions and recommendations in the report are remarkably congruent with recent comments from Gensler about expected SEC climate disclosure regulation. Are we starting to get an idea of what to expect?
The report is the result of President Biden's May 2021 Executive Order on Climate-Related Financial Risk. The EO directed the Treasury Secretary to engage with other members of the FSOC to consider, among other things, comprehensively assessing the climate-related financial risk to the stability of the U.S. financial system and issuing a report on any efforts by FSOC member agencies to integrate consideration of climate-related financial risk into their policies and programs—including the necessity of enhancing “climate-related disclosures by regulated entities” and a recommended implementation plan. (See this PubCo post.) The new 133-page report represents an initial review by the FSOC of “current efforts by its members to incorporate climate-related financial risk into their regulatory and supervisory activities, enhance climate-related disclosures, and assess climate-related risks to the financial stability of the United States.”
The FSOC views climate-related financial risks as “an emerging threat to the financial stability of the United States. In the United States and across the globe, climate-related impacts in the form of warming temperatures, rising sea levels, droughts, wildfires, intensifying storms, and other climate-related events are already imposing significant costs upon the public and the economy.” (Interestingly, the report indicates that the FSOC did not discuss climate-related financial risks until its March 2021 meeting.)
Although the report address multiple aspects of the climate issue—for example, it discusses methodologies for measuring GHG emissions—one aspect addressed in the report is disclosure. The report advocates that FSOC members, which include the SEC, “promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to take climate-related financial risks into account in their investment and lending decisions. Investors, market participants, and regulators need better data and information, including enhanced and transparent disclosures, to assess climate-related financial risks and their potential effects on the financial system. This information will be used to help gauge risks to individual institutions and markets and to financial stability.”
Climate-related disclosures can help investors understand companies' risks and risk-mitigation strategies, the report observed, as well as help investors identify companies “well-positioned to succeed in a low-GHG or net-zero emissions future.” According to the report, investors have increasingly requested access to information about the “risks posed to companies' properties and supply chains due to increasing severe weather events, sea-level rise, drought, or other physical effects of climate change. In addition, investors have requested information about companies' exposure to transition risk linked to their GHG emissions footprint.” Have companies developed mitigation strategies, such as shifting away from carbon-intensive energy sources? Are they prepared to address other transition risks, such as potential increases in the cost of using GHG-intensive energy? Scenario analyses performed “can contribute to the assessment and disclosure of climate-related financial risks by firms that have significant exposure to climate-related impacts.” In addition, the transition to a low-GHG economy can also present a number of opportunities, such as energy and resource efficiency and new products and services.
The report observes that disclosure is not just for investors; it can also help “inform other companies in the disclosing company's value chain that are exposed to the risks of the disclosing company, such as asset managers, lenders, insurers, and commercial counterparties,” allowing these other entities to “better assess, mitigate, and disclose their own risks,” and promoting efficient capital allocation and orderly markets. In addition, coordination among agencies as to new requirements for climate-related disclosures, consistent with their mandate and authorities, could promote consistency and comparability and help avoid unnecessary duplication.
The report summarizes a variety of different voluntary disclosure frameworks, but highlights the Financial Stability Board's Task Force on Climate-Related Financial Disclosures. The TCFD, the report indicates, is “recognized as the leading organizational structure for climate-related disclosure globally and is one of the leading frameworks used by companies in the United States. The TCFD's four core elements for disclosure of governance, strategy, risk management, and metrics and targets could be a useful starting point for disclosure requirements to ensure the consistency, comparability, and decision-usefulness of disclosures across firms. Given the widespread adoption of TCFD globally, this could also help promote international consistency and comparability.”
SideBar
Recently, remarks from Chair Gensler and Commissioner Lee have given us clues about what to expect from the SEC's forthcoming proposal. At Yahoo Finance's All Markets Summit on Monday, Gensler was asked his reaction to the new FSOC report on climate. What would those disclosures look like? How does the SEC plan to standardize the disclosure? Gensler said that the SEC staff was building on the types of disclosures that hundreds of companies have made voluntarily and gave his standard response about seeking disclosure that is “consistent, comparable and decision-useful.” But he also seemed to outline where the proposal for disclosure requirements is likely to be headed: qualitative disclosure about governance, strategy and risk management, and quantitative disclosure about some metrics, such as GHG emissions. (For example, he said, if a company has publicly committed to a reduction in its emissions by 2030 or 2050, how are they doing each year in reaching that target?) Sound familiar? These four elements are right in line with the core elements of the TCFD. It's worth noting that Gensler has previously made reference to the TCFD as a framework for the SEC staff to “learn from and be inspired by….” (See this PubCo post and this PubCo post.) Something that companies can begin to think about.
