One of the most important areas in climate governance in the past few years, has been a focus on the issue of disclosure. What do business firms need to disclose about climate risk both in mandatory and voluntary disclosure programs. There are two mantras behind the focus on climate-related disclosure. The first is you can only manage what you measure. Disclosure serves the purpose of requiring the gathering of data in the first place, if you measure it, then it can be managed. The second idea behind this is the famous saying by former justice of the US Supreme Court Louis Brandeis, that sunlight is the best disinfectant. By requiring business firms to disclose climate risks and impacts it provides greater information to the market as a whole, about how to address the climate problem. As we know climate change poses both risks and opportunities for business firms. But one of the biggest challenges is that investors, lenders, ensures, as well as government regulators don't always have a clear view of which companies and industries are going to do well and do poorly as the environment and the climate change. As a result without this reliable climate related financial information, markets can't accurately price climate-related risks and opportunities, and this has the potential to make the transition to a net-zero economy more rocky and less smooth than it needs to be. There are two different types of climate related disclosures that I'm going to focus on in this session. There are mandatory disclosures that are required by law, so the most well-known example of these in the United States would be mandatory public disclosures required by the Securities and Exchange Commission in 10-Ks, 10-Qs, or 8-K forums. There are also as we have learned non climate related mandatory disclosure laws for example the toxic release inventory which requires firms to disclose their releases of certain listed toxic chemicals. In addition to those disclosures that are required by law there are also voluntary disclosure programs. Voluntary disclosures are not made in response to a legal mandate. These may be in corporate social responsibility or ESG reports or a report to a specific voluntary initiative. For example the CDP which is formerly known as the Carbon Disclosure Project which provides a platform for disclosure of climate-related, water-related, and forestry-related risks and data. First to focus on the idea of mandatory disclosure it's important to understand who the regulator is. The Securities and Exchange Commission of the United States was created in the 1930s and the mission of the SEC is to protect investors, maintain fair orderly, and efficient markets, and to facilitate capital formation. The SEC has a regulation known as SK which requires publicly traded firms to make periodic and annual disclosures via forms 10-Q for quarterly reports, 10-K annual reports, and 8-K which are known as current reports, that must be filed after specific events like a merger and here's an example of the top of Apples 10-K form filed with the SEC. One key fact about mandatory disclosures is that because they're required by the Securities and Exchange Commission which is essentially a financial regulator only "material" information must be disclosed, and the word material is in quotes here because it has a legal meaning, materiality. What makes a fact material or not? The Supreme Court has said that a fact is material and therefore must be disclosed if there is, "A substantial likelihood that the fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available," about that firm or about that security. When we think about what material environmental information is, the SEC has actually spelled out that certain forms of environmental information are by necessity material and must be disclosed. These include whether the firm is engaged in some environmental litigation either with the government or a private party, whether there is a new or anticipated environmental regulation that is likely to have an impact on the firm's financial position as well as certain specific types of environmental risks. There's a current debate going on right now, because climate-related risks in many cases is going to be financially material. I can only think of the example of the PG&E bankruptcy, where the wildfires in California were so significant and raise such liability concerns for PG&E that it had to file for bankruptcy because its assets were not sufficient to cover its liabilities. That would be a clear case of having to disclose a climate-related risks that is financially material. The debate however ask, whether even if some information isn't financially material, should that ESG or environmental social and governance related information including on climate risk still have to be disclosed. Some ESG or climate-related issues may still have significant effects on the operations and strategies of the firm even if they might not qualify as financially material, so that's a topic that's up for debate right now. How has the SEC actually addressed the issue of climate-related disclosure specifically and not just the broader question of environmental disclosures. In 2010 the SEC issued what's known as guidance on the disclosure of climate change risk. A guidance is not a regulation. But a guidance sets forth the agency's interpretation of what the current regulations and statutes require of an issuer that is required to make these annual and periodic disclosures. The 2010 SEC guidance made clear that under existing regulations issuers of securities must disclose, climate change risks to performance and operations, physical risks, litigation or regulatory risks, and shifts in the markets for products and services. Just to give a few examples, physical risks could include, whether a plant or the operations of a firm are likely to be affected either by gradual sea level rise or by increasingly intense storms. Litigation or regulatory risks could be whether there's an anticipated new regulation or whether the company has been or is likely to be sued for activities that relate to greenhouse gas emissions. Shifts in markets for products and services could be shifts in consumer demand that make it for example less likely that environmentally conscious consumers are going to continue to purchase plastic water bottles. Actual disclosures by firms, have since 2010 been somewhat uneven and the SEC's enforcement of this guidance has been mixed. In 2021 the SEC began to take up the issue of climate related disclosures more actively than it had in the past. It invited comment with respect to climate related disclosures specifically as well as more broadly on ESG disclosures. These included questions like whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts and opportunities, and how to achieve greater consistency across those