By Ed Hirs
This article was published by Forbes on April 26, 2021.
More climate disclosure requirements are on the horizon for energy producers and energy consumers. The Securities and Exchange Commission (SEC) is thinking about imposing a one-size fits all requirement for publicly-traded and in some cases even private companies to issue assessments of how climate change will impact the companies. Issuers, lawyers, securities analysts, banks—well, just about everyone, is wondering what this may mean and how a new disclosure regime would look.
President Biden has announced a goal of reducing the emissions of US greenhouse gases to 50 per cent of the emissions in 2005. The administration is following the early Obama administration game plan of trying to close off domestic production of hydrocarbons with implicit assumption that such actions will eliminate consumption of hydrocarbons through a suite of regulatory actions out of the Environmental Protection Agency, Department of Interior and now the SEC. Under this all-of-the-above regulatory approach, the SEC analysis may give rise to a sort of climate redlining on issuers. The costs are uncertain. The immediate benefits are amorphous.
However, this hydrocarbon imperialism will ring hollow across the globe as the US will engage in offshoring of hydrocarbon production to fuel the US economy.
What is the deal with this new push from the SEC?
First of all, issuers already are required to report material climate risks to investors. The definition of material is an “eyes of the beholder” definition and leaves issuers some discretion to determine what materiality means for their specific business and industry. In many cases issuers are releasing non-material information related to climate in addition to appease demands for more information from issuers. But the discretion afforded issuers is also afforded investors to complain about the lack of disclosure. Consequently, companies are under the threat of continuous litigation for lack of disclosure. Is a material risk one-in-a-hundred for the next year? Or one-in-a-thousand for the next year? Or is it one-in-a-hundred over the next 20 years?
Under the SEC’s 2010 Guidance, issuers also have to consider how their businesses may be impacted by developments in federal and state legislation as well as treaties and international accords a requirement that is automatically more relevant under the Biden Administration as it sets a new agenda the Paris Agreement.
There are also many risk vectors that an issuer’s board already considers: financial, fraud, market, technology, regulations, political, counter-party. The amalgamation of these vectors informs the board, employees, lenders, insurers, shareholders, and communities. Ratings agencies assess these risks to provide financial markets with qualitative measures to assist investors but not to replace the investors’ own due diligence.
So if companies are already required to report this information, have the threat of litigation hanging over their heads if they do not, and boards already conduct comprehensive risk assessments, then why is the SEC considering more mandatory climate disclosure requirements?
In her speech on the topic, Commissioner Allison Lee answered the question when she emphasized the need for “comparability” of disclosure amongst issuers. In other words, she wants all issuers to disclose climate in the same way so investors can easily compare them and decide which companies are “good” and “bad” without expending many resources on such efforts.
The complexity of climate change may not lend itself to meaningful comparable disclosures beyond what is already required. If we rely upon the fundamental precepts of financial valuations, and, we daresay, efficient markets, the multiple risk vectors including exposure to climate change are already reflected in the valuation of the securities. Those companies with greater exposures are either hedged with property and casualty insurance already, or they are naked. This would be the appropriate disclosure for financial statements. Barring that, issuers could save costs and likely meet any new standards by applying a cigarette-like warning to their financials: “Climate change can be hazardous to the company.”
Ed Hirs is a UH Energy Fellow at the University of Houston