The Division of Corporation Finance at the Securities and Exchange Commission has announced it is considering new rules that would require asset managers to disclose more details on how climate change affects investments.
The division said on June 11 it may recommend the SEC “propose rule amendments to enhance registrant disclosures regarding issuers’ climate-related risks and opportunities.” Some institutional investors anticipate that such amendments could be implemented by next year.
Whether tougher rules are needed has been highly controversial. In fact, the SEC received more than 5,600 letters on the issue during the 90-day comment period that ended June 13. Many of these letters requested more climate change-related oversight.
Supporters have argued that companies need to tell investors about potential business risks brought on by climate change, including weather events like floods, drought, fires and more. Opponents maintain tougher rules would be unfair and make the investment markets less efficient.
Whether new rules are implemented or not, there’s no question that money has been piling into mutual funds and ETFs that say they use environmental, social and governance criteria to select investments. Financial advisors say there’s a growing interest among not just younger people but also older clients, particularly women, in values-based investing.
The big asks among supporters of amending the SEC’s rules include tougher disclosure for companies’ climate-related risks, a better reporting framework, and common standards.
BlackRock, Impax Asset Management, Trillium Asset Management, the American Institute of CPAs (AICPA), U.S. Senator Elizabeth Warren (D-Mass.), Microsoft and individual investors were among the many parties in favor of more disclosure.
“Since 2010, investor demand for, and company disclosure of information about, climate change risks, impacts, and opportunities has grown dramatically,” Allison Herron Lee, now a commissioner at the SEC, wrote in a March 15 letter inviting public comment. Lee served as acting chairman of the SEC from January to April of this year.
Food for Thought
Lee’s letter included 15 multi-part questions for consideration. The first question asked how the SEC “could best regulate, monitor, review, and guide climate change disclosures in order to provide more consistent, comparable, and reliable information for investors while also providing greater clarity to registrants as to what is expected of them,” and where and how such disclosures should be provided.
Other questions included: What information related to climate risks can be quantified and measured? What are the advantages and disadvantages of establishing different climate change reporting standards for different industries, and for developing a single set of global standards applicable to companies around the world? How, if at all, should registrants disclose their internal governance and oversight of climate-related issues? Are there any specific frameworks the SEC should consider? How should any disclosure requirements be updated, improved and otherwise changed over time?
The SEC didn’t respond to Rethinking65’s requests for comments on what its next steps could be or when it might update climate change disclosure rules. But we received responses from asset management firms that submitted comment letters on this issue.
“I’m very confident that the SEC will issue a rule on climate reporting, and it might even be issued this year,” Julie Fox Gorte, senior vice president for Sustainable Investing at Impax Asset Management LLC, the North American division of Impax Asset Management PLC and investment advisor to Pax World Funds, told Rethinking65 in an email.
Although “I wouldn’t expect any final rule to happen in 2021,” she said, because it would also likely have a 120-day comment period, “I’d be very surprised if there weren’t a rule on climate reporting finalized in 2022.”
“Every rule comes out in stages: In this case, we had an RFI (request for information) and then we’ll have a proposed rule, and then a final rule,” added Gorte. “But I don’t expect the SEC to do more than one rulemaking on climate risk reporting.”
“I’d be very surprised if there weren’t a rule on climate reporting finalized in 2022.”
— Julie Gorte, Impax Asset Management LLC
Gorte and Joseph Keefe, the president of Impax Asset Management LLC, co-wrote a comment letter to the SEC that included many suggestions. We asked her what ranks highest on her list of priorities. Her reply: 1) mandatory TCFD (Task Force on Climate-Related Financial Disclosure) reporting, at least for financial companies (asset managers, banks and insurance companies); and 2) required disclosure of major assets of physical risk assessment.
“The latter is something we petitioned the SEC to do last year, and together with the New York Common Retirement Fund, we’ve been engaging with the S&P 500 on this issue since late last year,” she said. “Physical risk is likely to dwarf regulatory risk in terms of financial impact, and disclosure of the basic information investors need to price physical risks like extreme precipitation, flooding, drought, extreme heat, fires, sea level rise and the expansion of tropical diseases and pests is key to pricing physical risks with any hope of accuracy.”
What is most important thing that Gorte would like retirees and their advisors to understand about ESG (environmental social and governance) investing?