disclosures. The SEC also asked for information about how it can best regulate monitor, review, and guide climate disclosures. What information related to climate risks is quantifiable and measurable. Should these quantifiable measures be required to be disclosed. Should industry be allowed to develop some industry disclosure standard or should the disclosure standard be developed by the government alone? How is it possible that the SEC can ensure minimum disclosures? Finally the SEC asked for public input on the advantages and disadvantages of a decision to rely on existing private governance standards including the TCFD, the Task Force on Climate-Related Disclosures, SASB, the Sustainability Accounting Standards Board or other standards like those of the Climate Disclosures Standards Board. In September of 2021 the SEC began taking more active enforcement action, with respect to the existing climate related disclosures by firms. On the right you can see an excerpt from a letter posted to the SEC's website. As you can see in this excerpt which is generic to ABC Corporation. You can see that with the SEC is beginning to zero in on, is the fact that some firms paragraph one, have been providing more expansive disclosure in corporate social responsibility reports than in SEC filings. Please advise us what consideration you gave to providing the same climate related disclosures in your mandatory SEC filings. Then the SEC goes on to ask for additional more detailed disclosures. This letter is consistent with the 2010 climate guidance that I mentioned earlier. The full text of the letter is on the right in the very narrow bar. But this can all be found on the SEC's website. Now that you understand the mandatory disclosure environment which is largely under the auspices of the SEC's regulatory space, I want to take a moment to focus on the private governance landscape because there's been a tremendous amount of action in this space. There are numerous private disclosure standards that exist today. Key among them are the TCFD or the Task Force on Climate-Related Disclosures, the SASB the Sustainability Accounting Standards Board, the GRI the Global Reporting Initiative, and the CDP the Carbon Disclosure Project formerly known. How did these private standards work? Well these organizations will set standards and have a set of principles or rules that say these are the things that you must disclose and in a framework, and they vary in their level of generality or specificity, and then companies can choose to sign on to one or more of these private disclosure standards, and use them as a guide for their voluntary sustainability reporting. One note is that the TCFD framework is designed not to guide firms in how they prepare their voluntary sustainability reports. The idea behind the TCFD, is that it would offer a framework for mandatory public regulatory filings in many different countries. In September of 2020, recognizing that there are many private Disclosure Standards not always in harmony with one another even if they share the same goals, several of the leading private standard organizations got together to call for better integrated disclosure. I want to take a moment now to focus on the TCFD which is one of the primary private Environmental Governance Disclosure Standards for Climate-Related Risks and Management. The TCFD was created in 2015 by the Financial Stability Board, and the goal was to promote more transparent and reliable climate disclosures. The idea was that more transparent and reliable as well as comparable climate disclosures are needed for business firms in the economy to make underwriting decisions, or investing decisions, or decisions as to whether to issue credit, as well as to understand the overall scope of risk that climate change poses to financial markets. That would be important to regulators as well as to private actors. The core elements of the TCFD recommendations which were formalized in 2017 focus on four categories. Governance, strategy, risk management, and metrics and targets. Again, I highlight that these are not mandatory standards or we're not envisioned initially to be mandatory standards they are voluntary, but that they would guide firms in how they prepare their public regulatory filings. Again the goal is to create consistency and transparency and reliability. The four categories of governance strategy, risk management, and metrics and targets are what I'd like to turn to now. This chart is a comparative study between 2017 and 2019, of whether companies are aligning their disclosures with the TCFD recommendations on each of these four primary factors. You can see that across all four of the factors there is at least a small increase between 2017 and 2019 of the percent of companies that are disclosing information in their mandatory legal regulatory filings, that is aligned with the TCFD recommendations for disclosure. On the first category of governance, the general principle of the TCFD is, that the organization should disclose its governance around climate-related risks and opportunities. That's divided into board oversight and the role of management. What are decisions for the managers on a day-to-day basis, and what are issues that need to be decided by the board of directors? As you think about this from the perspective of your organization, there are some important questions that you need to be asking. First, what are the processes by which the board and managers oversee and monitor the assessment and management of climate-related issues that the firm? Does the board of directors have specific committees dealing with climate related issues, or is climate-related risks and opportunities something that's integrated into existing committees? Different firms take different positions on each of these questions. Is there a designated management level officer? For example a chief sustainability officer or chief ESG officer, who's responsible for addressing climate-related risks and opportunities at your firm? Or are these responsibilities built into other existing positions? The second overarching category of the TCFD recommendations are disclosures that relate to strategy and the overarching goal here is that a firm should disclose the actual and potential impacts of climate related risks and opportunities on the organizations businesses, strategy, and financial planning where such information is material. The TCFD is aligned with this notion of financial materiality. Importantly the TCFD has instructed that the discussion of strategy should include a discussion of short medium and long-term risks. A second overarching question is, how resilient the organization strategy is overall, using climate scenarios? I'm going to explain climate scenarios in just a moment. This raises certain key questions for your organization. Of course this whole