Investors and Regulators Can’t Afford to Ignore Climate Risks
A new SEC rule will help ensure that companies adequately assess their climate-related financial risks.
Climate change impacts our health, safety, food sources, where and how we live, and much more. It is also spurring technological developments, new regulatory requirements, and changing consumer behavior as we work to avoid the worst climate outcomes. These all have financial impacts. Smart companies and investors are assessing climate-related risks and incorporating them into their corporate and investment strategies. But their efforts to do so are hindered by inconsistent and unreliable disclosures on climate-related financial risks.
Earlier this year, the Securities and Exchange Commission (SEC) proposed a new rule that will require public companies to disclose climate-related risks and their financial impacts. This is an important step for ensuring companies adequately assess their climate change risks and investors have the reliable, comparable information they need to make investment choices.
Here’s what you need to know.
Climate change poses major risks to our economy
From extreme drought and wildfires to record storms and flooding, climate change already imposes an enormous cost on the U.S. federal budget and our economy. In 2021 alone, twenty major climate disasters caused 688 fatalities and approximately $145 billion in damage. Over the past decade, the damage totals 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 facet of the U.S. economy, from the housing market to tourism to healthcare to agriculture. No industry is immune to climate-related financial impacts. In addition to increasing physical risks from climate disasters, companies will also be impacted by our transition to a pollution-free, clean energy economy. They may face uncertainty 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 must account for climate-related risks when they make investment decisions, just like any other financial risks. But they can’t do that without adequate, reliable disclosures. In 2010, the SEC issued guidance on climate-related disclosures, but did not provide sufficient detail on how a company should evaluate 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 disclosures needed to properly account for existing and future climate risks.
Some of the industries most at risk from climate change do not sufficiently address these risks in their disclosures. For example, Carbon Tracker recently reviewed disclosures for 107 oil and gas, transportation, utility, cement, consumer goods and services, and other industrial sector companies and found more than 70% did not indicate they considered climate-related risks in preparing their financial reports.
Another example of inadequate disclosures is the agriculture sector, which is both a major contributor to greenhouse gas emissions and among the industries hardest hit by climate change. Crop and animal production, farmers and farmworkers themselves, and supply and distribution chains are all highly vulnerable to extreme weather. Changes in government policy and consumer choices will also impact their bottom lines. The vast majority of industrial agriculture firms’ greenhouse gas emissions come from their supply chains (“Scope 3” emissions) — including emissions from cows, manure management, land use, and fertilizer use — rather than directly from firms themselves. But industrial agriculture firms do not currently disclose information about these emissions to investors, leaving investors uninformed about the level of transition risk they face.
The failures of current disclosure practices are particularly noticeable for emerging and energy-intensive industries. One such example is proof-of-work cryptocurrency mining. Crypto mining operations are increasing demand for fossil fuels, exacerbating pollution and in many areas, raising electricity rates and stressing the electric grid. U.S.-based Bitcoin miners produce between one quarter and up to 45 percent of the global greenhouse gas emissions caused by Bitcoin mining, the most prevalent proof-of-work cryptocurrency. But public cryptocurrency companies disclose little information on their energy consumption, fuel source, or greenhouse gas emissions, which are critical for analyzing their financial risks.
Disclosure of these risks is necessary to ensure investors have the full picture they need to make sound investment decisions.
Investors have tried to fill the gap, but it’s the SEC’s responsibility to act
In recent years, investors have tried to fill the gap in disclosures by seeking out climate-related information from other sources, such as science 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 are also demonstrating investor interest in more reliable climate-related disclosures. But voluntary disclosure frameworks and investors’ own gap-filling efforts can’t replace regulatory oversight.
The SEC does not set climate policy or enforce environmental laws, it protects investors; fosters fair, orderly, and efficient markets; and facilitates capital formation. Congress granted the SEC the authority and obligation to require the disclosures necessary or appropriate to fulfill its mission. As we’ve seen, without SEC oversight and rules, investors don’t get the consistent, reliable, and comprehensive disclosures they need. The SEC is responsible for evaluating changing risk exposure and identifying disclosure gaps that increase risk for investors and the markets. Just like with any other financial risk, 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, reliable, and consistent disclosures, and provides specifics about how it expects companies to disclose their climate risks. It provides transparency into how corporate managers and the board identify, assess, and manage climate-related risks. And it balances the need for more information with the need for workable and accessible disclosures.
This rule falls squarely within the SEC’s authority, and supports its mission of protecting investors, encouraging more efficient markets, and contributing to the financial stability of our economy. That’s why Earthjustice submitted comments urging the SEC to finalize strong disclosure requirements that will protect investors and ensure our markets accurately consider climate risks.
The SEC must not cave to political pressure from industry lobbyists who are fighting to maintain the status quo. Its job is to protect investors, including all of us whose retirement savings are in investment funds. The proposed rule does just that by ensuring that companies can’t hide or ignore the financial impacts of their climate risks. The SEC must act quickly to finalize the strongest possible rule.