Reporting Climate Change Risk
To Read Now
At this point, please complete Corporate Reporting and Externalities, an essay by Jeff Honhensee in the book, Is Sustainability Still Possible? State of the World 2013, by the WorldWatch Institute. (In case you are not familiar with it, the "State of the World" series is great! I highly recommend it.) You will find this reading under the Lesson 4 tab in Canvas.
In the reading above, Honhensee makes a strong case for corporate reporting of externalities as a company's responsibility to the public, which by definition bears the costs, as well as to its investors. Remember, externalities are the costs (or benefits) from economic activity that are borne by someone who did not play a role in said activity. Positive and negative externalities are not fully reflected in the price of products or services.
Disclosure of Climate Change-Related Business Risks
Upfront acknowledgment of risks to the business can help management anticipate, and plan for, future developments and increases investor confidence. In other words, what may have been once seen as a pure externality can, with a turn of events, cost a company and its investor's real money. For energy companies, many externalities fall into the category of risks that may suddenly become costly to the business, but probably none more so than externalities related to climate change. Perhaps more importantly in the near term, potential nonmarket action - particularly in the public sector, but also via private political action - can pose significant business risk(s) to a firm. Most of these actions are related to climate change externalities.
The Securities and Exchange Commission (SEC) is tasked with assuring firms provide reasonable disclosure of business risks to their shareholders. In 2010, the SEC issued the first (voluntary) Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change. The guidelines did not create new legal requirements but provide guidance on existing disclosure rules that may require a company to disclose the impact business or legal developments related to climate change may have on its business.
To Read Now
Read the SEC's January 27, 2010 Press Release regarding disclosure of climate change-related risks. This guidance is still seen as a major turning point in climate disclosure initiatives in the U.S.:
- "SEC Issues Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change." U.S. Securities and Exchange Commission, Jan. 27, 2010
- (Optional) You may have the desire to read through the thick, but descriptive, legalese of the full SEC Guidance in the Federal Register.
From the press release:
Specifically, the SEC's interpretative guidance highlights the following areas as examples of where climate change may trigger disclosure requirements:
- Impact of Legislation and Regulation: When assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material. In certain circumstances, a company should also evaluate the potential impact of pending legislation and regulation related to this topic.
- Impact of International Accords: A company should consider, and disclose when material, the risks or effects on its business of international accords and treaties relating to climate change.
- Indirect Consequences of Regulation or Business Trends: Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for companies. For instance, a company may face decreased demand for goods that produce significant greenhouse gas emissions or increased demand for goods that result in lower emissions than competing products. As such, a company should consider, for disclosure purposes, the actual or potential indirect consequences it may face due to climate change related regulatory or business trends.
- Physical Impacts of Climate Change: Companies should also evaluate for disclosure purposes the actual and potential material impacts of environmental matters on their business.
Why did the SEC decide to issue these new guidelines? A press release from a non-profit 501(c)3, Ceres, described it this way, "Today’s decision comes of wide-ranging climate-related business impacts – and strategies for addressing those impacts – in their financial filings. More than a dozen investors managing over $1 trillion in assets, plus Ceres and the Environmental Defense Fund, requested formal guidance in a petition filed with the Commission in 2007, and supported by supplemental petitions filed in 2008 and 2009." Addressing the way risks of externalities related to climate change are being included in corporate reporting is seen as a matter of protecting investors. For many, protecting the public and the environment would be sufficient cause. But here, the winning nonmarket strategy in the regulatory arena was the one that built a successful case, in the eyes of the SEC, by connecting the need to disclose climate-change risks with the need to protect investors.
To Read Now
As I'm sure you can imagine, the SEC's decision in 2010 has not been embraced by everyone. The article below provides some insight into one nonmarket approach to mitigate its impact.
- "A New Debate Over Pricing the Risks of Climate Change" The New York Times, Sept. 26, 2016.
As indicated in the article, assessing the financial risks posed by climate change are not limited to the U.S. In 2016, the Financial Stability Board (FSB) of the Group of 20, usually referred to as the "G20", asked its Task Force on Climate-related Financial Disclosures (TCFD) to "develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders, and insurance underwriters about the financial risks companies face from climate change." (The G20 is a forum of wealthy and economically emerging countries of the world. The official group is made up of government representative such as finance ministers, heads of state, and central bank governors. At the annual G20 meetings, the representatives consult with many international organizations such as the OECD, the World Trade Organization, International Monetary Fund, as well as private sector businesses, non-governmental organizations, and more. The G20 "traditionally focus on issues concerning global economic growth, international trade and financial market regulation.") It has become apparent to G20 members that issues related to climate change pose risks to businesses worldwide, and the establishment of the TCFD is an attempt to provide guidance on how to manage those risks.
To Read Now
The TCFD released its full report on December 14, 2016; you may be interested in reading it. For a summary of the report, please read the speech by the Chair of the G20 FSB below.
- "Remarks on the launch of the Recommendations of the Task Force on Climate-related Financial Disclosures," Bank of England, December 14th, 2016.
Planning for Climate Change Risk
With the risks of climate change-related externalities explicitly acknowledged, management is in a position to anticipate, plan for, and manage the risk (physical, policy, regulatory or otherwise). One way to mitigate these risks is by placing a price on carbon emissions, usually expressed in dollars (or whatever the relevant currency) per metric ton (tonne) of emissions. Carbon markets have been established at different scales throughtout the world, but companies are increasingly utilizing an internal cost to reduce risks and spur carbon reductions.
To Read Now
- For a glimpse at some of the international movement on internal carbon pricing, please read the Summary and Section 1 ("What is the purpose of assigning an internal price to GHG emissions?") of the Instute for Climate Economics' "Internal carbon pricing: A growing corporate practice" from November of 2016.
- Please also read "Microsoft Leads Movement to Offeset Emissions With Internal Carbon Tax" to learn about the robust internally-focused actions that Microsoft has taken to reduce emissions (a .pdf link is also available in case you cannot access the link above).
According to the Carbon Disclosure Project (CDP), an English non-profit that publishes environmental impacts of companies across the world, 437 companies had instituted internal carbon pricing as of 2015, which is triple the number in 2014. CDP reported that they expect more than 500 additional companies to do so by 2017 (as of February 2017 updated data are not available). As indicated in the articles above, there are different ways that companies do this. Microsoft actually charges individual units within its company based on their energy-based emissions, then uses these charges (expected to be $20 million in 2015!) to implement energy efficiency (e.g., building efficiency upgrades) and clean energy (e.g., solar, wind) measures in company units. Disney and Shell also use this model.
The CDP (via Bloomberg Business) also reports that many other companies are using internal carbon pricing when determining cost-benefit projections of potential projects and investments. This is what the Institute for Climate Economics referred to as a "shadow cost." Some of the world's major companies (General Motors, Nestle, Google, ExxonMobil, etc.), representing "more than $8 trillion worth of market value" price carbon internally. Though the price can vary widely by company, it has the effect of making projects that will result in lower emissions look more economically attractive.
Physical Impacts of Climate Change
The fourth bullet of the SEC's interpretative guidance (above) refers to a corporation's responsibility to disclose the risks of physical impacts of climate change. For companies in the energy sector, these risks are wide-ranging and abundant, as described in the reading below.
To Read Now
- "Climate Change and the U.S. Energy Sector: Regional Vulnerabilities and Resilience Solutions." from US Department of Energy, October 2015.
Read Executive Summary. You will investigate your geographical region in this week's homework.