What Congress Needs to Know About Corporate Climate Risk, Resilience, and Disclosures

The Environmental and Energy Study Institute (EESI) invites you to a briefing on corporate climate risk, resilience, and disclosures. The climate crisis is increasingly impacting companies of all sizes by threatening valuable assets, operations, and supply chains. At the same time, many companies contribute to the climate crisis by emitting greenhouse gases, and efforts to curb those emissions could impact companies. In March 2022, the Securities and Exchange Commission proposed a rule that, if adopted, would require publicly-traded companies to disclose climate-related risks and report their greenhouse gas emissions.

Panelists discussed the role of Congress in designing and overseeing policy for climate risk disclosures, and the benefits and impacts that the proposed rule would have on federal agencies, companies, and shareholders.

Highlights

 

KEY TAKEAWAYS

Standardized climate risk disclosures matter for investors because they provide much better information on how exposed investments are to climate risk and how companies are managing that risk, and they add in an accountability mechanism for companies. Several federal agencies and the Federal Reserve have joined the international Network for Greening the Financial System. It provides recommended regulatory policies and strategies for monitoring systemic climate risk that many central banks and financial regulatory groups across the world are beginning to adopt. The Task Force on Climate-related Financial Disclosures (TCFD) was created to develop a framework for investors to better understand what climate risks exist for publicly-traded companies in order to inform investors’ capital allocations. International alignment on climate risk disclosure is important because a single global reporting framework baseline is more cost-efficient for companies, makes investor choices better informed, and increases corporate climate reporting accountability to mitigate greenwashing.

 

Representative Sean Casten (D-Ill.)

• One of the main reasons for the Climate Risk Disclosure Act of 2021 (H.R.2570/S.1217) and the proposed U.S. Securities and Exchange Commission (SEC) rules is that there are trillions of dollars in environment, social, and governance (ESG) assets, yet ESG is not consistently defined.
• There is a significant need to understand which capital markets display financial risk from climate change. As of now, financial regulators do not have data to track these patterns. With disclosures, domestic and international financial regulators can begin to track the data and understand these relevant capital flows.

 

Madison Condon, Associate Professor of Law, Boston University

• In May 2021, President Biden issued “Executive Order on Climate-Related Financial Risk” (E.O. 14030), which gives all financial regulatory agencies a climate risk oversight mandate.
• The SEC has proposed three rules in response to President Biden’s executive order:
  • The Rules to Enhance and Standardize Climate-Related Disclosures for Investors, which would require corporations that are publicly-traded in the market to disclose their climate risk.
  • The Investment Company Names Rule, which would regulate how investors brand and market funds such as funds labeled “sustainable.”
  • The ESG Disclosure Rules would increase ESG disclosure rules for funds and advisers that claim to be ESG or use ESG data.
• Several federal agencies and the Federal Reserve have joined the international Network for Greening the Financial System. It provides recommended regulatory policies and strategies for monitoring systemic climate risk that many central banks and financial regulatory groups across the world are beginning to adopt.
• In addition to the SEC, several federal agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Department of the Treasury, are taking action to address climate-related financial risk.
• Climate risk is broken down into three categories: physical risk (direct damage to assets or property), transition risk (disruption from adjustment to a low-carbon economy), and liability risk (lawsuits related to not considering or responding to the impacts of climate change).
• Climate risk analysis in the financial sector, and physical risk analytics especially, is a rapidly expanding field.
• Some greenwashing concerns at the corporate level include: whether net-zero goals are actually achievable and based on science; whether “scope” emission reports are accurate and audited; and whether emission scenarios used by companies for assessing transition risks represent a reasonable range of plausible energy demand futures.
• Some greenwashing concerns at the fund level include: whether the fund rebranded as ESG with no substantive change to methodology; whether the composition of the fund is consistent with its prospectus description; whether fund investors understand what ESG metrics mean and how they are used; and whether fund shareholder voting records reflect ESG issues.
• There are three types of ESG funds: ESG Integration, ESG Focused, and ESG Impact. These types would have different levels of disclosure under the SEC’s proposed rules.

