Recently, when asked about how all of the U.S. agencies coordinate on climate issues, SEC Commissioner Allison Herren Lee observed that one way agencies coordinate is through the Financial Stability Oversight Council. The FSOC, which is chaired by U.S. Treasury Secretary Janet Yellen and includes SEC Chair Gary Gensler as a member, has just issued a new report on climate-related financial risk. The report concludes that climate-related financial risk is “an emerging threat to the financial stability of the United States.” Some of the discussions and recommendations in the report are remarkably congruent with recent comments from Gensler about expected SEC climate disclosure regulation. Are we starting to get an idea of what to expect?
The report is the result of President Biden’s May 2021 Executive Order on Climate-Related Financial Risk. The EO directed the Treasury Secretary to engage with other members of the FSOC to consider, among other things, comprehensively assessing the climate-related financial risk to the stability of the U.S. financial system and issuing a report on any efforts by FSOC member agencies to integrate consideration of climate-related financial risk into their policies and programs—including the necessity of enhancing “climate-related disclosures by regulated entities” and a recommended implementation plan. (See this PubCo post.) The new 133-page report represents an initial review by the FSOC of “current efforts by its members to incorporate climate-related financial risk into their regulatory and supervisory activities, enhance climate-related disclosures, and assess climate-related risks to the financial stability of the United States.”
The FSOC views climate-related financial risks as “an emerging threat to the financial stability of the United States. In the United States and across the globe, climate-related impacts in the form of warming temperatures, rising sea levels, droughts, wildfires, intensifying storms, and other climate-related events are already imposing significant costs upon the public and the economy.” (Interestingly, the report indicates that the FSOC did not discuss climate-related financial risks until its March 2021 meeting.)
Although the report address multiple aspects of the climate issue—for example, it discusses methodologies for measuring GHG emissions—one aspect addressed in the report is disclosure. The report advocates that FSOC members, which include the SEC, “promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to take climate-related financial risks into account in their investment and lending decisions. Investors, market participants, and regulators need better data and information, including enhanced and transparent disclosures, to assess climate-related financial risks and their potential effects on the financial system. This information will be used to help gauge risks to individual institutions and markets and to financial stability.”
Climate-related disclosures can help investors understand companies’ risks and risk-mitigation strategies, the report observed, as well as help investors identify companies “well-positioned to succeed in a low-GHG or net-zero emissions future.” According to the report, investors have increasingly requested access to information about the “risks posed to companies’ properties and supply chains due to increasing severe weather events, sea-level rise, drought, or other physical effects of climate change. In addition, investors have requested information about companies’ exposure to transition risk linked to their GHG emissions footprint.” Have companies developed mitigation strategies, such as shifting away from carbon-intensive energy sources? Are they prepared to address other transition risks, such as potential increases in the cost of using GHG-intensive energy? Scenario analyses performed “can contribute to the assessment and disclosure of climate-related financial risks by firms that have significant exposure to climate-related impacts.” In addition, the transition to a low-GHG economy can also present a number of opportunities, such as energy and resource efficiency and new products and services.
The report observes that disclosure is not just for investors; it can also help “inform other companies in the disclosing company’s value chain that are exposed to the risks of the disclosing company, such as asset managers, lenders, insurers, and commercial counterparties,” allowing these other entities to “better assess, mitigate, and disclose their own risks,” and promoting efficient capital allocation and orderly markets. In addition, coordination among agencies as to new requirements for climate-related disclosures, consistent with their mandate and authorities, could promote consistency and comparability and help avoid unnecessary duplication.
The report summarizes a variety of different voluntary disclosure frameworks, but highlights the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures. The TCFD, the report indicates, is “recognized as the leading organizational structure for climate-related disclosure globally and is one of the leading frameworks used by companies in the United States. The TCFD’s four core elements for disclosure of governance, strategy, risk management, and metrics and targets could be a useful starting point for disclosure requirements to ensure the consistency, comparability, and decision-usefulness of disclosures across firms. Given the widespread adoption of TCFD globally, this could also help promote international consistency and comparability.”
According to the report, the “TCFD’s core elements and recommended disclosures offer a useful structure for promoting the consistency, comparability, and decision-usefulness of climate-related disclosures, and have been widely adopted, in whole or part, by financial regulators around the world.”
Assessing current corporate disclosure, the report observes that there is a lot of variation “in the quality, coverage, and comparability of the disclosed information, due in large part to the voluntary nature of the disclosure and lack of mechanisms to assure consistency, comparability, and decision-usefulness.” It notes that even carbon-intensive companies may not be disclosing climate-related risk information. Even disclosure under the TCFD framework regularly falls short. According to the report, TCFD recently evaluated 1,651 companies that issued climate-related reports under the TCFD framework. Among the recommended TCFD disclosures, companies most often discussed how they integrated climate-related risks into their risk management programs, but still that discussion appeared in only 52% of disclosures. (The WSJ reports that only 32% of these companies reporting under TCFD “met its guidelines on climate disclosure.”)
The report lays out a number of recommendations. For example, the FSOC plans to form a Climate-related Financial Risk Advisory Committee (CFRAC), composed of a broad array of stakeholders, such as climate science experts and representatives from NGO research institutions, academia, business and consumers. The FSOC also recommends that its members (such as the SEC) invest in “staffing, training, expertise, data, analytic and modeling methodologies, and monitoring,” and that they “collaborate with external experts to identify climate forecasts, scenarios, and other tools necessary to better understand the exposure of regulated entities to climate-related risks and how those risks translate into economic and financial impacts.”
With regard to enhancing public climate-related disclosure, the FSOC had these general recommendations:
“Recommendation 3.1: The Council recommends that its members review their existing public disclosure requirements and consider, as appropriate, updating them to promote the consistency, comparability, and decision-usefulness of information on climate-related risks and opportunities, consistent with their mandates and authorities.
Recommendation 3.2: The Council recommends that its members, consistent with their mandates and authorities, consider enhancing public reporting requirements for climate-related risks in a manner that builds on the four core elements of the TCFD, to the extent consistent with the U.S. regulatory framework and the needs of U.S. regulators and market participants.
Recommendation 3.3: The Council recommends that its members, consistent with their mandates and authorities, evaluate standardizing data formats for public climate disclosures to promote comparability, such as the use of structured data using the same or complementary protocols, where appropriate and practicable.
Recommendation 3.4: The Council understands that information on GHG emissions promotes a better understanding of the exposures of companies and financial institutions to climate-related financial risks. The Council recommends that, consistent with their mandates and authorities, FSOC members issuing requirements for climate-related disclosures consider whether such disclosures should include disclosure of GHG emissions, as appropriate and practicable, to help determine exposure to material climate-related financial risks.
Recommendation 3.5: The Council recommends that its members continue to coordinate with their international regulatory counterparts, bilaterally and through international bodies, as they assess requirements for climate-related disclosures.”
With regard to the SEC in particular, the FSOC had this recommendation:
“Recommendation 3.6: Public Issuer Disclosures—The SEC staff are developing a proposal on disclosure requirements for public issuers related to climate-related risks for the SEC’s consideration. The Council is encouraged by the SEC’s work on this critical issue and supports its efforts to consider enhanced climate-related disclosures to provide investors with information that is consistent, comparable, and decision-useful.”