SEC looks to streamline sustainability rules

U.S. regulators are responding, with the Securities and Exchange Commission expected to issue proposed rules that would require companies to disclose information that may include data on greenhouse gas emissions, the financial impacts of climate change on operations, and progress toward stated climate-related goals. The rules would update guidance that the SEC issued in 2010.

The SEC’s call for public comment earlier on what the proposed rules should entail unleashed a barrage of responses from companies, investors, and consultants since March. Three out of four respondents called on regulators to mandate climate-risk disclosures, SEC Chairman Gary Gensler has said.

The current system of voluntary disclosures, in which each company chooses what information it shares with the public, makes it impossible for investors to compare peers within an industry, the SEC says. The regulator has foreshadowed that it wants to strengthen climate-related disclosures by forcing companies to release information of all direct risks as well as indirect greenhouse emissions that occur in their supply chains. Disclosures that are consistent among peers and tied to financial performance appear to be the goal.

“There is greater demand for disclosure: The market wants it, investors want it, companies want it,” says Steven Rothstein, managing director of Ceres Accelerator for Sustainable Capital Markets. “We are optimistic that the SEC will act by the end of the year.”

The key, he says, is that the disclosures should be based on methods and standards that all companies have to follow. 

“Having a consistent methodology would make a difference—it would have a very significant impact,” he noted.

Uniform standards would address an urgent need of investors, the nonprofit CFA Institute said in comments submitted to the SEC supporting robust disclosures. While three out of four investment executives surveyed last year told the institute that climate change was an important issue, a “lack of measurement tools” meant only 40% integrated climate change analysis into their investment process, the institute said.

Any SEC initial guidance on ESG compliance will accelerate what is already happening. Many banks, insurers, and companies have started embracing the United Nations’ Sustainable Development Goals and disclosing some climate data in response to public pressure, shareholder requests, and government rules in other countries.

Consumer-brand manufacturers have made greater strides regarding climate disclosures, perhaps because their products are more in the public eye. Other manufacturers lag, as do the oil and gas industries. Larger companies like General Electric tend to release more information than smaller ones. 

Real estate companies, because their assets face more physical risks, also are seen as one of the sectors that are paying more attention to climate change.

The banking industry, particularly larger banks, have been assessing their climate risks and moving toward more transparency because their operations are so wide-ranging that they in effect touch almost every corner of the economy. Insurers, which share many of the same risks as banks, are moving ahead as well. 

The banking industry’s exposure to climate risks is large, according to a new report from the nonprofit organization Ceres. 

To put the economic danger in perspective, the banking industry’s exposure to climate-change risk is greater than the exposure it faced during the subprime mortgage crisis in 2008.

Just looking at 28 of the largest U.S. banks, as much as $250 billion of their $2.2 trillion of syndicated loan exposure faces some physical climate risk. About two-thirds of that risk is from the indirect economic impact of climate change, such as supply-chain disruptions and lower productivity. Coastal flooding, driven by rising sea levels and more devastating storms, represents the largest source of direct risk.

The banking industry, led by large institutions including Bank of America and Citicorp, has been moving toward more disclosures in fits and starts. But an extensive and complete assessment of all their portfolios is essential, Rothstein said, and the banks are way behind on that.

Mandatory disclosures needed

Three main themes emerged from the thousands of missives received by the SEC regarding its effort to ensure that investors have the information they need about a publicly traded company’s climate-related risks.

First, corporate officials should be required to be more transparent about their long-term plans regarding environmental, social, and governance goals, and they should be held accountable if their public statements conflict with what they are actually doing. Otherwise the named officers of U.S.-listed companies will continue to focus on short-term financial goals. Second, disclosures must be mandatory, easy to access, and standardized in a way that allows for comparisons across industries and companies. Third, companies must include in their disclosures data on their supply chains. 

“It would be really efficient if there is one set of rules that issuers can disclose against,” said Betty M. Huber, co-head of ESG and environmental practices at the Davis Polk law firm.

The current system, in which every company—even in the same industry—uses different methods to assess their operations and discloses information in response to shareholder pressures, makes it difficult for investors to examine a company’s performance related to ESG or compare it to peers. This private ordering creates an environment in which misleading marketing tactics and so-called greenwashing can flourish. 

Just last month, it became public that DWS Group, Deutsche Bank AG’s asset-management arm, is under investigation by U.S. and German authorities after a former head of sustainability alleged that the financial institute exaggerated its use of ESG criteria in asset-management decisions. DWS rejected those claims.

Even without the new rules, the SEC has demanded money managers explain the standards they are using to classify funds holding an estimated $35 trillion in sustainable investment assets as ESG-focused. The SEC is also seeking information on ESG compliance programs, policies, and procedures, along with any statements made by managers in marketing materials or regulatory filings.

Regulators have the majority of investors on their side. In 2017, the CFA Institute found that 73% of its 2,800 members incorporated ESG information into the investment process. By 2020, the percentage was up to 85%.

While the details of the proposed SEC rules are not yet known, the very fact that there will be a consistent methodology to climate-risk disclosures will have an enormous impact. 

“This rulemaking will consolidate all the private ordering of the past,” says Huber.

It would also enable the U.S. to begin to catch up with the European countries and Asian countries that passed climate-disclosure requirements in recent years. France, for instance, in 2015 required publicly listed companies, institutional investors, and asset managers to report their climate-related risks, including costs associated with moving toward a low-carbon economy as well as the potential adverse impacts of extreme weather events and chronic stresses affecting business and economic assets.

Requiring public release of more climate-related information has pushed European companies to accelerate plans to reduce their emissions, Rothstein says, and he expects the same would happen in the U.S.  

“We are so far behind,” Rothstein said. “The market only works if there is good information. Right now, there is an asymmetry of information.”

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