 

Emily Wasley, Practice Leader of Corporate Climate Risk, Adaptation, and Resilience, WSP

• The Task Force on Climate-related Financial Disclosures (TCFD) was created to develop a framework for investors to better understand what climate risks exist for publicly-traded companies in order to inform investors’ capital allocations. The 2017 TCFD Final Report outlines a voluntary framework for climate-related disclosures that includes four core elements:
  • Governance, which describes board oversight and how management within the company assesses and manages climate-related risks and opportunities.
  • Strategy, which discloses the actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning where such information is material.
  • Risk Management, which discloses how the organization identifies, assesses, and manages climate-related risks.
  • Metrics and Targets, which discloses the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.
• The 2017 Final Report encouraged publicly-traded companies to voluntarily disclose their climate-related risks and opportunities and how they are managing them. It is important for the SEC proposed rules to be finalized because disclosure is not happening fast enough, especially as climate change accelerates.
• The TCFD highlights both transition risks (i.e., policy and legal, technology, market, and reputation risks) and physical risks (including acute and chronic risks).
• Implementing the TCFD recommendations effectively and equitably can be a vehicle for organizational change, management improvements, new business opportunities, and mainstreaming climate change across all decisions that companies make.
• Investors increasingly want to see transition plans from companies to outline how they will reduce climate risks and leverage opportunities. Climate adaptation plans are not being as discussed in the United States as they need to be.
• Risks and opportunities have financial impacts that are assessed through income statements, cash flow statements, and balance sheets.
• Climate scenarios help investors understand current climate risks as well as a range of future scenarios. Scenario analysis is then used to explore forward-looking potential physical and transition risks and opportunities.
• Adaptation planning includes actions to manage the physical impacts of climate change such as flood or fire protection, natural infrastructure investments, and business continuity planning. Transition planning includes actions to reduce greenhouse gas (GHG) emissions such as sustainable transportation, carbon sinks, and renewable energy.

 

Jane Thostrup Jagd, Deputy Director of Net Zero Finance, We Mean Business Coalition

• The International Sustainability Standards Board (ISSB) was created in 2021 and recently launched its first set of reporting standards.
• The SEC’s proposed rules are also a substantial development in climate-related disclosure.
• International alignment is important because a single global reporting framework baseline is more cost-efficient for companies, makes investor choices better informed to funnel their capital into green initiatives, and increases corporate climate reporting accountability to mitigate greenwashing.
• To ensure such an alignment, the SEC could reference the ISSB directly to maintain continued convergence and comparability.
• To further ensure alignment, companies’ reporting and target setting should be subject to safe harbor protections under the Private Securities Litigation Reform Act (P.L. 104-67).
• Boundaries for GHG emissions reporting should follow financial boundaries so that non-financial and financial data are aligned and easier to compare.
• Emissions from owned and used assets should be included in scopes one and two reporting [As defined by the U.S. Environmental Protection Agency (EPA), “Scope one emissions are direct GHG emissions that occur from sources that are controlled or owned by an organization…Scope two emissions are indirect GHG emissions associated with the purchase of electricity, steam, heat, or cooling.”].
• Financial rules for consultation and leasing can be reused to define boundaries.
• The nuances of reporting on leasing are particularly important to get right in the SEC’s proposed rule. Financial rules for leasing can be reused, which means the emissions from assets leased in should also be included in scopes one and two. Assets from owned and leased assets that are leased out to others should not be included in scope one and two, but they should be included in scope three [As defined by the EPA, “Scope three emissions are the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly impacts in its value chain.”]. 
• Ensuring this alignment between financial rules and assessment of climate-related risks and opportunities will make it easier for companies to integrate climate reporting into their existing systems, reporting, and auditing—and make the resulting reporting more robust.

 

Ryan McQueeney, Sustainable Investment Stewardship Analyst, Wespath Benefits and Investments

• Wespath is an asset owner primarily focused on pensions, retirement, health benefits, and endowments, which means they are interested in long-term value for investors.
• Wespath is a member of the Net-Zero Asset Owner Alliance, which is a United Nations-convened coalition featuring more than 70 asset owners from around the world and over $10 trillion in assets under management.
• Standardized climate risk disclosures matter for investors because they provide much better information on how exposed investments are to climate risk and how companies are managing that risk, and they add in an accountability mechanism for companies.
• In the investment field, the term stewardship refers to investor actions such as corporate engagement, proxy voting, and more nascent tools such as engagement with policymakers and regulators.
• Systemic risk is defined as a type of investment risk that cannot be “diversified away.” Systemic stewardship can be used to address systemic risk as described in Wespath’s paper, The Future of Investor Engagement: A call for systemic stewardship to address systemic climate risk.
• Many companies have already acted on opportunities to reduce emissions that also improve short-term profitability. So, any new emissions reduction efforts come at an increasing marginal cost. The role of investors is to push companies to move up the steepening cost curve, so that companies continue to reduce emissions even though it is more expensive to do so.
• Some companies have good reason to move up the curve, but there are five main limits that impact corporate engagement at this point.
  • For example, one limiting factor (covered under limit three in the report) is the inefficiencies of focusing on voluntary, company-by-company disclosure. The SEC’s proposed rules will hopefully reduce this inefficiency.
  • Another limit (covered under limit five in the report) is the boundaries set by the “rules of the game” or the policy and regulatory frameworks under which investors and companies operate. The SEC rules will also change the rules of the game.
• Systemic change is needed to address these limits. There is only so much that companies and investors can do themselves. There is a lot of work that must be done by policymakers when it comes to the practical realities of instituting such changes.

