With Earth Month upon us, we’re happy to report one small, incremental bit of progress in finance:
The Securities and Exchange Commission (SEC) will finally enforce ESG disclosure and begin requiring public companies to share their greenhouse gas pollution and climate risks.
Pressure Has Mounted – The SEC Finally Enforces ESG Disclosure
Back in a 2019 blog post we wrote about our key takeaways from three finance-focused climate events we attended.
The events had confirmed our understanding that ESG investing – that is, investing in funds that claim to prioritize environmental, social, and governance (ESG) factors – was subjective and, at best, financial industry “greenwashing.”
Reason: Up until now, the SEC has not required public companies to disclose any ESG metrics. Without metrics, ESG fund managers were forced to make subjective judgement calls about their fund’s holdings (note: unless explicitly stated, ESG funds rarely divested from any specific companies or asset classes). Despite this reality, fund companies marketed these funds as fuzzy, feel-good environmentally-socially-conscious investment solutions.
At the time, the SEC defended it’s position by claiming that ESG metrics were nonmaterial to shareholders/investors.
Since then, and considering that there is now over $40 trillion in assets globally invested in ESG funds, there has been significant pushback from nearly all corners of the investment world. Individual and institutional investors, state pension funds, endowments, and even sovereign wealth funds have all pushed for more ESG disclosure.
Why Do Investors Want More ESG Disclosure?
One possible answer is, for the same reason they want good consistent financial disclosure: They want to be able to understand how companies work, so that they can buy the good ones and avoid the risky ones.
And most of the SEC’s proposal is about that sort of thing: Climate risks can affect a company’s business and financial results, so investors need to understand those risks to understand the business.
In other words, an about-face:
Emissions + climate risks = material information for shareholders/investors
This marks a major shift in how corporations must show they are dealing with climate change.
For the first time ever, the SEC finally enforces ESG and plans to require businesses to outline the risks a warming planet poses to their operations. In fact, some large companies will have to provide information on emissions they don’t make themselves, but come from other firms in their supply chain.
The rules will require companies to:
- describe what climate-related risks they face and how they manage those risks
- disclose, if applicable, a “transition plan” to adapt to a warming world, or whether they “use scenario analysis to assess the resilience of their business strategy to climate-related risks,”
- disclose and quantify the use of carbon offsets
- disclose how their financials are affected by climate risk
In essence, the SEC is proposing a complex accounting regime for ESG, a legally approved set of Generally Accepted Climate Principles, with its own body of technical standards and its own set of climate attestation professionals.
While we’re optimistic that these new disclosure requirements will improve ESG investing, do note that it will take time. Implementation will take place between fiscal year 2023 and 2026 (depending on the size of company).
While increased disclosure of public companies is good, the UN’s Intergovernmental Panel on Climate Change’s (IPCC) latest climate report suggested that ESG investing “does not yield meaningful social or environmental outcomes.”
Instead, the report cited, in order to avert the increasingly likely scenario of catastrophic global warming, the world needs stronger government policy and enhanced regulation.
Happy Earth Month.
How will you do your small part to honor Mother Earth this year?
Let us know!