In keynote remarks at the Investor Action on Climate Webinar put on by Principles for Responsible Investment and the London Stock Exchange Group, as well as participation in another virtual “fireside chat” at the 10th Annual Meridian Global Leadership Summit, Lee focused on climate disclosure and the importance of collaboration. The SEC's role is focused on the capital markets, Lee said, helping to “ensure that decision-useful information gets into the markets in a timely manner by, among other things, setting public company disclosure standards.” To that end, the SEC has been assessing how best to facilitate disclosure and is fortunate in having available a wealth of disclosure and voluntary frameworks to build on. “Because of this work,” Lee continued, “regulators can now pick up the baton to help achieve what a voluntary system alone cannot—that is, consistent, comparable, and reliable disclosure. Disclosure that works for investors, provides certainty for issuers, and provides fundamentally important transparency around the systemic risk posed by climate change.” (Note that, while Gensler uses the phrase “consistent, comparable and decision-useful,” Lee substitutes in “reliable.” Does that suggest that she's a proponent of independent audit or attestation of the information provided? She has previously remarked that symmetry around ESG and financial reporting, such as through attestation, needs to be the “ultimate goal.” See this PubCo post.)
Although there is substantial voluntary disclosure, Lee observed at Meridian (below based on my notes), there are some big gaps—some companies provide no disclosure around climate, while others provide some information, but it varies from company to company and, as a result, is not necessarily comparable. Lee noted again that the SEC hopes to build on much of the work that has already been done. The interviewer asked Lee about the challenges of international compliance—that companies are concerned that they will have different reporting obligations under different disclosure regimes globally. Lee said that global harmonization was important and that she contemplated an international baseline with variation targeted to different jurisdictions. When asked about sector-specific standards and metrics, Lee raised the question of whether the SEC was really best positioned for that type of sector-specific granularity—perhaps that might best be handled by a domestic standard setter.
According to the report, the “TCFD's core elements and recommended disclosures offer a useful structure for promoting the consistency, comparability, and decision-usefulness of climate-related disclosures, and have been widely adopted, in whole or part, by financial regulators around the world.”
SideBar
TCFD Core Elements and Related Disclosure Recommendations
Summarized below are some of the disclosures recommended by the TCFD for the core elements:
- Governance: The organization's governance around climate-related risks and opportunities
Recommended Disclosures
a) The board's oversight of climate-related risks and opportunities, including processes related to, and frequency of, advising the board regarding climate issues, whether the board considers climate change when reviewing strategy, plans and objectives, and the nature of board oversight of progress toward goals
b) The management's role in assessing and managing climate-related risks and opportunities, including whether a management-level employee has responsibility for climate issues, reporting to the board, and monitoring by management.
- Strategy: The actual and potential impacts of climate-related risks and opportunities on the organization's businesses, strategy and financial planning
Recommended Disclosures
a) Climate-related risks and opportunities the organization has identified over the short, medium and long term, including the duration of the those time horizons, a description of the climate issues for each timeframe and of the process used to determine which risks and opportunities will have financial impact.
b) The impact of climate-related risks and opportunities (including any climate scenarios) on the organization's businesses, strategy, and financial planning, such as the impact on products, R&D and operations, and how climate risks and opportunities are factors in financial planning, providing a “holistic picture of the interdependencies among the factors that affect their ability to create value over time.”
c) The resilience of the company's strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario, along with a description of where strategies may be affected by climate, how strategies might change in response and the scenarios and time horizons considered.
- Risk Management: The processes used by the company to identify, assess, and manage climate-related risks, including how the significance of climate risk is assessed relative to other risk
Recommended Disclosures
a) The company's processes for identifying and assessing climate-related risks, such as applicable and expected regulatory requirements, processes for assessing size and scope and definitions of risk terminology.
b) The company's processes for managing climate-related risks, including how decisions are made and prioritized to mitigate or accept risks.
c) How processes for identifying, assessing and managing climate-related risks are integrated into the organization's overall risk management.
