A nor’easter is blowing through Radical Compliance headquarters today here in New England, so what better time to talk about climate change? We have a few items about climate change risk assessment and disclosure that are worth noting.
First is a speech given last week by SEC commissioner Allison Herren Lee, who has spoken about climate change policy issues more than any other SEC commissioner this year. Plus Lee is a Democratic appointee, which means her words are worth studying as the rest of us try to discern where the SEC might go with its forthcoming climate change disclosure proposals. She made two points worth noting.
First, Lee laid more groundwork for why SEC rules about climate change disclosure are necessary at all. She began with the observation that plenty of companies already do make climate disclosures in some form or other, because investors have pressured the companies for that information. Over the last 10 years or so, a cottage industry has sprung up to develop sustainability standards, disclosure frameworks, and reporting templates.
The drawback, however, is that we have too much diversity in all that disclosure: too many firms disclosing climate risks calculated according to their own formulas, rather than against fewer, more rigorous and widely accepted standards.
So the next necessary step, Lee said, is to bring more uniformity and clarity to all that disclosure — which is precisely the role a securities regulator can play in this conversation. Or, as Lee said herself:
Because of this [prior] work, regulators can now pick up the baton to help achieve what a voluntary system alone cannot — that is, consistent, comparable, and reliable disclosure. Disclosure that works for investors, provides certainty for issuers, and provides fundamentally important transparency around the systemic risk posed by climate change.
That’s the goal here: consistency, comparability, uniformity. Yes, while the cost of compliance falls foremost on the company, the disclosures help other market participants to make better decisions, and the benefits of those sharper decisions will help us all over the long run.
To that extent, climate change disclosure is akin to SOX compliance. Yes, the costs fall to corporations in the immediate term; but the benefits of more reliable financial statements are much larger, for more market participants, over the long term.
Why Talk About This Now?
I suspect Lee is also making these statements as a preview of how Democratic SEC commissioners will justify a climate change disclosure rule, which supposedly will be unveiled by the end of this year. Whatever rule the SEC might adopt, Republicans will challenge it in court; so Lee is doing some spadework now to make the SEC’s position more defensible.
In that sense, then, Lee’s remarks last week were the next logical step after remarks she made over the summer about ESG disclosures. In those previous remarks, Lee warned that investor demands for more disclosure about ESG issues are so high that corporate boards can’t ignore those calls.
“[D]irectors must reckon with this growing consensus and growing demand from the shareholders who elect them,” Lee said at the time. “Accordingly, boards increasingly have oversight obligations related to climate and ESG risks.”
Lee’s previous remarks essentially were telling everyone that material risks, subject to securities disclosure rules, are whatever investors say those things are; and boards have a duty to address them — even if the issues are non-financial in nature, like ESG.
Now Lee is saying that if companies are disclosing ESG information, that’s great; but investors do need that information to come in reliable, comparable, digestible format. So a disclosure rule from everyone’s favorite securities regulator is necessary.
Will Republicans agree with that? Of course not. They’re still stuck on the idea that only financial information can be material, and therefore subject to disclosure rules. But these are the arguments that will be hashed out in the inevitable court challenge, and Lee’s comments are a glimpse into what Democrats might say.
Climate Change Going Global
Lee’s second point touched on international standards for ESG. She praised the IFRS Foundation, which sets International Financial Reporting Standards, for its recent moves to establish an International Sustainability Standards Board (the ISSB, because everything in corporate regulation needs an acronym).
Again, Lee’s own words:
Climate is of course a global challenge that demands a global solution. That’s why we must seek ways to collaborate across jurisdictional boundaries to promote consistency in climate-related disclosure … The ISSB can hopefully provide an international baseline for sustainability reporting on which individual jurisdictions can build. Such an approach would balance both the need for consistency across borders with the particular needs of individual jurisdictions.
We can use our experience with financial reporting standards to understand what’s going on in ESG land today.
The United States has the Financial Accounting Standards Board, which sets Generally Accepted Accounting Principles that corporations use to make standardized, reliable financial disclosures to investors. The IFRS Foundation does the same with International Financial Reporting Standards, used as the basis of financial disclosures in the European Union and elsewhere around the world. FASB and the IFRS Foundation collaborate all the time, to assure that GAAP and IFRS are generally in step with each other. Got it?
For ESG reporting to work over the long term and on a global scale, then in the fullness of time we’ll need to use a similar model for ESG disclosure standards. So I would not be at all surprised to see the SEC push for companies to use ESG disclosure standards developed by the Sustainability Accounting Standards Board; which will then work closely with the International Sustainability Standards Board (once the ISSB is fully operational) to coordinate development of standards on a global level.
Will Republicans screech about this too, painting it as some globalist plot foisted upon us by George Soros and Hillary Clinton? Of course. But if we really want a methodical, effective approach to gaining insight into climate-related risks, ultimately the disclosure regime will need to look something like what’s described above.