“Climate risks and opportunities have only really crossed the Rubicon from tree-hugger issue to material issue in the mainstream investment world in the last five years,” she said. “While most of the investment world recognizes the existence of transition and physical risks, recognition is still one step short of pricing, and we’re still quite a long ways from reasonably accurate pricing of physical risk.”
“That said, it’s still possible to price climate risks and recognize investment opportunities — like vehicle electrification, renewable energy and green energy storage, efficient water use and renewable fuels — and ALL investors should be doing that,” she said. “At this point, investors have a fairly simple and somewhat stark choice: They can either start to price climate risks and opportunities, or they can await a series of increasingly unpleasant surprises.”
Beyond a new rule on climate reporting, Gorte added that she would not be surprised to also see a new rule revising last year’s rule on shareholder proposals, a rule revising last year’s rule on proxy voting advice; and perhaps a rule on human capital disclosure. “All of these things are on the SEC’s regulatory agenda for the next six months,” she said.
She also thinks the SEC may later get to a rule covering broader ESG reporting. “They may wait and see how it goes with the new European reporting regime,” she says, “but I think it’s reasonably likely that they’ll consider a rulemaking on ESG reporting before the next [U.S.] presidential election.”
A Need for Information
Elizabeth Levy, CFA, a portfolio manager and research analyst at Trillium Asset Management, which also submitted to the SEC a very detailed comment letter on climate change disclosure, weighed in too.
“We are hopeful that the SEC will progress with a rule making for mandatory ESG and climate disclosure in the next few months, as these issues are clearly a priority for the Commission,” she told Rethinking65 via email. “The many comments submitted in favor of this disclosure points to investor interest in, and need for, this information.”
“We would expect the disclosure requirements to be rolled out in phases, potentially based on the size of the responding companies and specific reporting requirements,” she said. “Using existing frameworks, such as from the Taskforce on Climate-related Financial Disclosures (TCFD) would allow that roll out to happen more quickly than starting from scratch.”
Complete, Consistent and Comparable
Trillium’s comment letter included a lot of detail about what a mandatory ESG disclosure framework should include, so we also asked them what they’d make top priority.
“The most important thing to us is that the climate and ESG disclosures that result from this process be complete, consistent, and comparable,” said Levy. “We investors need to be able to use this information to judge how potential investments are performing, how they are living up to their own commitments, and how they stack up compared to peers.”
“Having a consistent set of disclosed metrics will allow us to use this information in our investment process,” she said. “At the same time, we need to understand management’s approach to managing these complex issues, so we need qualitative information in addition to specific metrics, similar to the way the notes to financial statements provide context to those numbers.”
“Integrating ESG values and information into portfolios is easier than it ever has been,” said Levy. “The challenge for retirees and their advisors is to make sure that the ESG investment vehicles you chose are actually accomplishing your ESG goals by making sure the investment process, and resulting investments selected, match your needs and expectations.”
“With so much interest in ESG investing, there are lots of great choices available, but greenwashing may mean that an investment vehicle doesn’t live up to expectations,” she says. “Careful due diligence into the history and investment process of a particular investment should help you ensure that your ESG investment meets your needs and expectations.”
Not all the comment letters to the SEC favored greater climate change disclosure.
David Burton, a senior fellow in economic policy at the Heritage Foundation, listed a number of “key points” in his letter, including: “Climate change disclosure would impede the Commission’s important mission,” which is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
Burton also noted that “Immaterial climate change ‘disclosure’ would obfuscate rather than inform”; “Climate models and climate science are highly uncertain”; and “Economic modeling of Climate Change Effects is even more uncertain,” and “The costs imposed on issuers would be large.”
Jennifer Schulp, director of financial regulation studies at the Cato Institute’s Center for Monetary and Financial Alternatives, indicated in her comment letter to the SEC that she shares many of the same concerns as Commissioners Hester Peirce and Elad Roisman, who are both Republicans.
According to the Cato Institute’s informal analysis, more than 95% of the companies in the S&P 500 published a sustainability report in 2020, she wrote. “First, and perhaps most importantly, whatever disclosure framework the SEC were to mandate, the SEC would be stepping in to pick ‘winners’ and ‘losers’ in an already functioning private marketplace for information.”
Whether you and your clients care about ESG or not, it will be important to keep an eye on what direction the SEC takes. Here are other items on its regulatory agenda this spring, in various stages of consideration.
Jerilyn Klein is editorial director of Rethinking65.