August 16, 2022

Investors and Regulators Cannot Ignore Climate Risks

With the contributions of Mandy DeRoche, Executive Vice President of the Coal Program, and Jeffrey Stein, Legal Member of the Sustainable Food and Agriculture Program

Climate change affects our health, safety, food supplies, where and how we live, and much more. It also promotes technological advances, new regulatory requirements and changing consumer behavior while working to avoid the worst climate consequences. All of these have financial implications. Smart companies and investors assess climate-related risks and incorporate them into their corporate and investment strategies. But efforts to do so are hampered by inconsistent and unreliable disclosures about climate-related financial risks.

Earlier this year, the Securities and Exchange Commission (SEC) proposed a new rule will require public companies to disclose climate-related risks and their financial implications. This is an important step to ensure that companies adequately assess their climate change risks and that investors have the reliable, comparable information they need to make investment choices.

Here’s what you need to know.

Climate change poses great risks to our economy

From extreme droughts and wildfires to record storms and floods, climate change is already taking a huge toll on the US federal budget and our economy. Caused by twenty major climate disasters in 2021 alone 688 deaths and approximately $145 billion in damage. Over the past decade, damage has been more than $1 trillion. The costs to communities, companies and every government will only increase as climate-related extreme weather worsens.

Climate change threatens every aspect of the US economy, from the housing market to tourism, healthcare and agriculture. No industry is immune from climate-related financial impacts. In addition to the increased physical risks from climate disasters, companies will also be affected by our transition to a pollution-free, clean energy economy. They may face uncertainty stemming from changes in law, policy, technology, consumer behavior and social norms. The combination of physical risks and transition risks can create even more economic uncertainty and disruption for some industries.

Investors need more information to assess climate risks

Investors, like other financial risks, must take climate-related risks into account when making investment decisions. But they cannot do this without adequate, reliable explanations. In 2010, the SEC published guidance on climate-related disclosures, but did not provide sufficient detail on how a company should assess and disclose climate-related risks. In the absence of clear federal disclosure rules, companies, investors, and financial institutions have developed a constellation of voluntary reporting frameworks and systems. While important in laying the groundwork, these voluntary efforts have not resulted in the comparable, reliable explanations needed to properly account for current and future climate risks.

Some of the sectors most at risk from climate change do not adequately address these risks in their statements. For example, Carbon Tracker recently reviewed disclosures for 107 oil and gas, transportation, utilities, cement, consumer goods and services, and other industrial sector companies and found: more than 70% did not indicate that they take climate-related risks into account while preparing their financial reports.

Another example of under-disclosure is the agriculture sector, which is both the largest contributor to greenhouse gas emissions and one of the sectors most affected by climate change. Crop and livestock production, farmers and agricultural workers themselves, and their supply and distribution chains are highly vulnerable to extreme weather conditions. Changes in government policy and consumer preferences will also affect their profitability. The vast majority of agribusiness firms’ greenhouse gas emissions come directly from their supply chains (“Scope 3” emissions) rather than directly from the firms themselves – including emissions from cows, manure management, land use and fertilizer use. However, agribusiness firms currently do not disclose information about these emissions to investors, leaving investors unaware of the level of transition risk they face.

The failures of current disclosure practices are particularly striking for emerging and energy-intensive industries. One such example is proof-of-work cryptocurrency mining. Crypto mining operations are driving demand for fossil fuels, increasing pollution and driving up electricity prices in many areas and straining the electricity grid. US-based Bitcoin miners produce between a quarter and 45 percent of global greenhouse gas emissions caused by Bitcoin mining, the most common proof-of-work cryptocurrency. But public crypto companies disclose little information about their energy consumption, fuel source or greenhouse gas emissions, which are critical for analyzing their financial risks.

Disclosure of these risks is essential to ensure that investors have the full picture they need to make sound investment decisions.

Investors tried to fill the gap, but it’s up to the SEC to take action

In recent years, investors have sought to fill the gap in disclosures by seeking climate-related information from other sources, such as scientific organizations or climate data groups. Numerous organizations are working to develop better tools for the public, companies and investors to address climate-related risks. Shareholder votes and voting policies also demonstrate investor interest in more reliable climate-related explanations. But voluntary disclosure frameworks and investors’ own gap-filling efforts cannot replace regulatory oversight.

The SEC does not set climate policy or enforce environmental laws, protecting investors; promotes fair, orderly and efficient markets; and facilitates capital formation. Congress has given the SEC the power and obligation to request disclosures necessary or appropriate to carry out its mission. As we have seen, without SEC oversight and rules, investors cannot get the consistent, reliable and comprehensive disclosures they need. The SEC is responsible for assessing changing risk exposure and identifying disclosure gaps that increase risk for investors and markets. As with other financial risks, it must act to address information asymmetry that can misinform investors and create unnecessary market risk.

SEC’s climate risk disclosure rule protects investors

In March, the SEC proposed a new climate risk disclosure rule to close the information gap. The proposed rule requires more rigorous, credible and consistent disclosures and provides details on how companies expect them to disclose climate risks. It provides transparency on how corporate executives and the board of directors define, assess and manage climate-related risks. And it balances the need for more information with the need for actionable and accessible explanations.

This rule is fully within the SEC’s mandate and supports its mission to protect investors, promote more efficient markets, and contribute to the financial stability of our economy. That’s why Earthjustice has sent comments urging the SEC to complete strong disclosure requirements that will protect investors and ensure that our markets properly consider climate risks.

The SEC must not succumb to political pressure from industry lobbyists fighting to preserve the status quo. Its job is to protect investors, including all of us whose retirement savings are in mutual funds. The proposed rule does this by ensuring that companies do not hide or ignore the financial impacts of climate risks. The SEC must act quickly to complete the strongest rule possible.

Leave a Reply

Your email address will not be published.