Author: Flavia Micilotta, Director ESG Solutions, Funds Services, TMF Group
Climate risk disclosures have been already the focus of financial market participants and other stakeholders in the investor’s community since a number of years now and regulators have been formalizing their ask at global level to ensure common understanding and alignment of precise needs. It is now generally acknowledged that ESG data adds value to financial analysis and corporate evaluation and is part of a global push by regulators to acknowledge climate change as a risk to their economies and the financial system.
An increasing number of institutional investors increasingly recognise ESG factors as drivers of value while emphasizing the importance of ESG issues to corporate performance. Many of them also accept that integrating ESG factors into the investment process can help them make more effective investment decisions by strengthening their risk management and aligning investment strategies with the priorities of stakeholders. Investors will assess companies on how well they manage their ESG issues as an indicator of their ability to run their business and maintain financial sustainability. These concepts are the backbone of responsible investing and sustainable finance.
European regulators have already pushed new climate reporting guidelines for companies already in 2019 consistent with existing corporate reporting requirements and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Aimed at corporate players, they were meant to provide guidance on how to report on the impacts of their business on the climate and on the impacts of climate change on their business (double materiality). Most companies at international level are already providing data on their greenhouse gas emissions, sometimes even from their suppliers (Scope 3).
Having paved the way for these structural reporting changes, regulators have concretely focused their work particularly in the past two years to propose a framework of defined guidelines able to streamline efforts and data to help with reporting obligations. This landmark move of the SEC further strengthens this trend and reporting needs.
Throughout the course of last year, the SEC has clearly demonstrated its willingness to include climate and ESG issues to its supervisory role, recognizing it as part of its mandate. After the announcement of the ESG Task Force set-up, in March last year, much effort was directed at developing initiatives to proactively identify ESG-related misconduct. The main focus of the work is set to be around identifying any ‘material gaps or misstatements in issuers’ disclosure of climate risks under existing rules’. The task force has been also set up with the goal to deploy sophisticated analysis to check, monitor and verify the truthfulness of information to spot potential breaches. These developments come to complement the appointment at the beginning of last year and prior to these latest task force developments, of Satyam Khanna as a Senior Policy Advisor for Climate and ESG.
Last May 2021, SEC Chair Gary Gensler reaffirmed his intention before the Asset Management Advisory Committee, to dive deeper in the relation between the data and criteria used for the disclosure asset managers make on sustainability and diversity and inclusion. That would entail also standardizing the definitions around such disclosures, almost like defining a ‘taxonomy’ common for every market participants, and similar to what EU regulators have been focusing on. Investors provided feedback to the SEC regarding their expectations around disclosure: “More than 550 unique comment letters were submitted in response to my fellow Commissioner Allison Herren Lee’s statement on climate disclosures in March. Three out of every four of these responses support mandatory climate disclosure rules.” This quest from investors has been met when on the 21st of March the SEC launched, as expected, a landmark proposal for a climate risk disclosure rule that could require thousands of companies across corporate America to begin publicly reporting information about their environmental footprint, including greenhouse-gas emissions.
A fast-moving calendar
As just mentioned, the pack leader in the field of regulatory ESG disclosure remains the EU, with the European Commission proposal for a Corporate Sustainability Reporting Directive already in April last year which followed the initial climate guidelines in 2019. A year later, last March, the SEC released a proposal for climate-related disclosures – comments are due by July 17th. By February 2024 large accelerated filers will be required to file their first climate disclosures (scope 1 and 2) for FYI 23, if rules are finalized and effective by December this year; while scope 3 reporting will be due by February 2025.
In the words of the SEC Chair, the name of the game is clearly to foster a ‘quality’ level playing field of ‘material’ information, which also includes forecasts, and which can impact investment decisions. This builds towards creating a full and fair disclosure to enable investors take the risks they choose in a transparent way.
An economic and financial tsunami
A few days after the SEC proposal came out, the International Financial Reporting Standard (IFRS), thorough the newly established International Sustainability Standards Board (ISSB), at COP26, with the aim to develop a comprehensive global baseline of sustainability disclosures for the capital markets, launched a consultation on its first two proposed standards, one being on general sustainability-related disclosure requirements, the other being on climate-related requirements specifically. This is part of consultation which is open until the end of July and that will help issue a new set of Standards before year-end.
If we take a step back and look at the recent moves on sustainability disclosures taken in the US alone, it’s fair to conclude that we are confronted with clear changes which will inevitably reshape the corporate and financial world.
In his 2020 letter to other corporate executives, BlackRock CEO Larry Fink defined ‘climate change as a defining factor in companies’ long-term prospects’. The fast evolution we have seen particularly in the last few years makes us generally agree this the statement, as we clearly are ‘on the edge of a fundamental reshaping of finance’. Let’s hope the entire industry is able to capture the possibilities arising from this moment.
