An Approach for Investors, Companies

For whom is climate disclosure intended? This simple, unanswered question is central to evaluating the role of the SEC in further regulating climate disclosures. Some investors are calling for standardization of disclosures so they can compare risk across companies. However, a countervailing view is that climate disclosures are intended as risk assessment tools for the companies — a goal that could be undercut by regulatory requirements to use standard procedures.

With the publication of the final report of the Task Force on Climate-Related Financial Disclosure in 2017, many investor efforts came in the form of shareholder resolutions or letters asking companies to engage in scenario analysis to examine the impacts of steep emissions cuts required to achieve the goals of the Paris Agreement.

While TCFD aims to facilitate enhanced capital allocation by providing information to allow for pricing climate risk, its framework does not specify methodologies for the scenario analysis. The result has been that there is wide variation both in the actual assumptions that companies are making in projecting climate futures and the information they are disclosing. This has led to a patchwork of disclosures that are difficult for investors to compare.

As the SEC’s Asset Management Advisory Committee’s ESG Subcommittee recently noted, drawing a connection between corporate financial performance and environmental-social-governance policies (including climate) requires more robust frameworks, including the use of benchmarks and independent validation of ESG performance. Therefore, to the extent that the goal of climate reporting is to facilitate market transparency, the SEC’s role in developing a more consistent, robust disclosure framework for climate risk is essential.

However, an alternative view is that climate scenario analysis should be a tool to enhance corporate resilience. Many companies engaging in TCFD-style analyses benefit from evaluating their governance, internal organization, and business opportunities that emerge from the energy transition. From this perspective, the climate scenario analysis should be a tool for imagination. If the enhancement of organizational resilience is the goal, then companies should be encouraged to evaluate a variety of orderly and disorderly energy transition scenarios to plan for the climate future and disclose results as appropriate. A prescriptive regulatory approach to climate risk analysis and disclosure has the potential to stifle this kind of creativity.

Consider the following example. With the encouragement of investors seeking standardization, oil and gas companies have mostly adopted the practice of basing their scenario analyses on the International Energy Agency’s demand projections, which assume an orderly energy transition with robust natural gas demand through 2040. However, reliance on IEA scenarios neither provided companies with tools to evaluate short-term market shocks nor the potential for a sudden, lasting change in demand. There is nothing in the IEA scenarios that allows companies to test for the impact of the sudden drop in demand caused by COVID-19 and the collapse of OPEC+.

Given this, are energy companies better off with standardized scenario analysis that provides investors with clearly comparable information premised on an orderly energy transition? Or should we encourage the imagination that comes with the development of a range of short- and long-term scenarios to enhance corporate resilience and preserve long-term value?

No matter where you come out on these questions, there is value in enhanced transparency around climate disclosures. As such, the SEC could play a role in mandating a standardized method for disclosing the types of climate risk evaluations companies are undertaking, the assumptions underlying them, and what actions are being taken to mitigate any identified risks. This type of a framework could both encourage continued corporate imagination to build resilience and provide investors with enough information to compare the climate risk profiles of companies.