Learning from US moves towards climate disclosure

In March 2022, the United States’ Securities and Exchange Commission (SEC) proposed that all publicly listed US companies be mandated to report their climate data in alignment with the task force on climate-related financial disclosures’ (TCFD) recommendations.

When the proposal was opened for public comment and feedback, the SEC received over 3,400 letters – significantly more than it customarily does when seeking public input. Responses came from small businesses, large corporations, trade organisations, investors, auditors, academics and individual citizens. The proposal has received both endorsement and criticism from business leaders, government representatives and the media.

This raises questions like should the Securities and Exchange Commission of Pakistan (SECP) also consider climate disclosure for publicly listed companies? Would this enable regulators to assess which companies have the largest environmental footprint and differentiate good actors from bad actors? SECP officials should draw lessons from the US’s experiences below as they play out over the course of next year.

Legal experts predict that the SEC will take until the end of 2022 to finalise and publish a rule, in some form, on mandatory climate disclosures. However, they say, this rule will almost certainly face legal challenges.

In particular, experts believe the SEC will face claims that the rule is an overreach of its regulatory authority. Other contentions include the belief that mandatory reporting places an undue burden on companies and might hurt financial returns.

So far, companies rely on guidance based on a 1976 Supreme Court decision. This guidance focuses on materiality, ie, those considerations likely to affect financial performance and are key to a business’s goals, decision-making and impact. It also grants much discretion to companies on how to undertake this reporting.

Reporting data in line with TCFD would be quite a departure from the solely materiality-focused reporting. In addition to reporting scope 1, 2 and 3 emissions, companies would also have to report the potential impact of climate risk on their business, strategy and future health.

The four pillars of TCFD

TCFD recommendations are largely qualitative in nature and can be summarised as follows:

Governance: Companies should disclose their management and board’s strategy for monitoring and assessing climate risk (and opportunity).

Strategy: Companies should identify climate risks and opportunities foreseen over the short, medium and long term; explain the impact of these risks and opportunities on their planning and operations; and assess how resilient their strategy is in various climate-related scenarios (ie, climate stress tests). Risk management: Companies should explain their process for identifying and managing climate risk and how this process fits into the overall picture of risk management.

Metrics and targets: Companies should disclose the specific metrics used to inform their climate strategies, including the disclosure of scope 1, 2, and 3 greenhouse gas emissions among other conventional metrics. They should also disclose climate goals or targets and their progress towards reaching them. Environmental, social and governance (ESG) issue, in general, has gotten caught up in America’s culture wars. This proposal has been viewed in some quarters as part of a greater push for liberal agendas.

Certain Republican state governors (eg those of Florida, Texas and West Virginia) believe the SEC is overstepping its legal role of regulating the trade, marketing and issuance of securities (which includes for private markets) for the protection of investors.

Florida, in particular, has banned taking ESG considerations into account when making investments on behalf of its state pension plan. Financial regulators at the SECP can learn three important lessons from the experiences of the US SEC. One, mandatory climate disclosures from publicly listed companies will provide a heat-map or bird’s eye view of good actors and bad actors when it comes to environmental and climate performance.

A large amount of data will be gathered, which can be used for benchmarking, setting standards, targets and thresholds. The World Economic Forum has predicted that half of the top 10 risks over the next decade are related to climate.

If enacted, this would be hugely beneficial to investors who can then compare the risk profiles of potential investments in a transparent and standardised manner.

Two, despite the major advantage above, there will definitely be pushback from public and private factions, who do not believe that climate risk mitigation is the mandate of financial regulators. They consider climate action to be going beyond the scope of businesses, who have a sole focus towards maximising shareholder value through conventional, financial processes.

Three, well-formulated standards and attestation and assurance bodies would need to be set up to ensure that the information, which is being reported, meets minimum criteria and that reporting is accurate.

Given the international move towards ESG reporting and climate risk disclosure, it is advisable for the SECP to start thinking about mandatory climate disclosure and Pakistan’s role in a greener economy.

The writers are among the founding team of ESGTree.com, a technology platform focused around ESG management for private equity and venture capital firms

Published in The Express Tribune, December 19^th, 2022.

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