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The Time is Right to Require Disclosures About Climate Risk

Financial Information Should Be Mandated by the SEC

I have previously blogged about the importance of disclosing issues related to corporate social responsibility (CSR) in the financial statements or some other form of reporting.  The SEC has examined the potential economic effects of mandated disclosure and reporting standards for CSR, environmental, social, and governance (ESG) criteria and sustainability. There is no agreement about mandated disclosures. Investors need this information if they are to become educated about how companies are meeting their overall responsibilities to society, including those that go beyond profits and losses. Today, I address what has become a hot button issue regarding financial disclosures – the disclosure of risks to the climate and potential economic costs.

Climate Risk Disclosure Act of 2021 (H.R. 2570)

The SEC just announced that it is seeking more details from companies about their climate risks as it moves toward proposing new disclosure requirements about these conditions. This follows a debate in Congress about how to deal with such matters. Back on June 16, 2021, the U.S. House of Representatives passed the Climate Risk Disclosure Act of 2021, H.R. 2570, legislation to require public companies to disclose information about their exposure to climate-related risks. The bill has not been taken up yet by the Senate.  

The U.S. lags far behind our global partners in safeguarding our financial system against the climate crisis. By increasing market transparency through the establishment of clear, easily comparable climate disclosure standards, H.R. 2570 will enable investors to appropriately assess climate-related risks, safeguard against financial risk resulting from environmental catastrophes, and help the market transition from fossil fuels to cleaner, more sustainable energy sources in time to prevent the worst impacts of the climate crisis. Climate risk

According to the Climate Risk Disclosure Act, climate change has the potential to affect companies in two ways. First, climate change – rising sea levels, extreme storms, water shortages – directly threatens valuable company assets. Freddie Mac has stated that climate change appears “likely to destroy billions of dollars in property and to displace millions of people,” which will produce “economic losses and social disruption . . . likely to be greater in total than those experienced in the housing crisis and Great Recession.” 

Second, global efforts to reduce greenhouse gas emissions or otherwise mitigate the effects of climate change could dramatically affect the value of company assets. The Task Force on Climate-related Financial Disclosures has written that the reduction in greenhouse gas emissions “coupled with rapidly declining costs and increased deployment of clean and energy-efficient technologies could have significant, near-term financial implications for organizations dependent on extracting, producing, and using coal, oil, and natural gas.” These “climate-related risks and the expected transition to a lower-carbon economy affect most economic sectors and industries.”

The effects on the fossil fuel industry are likely to be most severe. To successfully limit global warming to two degrees or less relative to pre-industrial levels – the goal of the Paris climate accord – energy experts estimate that at least 82% of global coal reserves, 49% of global gas reserves, and 33% of global oil reserves must remain unused over the next 30 years. A recent study projected that “stranding” these booked assets could “amount to a discounted global wealth loss of $1-4 trillion,” with the U.S. at particular risk of seeing its fossil fuel industry “nearly shut down.”

The market lacks information about companies’ exposure to these risks and it appears to dramatically undervalue the potential impact of climate change. While the SEC has issued guidelines suggesting that companies consider the effects of climate change on company assets, it has not mandated any specific disclosures. 

The Solution?

The Climate Risk Disclosure Act requires public companies to disclose critical information about their exposure to climate-related risks. It directs the SEC, in consultation with climate experts at other federal agencies, to issue rules within one year that require every public company to disclose:

  • Its direct and indirect greenhouse gas emissions
  • The total amount of fossil-fuel related assets that it owns or manages
  • How its valuation would be affected if climate change continues at its current pace or if policymakers successfully restrict greenhouse gas emissions to meet the Paris accord goal; and
  • Its risk management strategies related to the physical risks and transition risks posed by climate change

The bill directs the SEC to tailor these disclosure requirements to different industries and to impose additional disclosure requirements on companies engaged in the commercial development of fossil fuels. 

The time has come to require disclosures about climate risks that arise from actions by companies. Companies are stewards of the environment and need to protect it for future generations. We need to gather relevant data to provide transparency on these issues, better inform investors about the treatment of the environment by companies, many of whom wield immense power, and better regulate them with respect to climate-related activities and their financial implications.

Blog posted by Dr. Steven Mintz, The Ethics Sage, on March 15, 2022. You can sign up for his newsletter and learn more about his media activities at: https://www.stevenmintzethics.com/. Follow him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.