time we've been focusing on climate change, and if all you have is a hammer everything looks like a nail. You need to and within your organization determine the relative significance of Climate-Related risks Vis-a-vis other risks and priorities for managing the firm, and not focus only on one type of risk. What are the relevant Climate-Related issues for the short term the medium term and the long-term? Those might differ across different aspects of the firm's production process. You might have short-term risks in operations or supply chain but medium and long-term risks with respect to investment in R&D. Finally what's the process that your organization has in its strategy to determine which risks are going to have a material financial impact on your organization. Considering things like operating costs, revenues, CapEx, capital allocation, acquisition, and investment or divestment as well as access to capital. What's scenario analysis? Scenario analysis is defined as a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty. It can be qualitative or quantitative. What does that mean in plain English? We're a business that makes widgets, imagine what our business is going to look like under a two degrees Celsius scenario, imagine what our business is going to look like under 1.5 degrees Celsius scenario or imagine what our business is going to look like under a four degrees Celsius scenario. There's uncertainty about where we're going to go even under any of these three conditions. The idea of scenario analysis is to enhance strategic considerations or conversations within the firm about its future. Many investor organizations have been asking in shareholder proposals as well as conversations with firms, for firms to do more in-depth climate scenario analysis. Because this can help to enhance the understanding of investors or lenders for insurance underwriters or other actors within financial markets, about how robust the organization strategy actually is to address climate issues. It's very easy to make bold pronouncements but if they're not backed up with a scenario analysis, it's really hard to know how effective they are going to be. The disclosure is related to the scenario analysis ought to include key assumptions. What's the timeframe? What are the sensitivities to certain assumptions? How will the organization respond under different scenarios? What are the implications for key strategic decisions? The third category is risk management. The general principle here is that the TCFD would require an organization to disclose how it identifies assesses and manages climate-related risks, so this is all about risk management. What's your process for identifying these risks? What's your process for managing the risks? How is climate risk management integrated into a firm's overall risk management strategy? Before firms were being asked to focus and focusing on climate related risks, presumably your firm had some risk management strategy to address other risks? What are key questions for your organization going forward. Pursuant to the TCFD, you should be asking, how do you determine the relative significance of climate risks versus other risks and how do you prioritize those risks? What are the risks relating to emerging regulatory requirements? Do you anticipate that the government will be regulating in your sector? Or do you anticipate that there will be some disclosure rules that apply across the board to all sectors? How do you decide how to respond to the risk? There are several options, you could mitigate the risk, try to reduce its severity, you could transfer the risk to another entity or do you try to accept the risks and control them. Each of these are part of a robust risk management strategy for climate that your organization needs to think about. The final category of the TCFD recommendations is metrics and targets. Given the fact that there is not one global government in the world, different governments have different metrics and targets that companies in different industries need to reach and in some cases governments don't have metrics and targets at all, and therefore firms are left to rely on a plethora of different private environmental governance standards. The TCFD recommends that firms disclose the metrics and targets that they use to assess and manage the relative climate-related risks and opportunities where such information is material. What are the metrics that you use as a firm? The TCFD recommends disclosing not only scope 1 and 2 emissions but also scope 3 greenhouse gas emissions and risks. This is a recommendation to look at the entire value chain and not just those climate-related risks that are part of your immediate business operations. Finally, the TCFD recommendations asked firms to describe their targets and performance against those targets. Key questions for your organization include, disclosing the metrics on climate related risks and opportunities, but also with respect to water, energy, food use, waste management, and other environmental considerations. You need to be thinking as an organization, how are these metrics incorporated into performance evaluation and compensation? Are employees incentivized to reduce emissions in line with targets, and if so what are the performance indicators that are being used? Are the metrics absolute or intensity based? That means, an absolute reduction is our firm will reduce by 10 percent over a baseline of this year by our target year. An intensity based metric is an efficiency measure. If we're producing X cars using this much energy the idea is that we will reduce our energy use by 20 percent. But you can't necessarily with an intensity based target guarantee that emissions reductions will take place, because you can simply make more cars. What is the timeframe? What is the base here? How are these metrics going to progress over time? Then finally, the TCFD recommends that methodologies and historical data are provided in order to allow for performance benchmarking. I'd like to conclude this session with a few key takeaways. Different organizations and researchers have set forth scenarios that would keep global warming at or below our target of 1.5 degrees Celsius. There are not only risks but also opportunities for firms in connection with the transition to a zero-carbon economy or a net-zero economy. What I focused on here, is the idea that both public and private actors have an important role to play in ensuring that the transition to a net zero economy is smooth and finally that you can only manage what you measure. There's a growing focus on the importance of quality climate risk disclosures, not only do public regulators like the SEC focus on this issue, but also non-governmental actors like the TCFD among others. Disclosures can lead to improved management of material climate risks
