Kaitlyn Jauregui – The Securities and Exchange Commission (SEC) posted two proposed rules to amend the Securities Act of 1933 and the Securities Exchange Act of 1934 on the federal registrar calling for increased climate-related disclosures. If enacted, investors will gain the material knowledge needed to make strategic investments that align with their values. There are many wrinkles that need “ironing out” as the SEC sorts through the thousands of comments to create a more uniform and effective reporting method. Either way, both publicly traded companies and investment advisors should be prepared to hang their not-so-green laundry.
The first proposed rule, the Enhancement and Standardization of Climate-Related Disclosures for Investors, requires registered companies to provide climate-related information in their annual reports and other filings. Despite the current lack of enforceable requirements for climate disclosures, 92% of S&P 500 companies published sustainability reports in 2020. If companies already provide sustainability reports, then why must SEC take action at all?
Sustainability is an internal-looking concept focused on operation efficiency, such as reducing energy use to cut costs. Climate disclosures will instead analyze the environmental impact of and on the company. A climate risk assessment can reveal factors influencing financial performance like how natural disasters disrupt operations and destroy inventory, increasing costs.
The lack of enforceability of sustainability reports means companies can present information how they want. These reports are mostly a marketing ploy and not a reliable source for investors. Because companies can share their eco-friendly initiatives and hide their harmful practices, it is difficult to compare the sustainability efforts of one company to another. With inadequate information, investors do not have the material knowledge needed to make informed decisions.
The SEC’s proposal to increase Climate-Related Disclosures, if enacted, will allow investors access to accurate data to consider when choosing how to invest responsibly. Companies are to represent “climate-related risks that are reasonably likely to have a material impact on its business, results of operations, or financial condition,” according to the SEC’s proposal. Greenhouse gas emissions and carbon footprints are to be recorded as well. The combination of qualitative risk assessment and quantitative pollution metrics serve as material knowledge for investors to rely upon in order to make wise investment decisions.
In order for companies to live up to the “green” social media posts and product packaging so many proudly boast, there are a few measures they can take ensure they function environmentally responsibly. One tactic is that companies can hire consultants that assess climate risks to help in preparing their disclosure reports. Companies can also staff their Sustainability departments with employees who have business and scientific backgrounds in climate change to create a positive environmental impact. The most challenging step companies need to take in anticipation of these SEC rules is to gather accurate information from third parties within the supply chain to measure pollution and other risk factors.
Investors, on the other hand, should prioritize attention to their branding. The second of the SEC’s recently proposed rules is the Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices. If enacted, this rule will require investment advisers who brand themselves as “green” or focused on “impact investing” to transparently share their decision-making process. The SEC is ensuring these investment advisors are not deceiving investors into contributing to a company that’s commitment to sustainability only exists on the surface, and therefore conflicts with their financial and ethical goals. For example, the fictional business of Vegan Investment Company, when reporting to the SEC, would state that they seek to support animal-friendly corporations in their Strategy Overview. They would then write about how they research prospective companies to invest in that elevate animal rights. If the SEC were to investigate and find that an investment advisor from Vegan Investment Company allocated a client’s funds to Boar’s Head, then there is an unsettling discrepancy in which action would need to be taken.
While the SEC hangs the clothesline, investment companies should reflect on their marketing strategies. If they are confident in their ESG strategy, then there is no need for alterations. If they exaggerated how much they care for ESG, then investment advisors can rename their company and or choose specific vocabulary in their branding that accurately reflects their approach to achieving financial returns and social responsibility.
Because the proposed SEC rules would require changes to already existing forms, and many complexities remain, like metric tracking and industry standards, it could take months or years for them to be enacted and effect change. Hopefully, it will come sooner than later so that investors can be confident that their money is going towards businesses that strive for a greener future.