The SEC Demands a One-Size-Fits-All Climate ‘Risk’ Disclosure System
Modesty is not a defining characteristic for numerous policy-makers in Washington, among them regulators asserting that climate “risks” are significant for individual firms and economic sectors — precisely how do they know? — and that, therefore, they must be reported so that investors can have more rather than less information. Allison Herren Lee, the acting Chairman of the Securities and Exchange Commission, argued recently as follows:
Investors are demanding more and better information on climate and ESG, and that demand is not being met by the current voluntary framework. Not all companies do or will disclose without a mandatory framework, raising the cost, or resulting in the misallocation, of capital. Investors also aren’t getting the benefits of comparability that would come with standardization. And there are real questions about reliability and level of assurance for the disclosures that do exist. Meanwhile issuers are assailed from all sides by competing and potentially conflicting demands for information. That’s why we have begun to take critical steps toward a comprehensive ESG disclosure framework aimed at producing the consistent, comparable, and reliable data that investors need.
Where to begin? An SEC interpretative rule finalized in 2010 “provide[s] guidance to public companies regarding the Commission’s existing disclosure requirements as they apply to climate change matters.” In other words, firms already must disclose how they are evaluating and mitigating the risks of future climate regulations and impacts to physical assets. This is a bottom-up (that is, decentralized) approach under which disclosures can be tailored to the innumerable differences among companies and sectors, thus allowing a broad range of disclosure frameworks for investors to evaluate in the context of their portfolios. Because companies are long-lived concerns, or at least are expected to be, they have powerful incentives to provide unbiased information so to maintain their credibility, notwithstanding Lee’s unthinking assertion that “not all companies do or will disclose without a mandatory framework.”
Lee’s argument for consistency, comparability, and standardization would replace that existing framework with a top-down mandate, justified on the grounds that such standardization would yield a straightforward view of a climate “risk” issue, despite the reality that it remains massively complex. In other words, she is arguing that the existing disclosure system fails to provide “material” information because the disclosures are not comparable. That assertion is incorrect precisely because companies and sectors are different. Top-down “comparability” is an illusion: Investors would have to interpret the “standardized” information in the context of their specific investments. Moreover, as John Cochrane of Stanford University has pointed out, “material” risks are short term — say, over a ten-year horizon — while climate risks are very far in the future, and thus are afflicted with enormous uncertainty: “‘Risk’ means unforeseen events. We know exactly where the climate is going over the horizon that financial regulation can contemplate.”
A requirement for “comparable” disclosure of the business “risks” created by anthropogenic climate change would be deeply speculative, and the level of detail and scientific sophistication that would be needed to insulate firms from shareholder lawsuits are staggering. Such self-protective “disclosures” would run thousands of pages, with references to thousands more, and the idea that such “disclosures” would facilitate improved decision-making by investors is laughable.
It is easy to predict, however, that this disclosure requirement would be a full-employment act for various consultants, and a disclosure of mild risks followed by, say, a strong storm — never attributed to natural climate variability — would lead to a massive litigation threat. The system envisioned by Lee is guaranteed to elicit disclosures of purported “risks” larger rather than smaller, regardless of the actual evidence: Firms will have powerful incentives to undertake climate analysis under assumptions and methodologies insulating them from adverse regulatory action and litigation. That outcome is the real potential source of Lee’s “misallocation of capital.” Will Lee propose some sort of safe-harbor methodology for climate-risk disclosures? That the answer is not obvious is troubling.
Precisely because neither the SEC nor public companies are in a position to evaluate climate phenomena, a bottom-up approach allowing for a multitude of methodologies is preferable to a system yielding “comparable” analyses that might prove highly inconsistent with the future evidence as it unfolds.
Notwithstanding ubiquitous assertions to the contrary, future climate phenomena are uncertain, and efforts to distinguish natural from anthropogenic impacts are extremely complex. Uncertainty is a central theme of the most recent assessment report from the Intergovernmental Panel on Climate Change, and IPCC is decidedly dubious (Table 12.4) about the various catastrophic effects for the climate system often asserted to be imminent or likely.
And the future evolution of climate policies, whether in the U.S. or at an international level, is unknowable. The evaluation and disclosure of complex climate “risks” would be costly, a reality that will induce some firms that otherwise would opt to acquire capital in public markets not to do so, substituting such alternatives as venture capital. The aggregate allocation of capital would be made less productive, not a salutary outcome for the investors that are the supposed beneficiaries of climate “risk” disclosures.