- Metrics and Targets: The metrics and targets used to assess and manage relevant climate-related risks and opportunities
Recommended Disclosures
a) The metrics and methodologies used by the company to assess climate-related risks and opportunities in line with its strategy and risk management process, such as, where relevant, metrics associated with water, energy, land use and waste management, internal carbon prices, revenue from products and services designed for low-carbon uses, with each presented for historical periods to allow trend analysis.
b) Scope 1, Scope 2 and, if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks, calculated in accordance with GHG Protocol methodology and presented for historical periods to allow trend analysis.
c) Key targets used by the company to manage climate-related risks and opportunities, as well as performance against targets, such as those related to GHG emissions, water and energy usage relative to expected regulatory requirements, market constraints, efficiency or financial goals or other goals. Descriptions of targets could include whether the target is absolute or intensity-based, time frames, base year and key performance indicators and methodologies.
The recommended disclosures related to “strategy” and “metrics and targets” are subject to materiality assessments. (See this PubCo post.)
Assessing current corporate disclosure, the report observes that there is a lot of variation “in the quality, coverage, and comparability of the disclosed information, due in large part to the voluntary nature of the disclosure and lack of mechanisms to assure consistency, comparability, and decision-usefulness.” It notes that even carbon-intensive companies may not be disclosing climate-related risk information. Even disclosure under the TCFD framework regularly falls short. According to the report, TCFD recently evaluated 1,651 companies that issued climate-related reports under the TCFD framework. Among the recommended TCFD disclosures, companies most often discussed how they integrated climate-related risks into their risk management programs, but still that discussion appeared in only 52% of disclosures. (The WSJ reports that only 32% of these companies reporting under TCFD “met its guidelines on climate disclosure.”)
The report lays out a number of recommendations. For example, the FSOC plans to form a Climate-related Financial Risk Advisory Committee (CFRAC), composed of a broad array of stakeholders, such as climate science experts and representatives from NGO research institutions, academia, business and consumers. The FSOC also recommends that its members (such as the SEC) invest in “staffing, training, expertise, data, analytic and modeling methodologies, and monitoring,” and that they “collaborate with external experts to identify climate forecasts, scenarios, and other tools necessary to better understand the exposure of regulated entities to climate-related risks and how those risks translate into economic and financial impacts.”
With regard to enhancing public climate-related disclosure, the FSOC had these general recommendations:
“Recommendation 3.1: The Council recommends that its members review their existing public disclosure requirements and consider, as appropriate, updating them to promote the consistency, comparability, and decision-usefulness of information on climate-related risks and opportunities, consistent with their mandates and authorities.
Recommendation 3.2: The Council recommends that its members, consistent with their mandates and authorities, consider enhancing public reporting requirements for climate-related risks in a manner that builds on the four core elements of the TCFD, to the extent consistent with the U.S. regulatory framework and the needs of U.S. regulators and market participants.
Recommendation 3.3: The Council recommends that its members, consistent with their mandates and authorities, evaluate standardizing data formats for public climate disclosures to promote comparability, such as the use of structured data using the same or complementary protocols, where appropriate and practicable.
Recommendation 3.4: The Council understands that information on GHG emissions promotes a better understanding of the exposures of companies and financial institutions to climate-related financial risks. The Council recommends that, consistent with their mandates and authorities, FSOC members issuing requirements for climate-related disclosures consider whether such disclosures should include disclosure of GHG emissions, as appropriate and practicable, to help determine exposure to material climate-related financial risks.
Recommendation 3.5: The Council recommends that its members continue to coordinate with their international regulatory counterparts, bilaterally and through international bodies, as they assess requirements for climate-related disclosures.”
With regard to the SEC in particular, the FSOC had this recommendation:
“Recommendation 3.6: Public Issuer Disclosures—The SEC staff are developing a proposal on disclosure requirements for public issuers related to climate-related risks for the SEC's consideration. The Council is encouraged by the SEC's work on this critical issue and supports its efforts to consider enhanced climate-related disclosures to provide investors with information that is consistent, comparable, and decision-useful.”
SideBar
What is holding many companies back from more disclosure? According to an article in the WSJ, one commentator cited as a reason the “patchwork landscape of competing reporting frameworks and a dearth of in-house expertise[, which] often make a complicated task seem even more daunting for companies.” Likewise, a survey of 800 large companies conducted by a climate intelligence firm also pointed to the “complexity” of the task as the most significant reason for companies' reluctance. However, the article points out, in some cases, companies that overcame these impediments have ultimately found the effort worthwhile. For example, one semiconductor manufacturer said its endeavors to mitigate climate risk “helped it to dodge the impact of a drought”: the company's manufacturing process is water-intensive, and the company's water conservations efforts, including construction of a water reclamation plant, were “part of the reason its factories could keep running as usual, while others saw costs rise.”
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