Jose Maria Ortiz l Palladium - Mar 23 2022
What We Can Expect from the SEC’s Proposed New Climate Disclosure Rules

Jose Maria Ortiz, Palladium Managing Director

This week, the Securities and Exchange Commission (S.E.C.) gave initial approval for a climate disclosure rule that would require public companies to tell their shareholders and the federal government how they affect the climate. This is a huge step forward in making climate a central issue for the business community, which has long struggled with uneven sustainability regulations and commitments.

A growing number of companies are making commitments to Net Zero, and investors are actively discussing climate risks in their portfolios. Mandatory disclosure, however, will have a systemic impact on the industry.

The goal, of course, is to give investors a clearer idea of the risks that climate change might pose to companies. Perhaps more importantly, the disclosure rule can bring transparency and accountability when it comes to the role companies play in the Earth’s rising temperatures and the impact that climate will have on them.

While it’s clear that public companies will be most affected by the change, there are three other stakeholders that I think will be positively impacted by the disclosure rule; financial analysts, investors, and governments.

Financial analysts are critical in the determination of share prices in the market and generally have a traditional understanding of the industries and business models of the companies on which they report. They understand profit and loss statements, balance sheets, cash flows, and risks, but are often not well-versed in climate and how it affects their companies. That will need to change very quickly.

Moving forward, climate disclosures will be an integral part of analyst discussions with companies, and analysts will have to be able to evaluate if there is a material risk associated with them. In addition, they will have to assess any financial liabilities associated with a company’s carbon footprint and include it as a factor in their target prices for shares or risk ratings for debt.

Similarly, though some investors have already dipped their toes in the climate pool, the shift in disclosures will expose them to far more detail around climate. While it may be a difficult transition, it will lead to greener and more resilient portfolios. From ensuring that the risk to return equation includes climate details, to assessing the risks of individual investors and portfolios as a whole, I’m personally interested to see how changing investor behaviours over time will shift preferences overall.

"Climate is no longer a CSR investment, but a business imperative, and I expect that the capital deployed will increase twenty to thirty-fold over time."

Though less evident, both local and national governments will be impacted by these disclosures as well. Take, for example, a major company that has a factory in a flood risk-prone town. In order to keep the factory and its jobs in town, the local council might invest in more resilient infrastructure to protect from future flooding. I expect we’ll see growing concerns around adaptation to climate change in order to support companies and reduce liabilities. We may even witness companies asking local governments not for tax breaks, but instead for adaptation investments to protect them from any risks they disclose.

Finally, public companies are at the heart of the disclosure discussion. The disclosures will be audited, which means that companies cannot report on things that aren’t backed up by evidence or greenwash their work. As analysts and investors begin to include climate liabilities in their share prices, it will inevitably modify CEO and board behaviour – which are usually renumerated by stock price values – producing a shift towards investing in becoming more resilient and reducing overall carbon footprints.

The hope is that as companies begin setting targets around emission reductions and resilience, there will be an increased flow of capital towards transforming value chains, creating a critical trickledown effect of sustainability. Climate is no longer a CSR investment, but a business imperative, and I expect that the capital deployed will increase twenty to thirty-fold over time. And with new regulations, comes the need to track data accurately around those regulations, and I expect we’ll also see increased reporting and structures for it. Systems such as the one recently proposed by Palladium thought leader and co-creator of the Balanced Scorecard, Dr Robert S Kaplan in his latest Harvard Business Review article, to track and report emissions across an entire supply chain will inevitably gain attention and traction across the business sector.

Like any major shift towards a more sustainable world, this is a journey, and these changes won’t happen overnight. But should the S.E.C. finalise the climate disclosure rules, it will be an important step towards making climate a central issue for the entire business community.

It’s not perfect (nothing is), but we should be celebrating this massive step forward and then building upon it. Our planet is at stake, and all businesses with it.