 

Q&A

Q: From the different perspectives of stakeholders, how would standardized climate risk disclosures be helpful?

Condon:

• There are many different ways to report scope three emissions because of the flexibility of the equations which are used to calculate emissions, leading to varied reporting between different industries. Standardization can help reduce these discrepancies.
• Reporting of scope three emissions is still evolving. It is not clear that scope three is the best measure of transition. There are other factors—like jurisdictional exposure or the type of industry you are investing in—which can change a company’s emissions but may not be accounted for through crude scope three analysis.

Wasley:

• Standardization creates a good baseline for everyone to be on the same page in understanding that climate change is a systemic risk impacting the global financial system. This will help us move forward and take action.
• It helps all stakeholders go through the process of understanding what their risks are and how climate change affects all kinds of business operations.
• We are not seeing enough companies engaging with their communities and investing in resilience for the communities.
• Standardization increases transparency.

 Jagd:

• More comparable and widespread reporting could allow the financial sector to eliminate ESG ratings. They are not popular with companies, and they do not work well.
• It would be fantastic to use the data directly from the companies instead.

McQueeney:

• Having standardized climate risk disclosure will free up substantial time for investors to start focusing on other things. The sector needs to get past climate disclosure and more into actual climate action.
• There is an undergirding theory to sustainability disclosure holding that companies are more likely to perform well on something if they are forced to report on it. In a hypothetical situation where everyone is reporting climate risk disclosures, now there is important comparable information that could inspire more climate action.

 

Q: What are the opportunities to address corporate climate risk equitably?

Condon:

• One big concern is that encouraging the economy to divest in risky areas and invest in less risky areas has direct impacts on people who live or work in risky geographical locations or economic sectors.
• The Community Reinvestment Act, enacted in 1977, requires banks to use a part of their investment to fund certain communities and underprivileged groups. This could be used as a framework applied more broadly to think about the intersection between financial risk and systemic risk.
• Companies need to start thinking about how supply chains, labor forces, and consumers are all affected by climate change.

Wasley:

• Through research done by the Task Force for Equity in Climate-Related Financial Disclosures, it was found that engaging and investing in gender equity advances climate action.
• If equity is not centralized in company decision-making for climate action, companies will create a more vicious cycle where they divest from vulnerable areas that need support to regenerate resources that have been extracted from them.
• Emphasizing leadership and empowering and promoting people of color and women across management will lead to more accelerated climate action.

 Jagd:

• Company disclosures should include measures of equity.

McQueeney:

• These are intersectional issues, so it is a good idea to layer these metrics on top of each other to look at their relationships.
• Investors do not want climate solutions to impact marginalized communities negatively, and this dialogue should extend internationally.
• Economic incentives can be used to intentionally reinvest in communities that need it the most.

 

Q: Are there ways that the proposed SEC rules could be crafted to help sectors that face higher burdens make the required disclosures more easily?

 Jagd:

• The SEC could consider a slimmer requirement for small and medium-sized enterprises. A minimum requirement for reporting that is expanded when companies become larger could be helpful.
• Sectors like food and agriculture will probably need to report on scopes one and two, but not necessarily scope three.

McQueeney:

• At an individual farm level, we do not want to be burdening small farmers with costly administrative work.
• It would make more sense for companies to invest in providing technology and solutions to suppliers rather than making whole-scale shifts to their supply chains.
• Potential burdens to small farmers is not a point that the SEC has ignored, and scope three will still be modeled to some degree.

Condon:

• Agriculture is a good example of where there has been too much focus on scope emissions and not enough focus on physical risk. This summer entire herds of cattle were dying and there was no way to dispose of the bodies, and international crop yields were down. This was a hard to predict situation, but it raises questions of resilience, which could be measured in a different way through governance mechanisms rather than a pricing of risks.

Wasley:

• The apparel industry notoriously uses a lot of water and emits a lot of greenhouse gases. This global issue affects local communities most heavily.
• Local suppliers offer goods and services to global corporations. These global corporations in turn must invest, share best practices, and be a global steward to mom-and-pop shops.

 

Compiled by Shreya Agrawal and Elina Lingappa and edited for clarity and length. This is not a transcript.