Climate Capitalism - Why Climate Change is an Investor Issue
Climate Change Creates Business Risk. Investors Need to Know What Those Are.
To borrow a phrase from Marc Andreesen, climate change is eating the world. Climate change is eating the world, and its impact only continues to grow.
We often talk about climate change as if it is a self-contained “environmental” matter when it is our most intersectional issue. Climate change affects the air we breathe and the water we drink, infrastructure, housing, and broader socioeconomic progress. We are facing a challenge that affects us all - rich and poor, old and young - that will define the course of humanity, and it will only be solved through a concerted and collective effort by the public and private sectors.
The SEC’s Propose Climate Disclosure Rule
The U.S. Securities and Exchange Commission (SEC) voted recently to codify this collaboration between government and industry. The SEC issued a proposal requiring public companies to disclose climate-related financial risks. The proposal represents a long overdue but critical start in instituting the same rigor and standardization to disclose climate risk with other forms of financial risk. The proposed rule sets a range of disclosure mandates requiring registrants to disclose “any climate-related risks that are reasonably likely to have a material impact on the registrant’s business or consolidated financial statement.” Registrant’s climate risk subject to disclosure include financial risks stemming from physical risks, transition plans, risk management processes, greenhouse gas emissions, and climate-related targets.
Those opposing the proposal claim that addressing climate risk oversteps the legal authority of the SEC – providing material information to investors to make informed investment decisions. Their claim represents a flawed argument because climate risk is investor risk. Financial harm can arise from “transition risks” (e.g. shifts in regulation, technology, and competition) and “physical risks” (e.g. flooding, drought, and wildfires). Given both the idiosyncratic[1] and systematic[2] risks climate change poses, climate data is essential for investors in assessing company management and board performance.
How Climate Change Impacts Business
Climate change has transformed not only our physical landscape but also the landscape upon which industries will be built, contested, and proven. The reality is businesses and investors today are facing emerging and increasingly severe forms of financial risk. A recent study estimates that the 215 largest companies face almost $1 trillion in climate risks. In the last two years alone, the United States has experienced 42 weather disasters totaling $240 billion in economic damages. In the absence of adequate climate data, there can be no viable market for real estate lending or insurance if we cannot estimate risk in the face of extreme weather events.
These impacts go beyond weather disasters disrupting property or supply chains but threaten many of the conveniences we take for granted and therefore have little to no redundancies. The South Asian heatwave is giving us a preview of things to come. The heatwave has scorched wheat crop, ramped electricity demand, restricted business hours, and continues to threaten the survivability of the 49% of Indian workers employed outdoors. As food and energy prices increase, inflation and interest rates are to follow, constricting credit markets. Furthermore, multinational corporations, the tried and trusted ”blue-chip stocks,” face real and immediate harm if major business partners and markets are paralyzed in the face of increasingly frequent and severe weather events. Climate risk is investor risk.
Why Investors Need Climate Disclosures
Investors have been among the most vocal in calling for the SEC to act. Ninety-three percent of institutional investors believe that markets have not fully incorporated climate-related risks. The International Monetary Fund (IMF) reports that equity markets do not accurately reflect the physical risk of critical climate change scenarios, a mispricing that could undermine financial returns. Climate risk disclosures would allow investors to incorporate material information into investment decisions, avoiding sudden repricings and market disruptions.
Standardized climate disclosures will also allow for more productive investor engagement. Today, investors need to coalesce self-reported company sustainability data, government reports, and studies for each company. Streamlining this expensive, unreliable, and inconsistent data acquisition process will improve shareholder engagement. In the capital markets, few things are as important as how and why investors use information for voting and asset allocation.
The threats climate change poses to the U.S. economy are undoubtedly challenging; however, of equal certainty are their significance to the stability of our financial system. The U.S. Financial Stability Oversight Council (FSOC) stated, “climate-related financial risks are an emerging threat to the financial stability of the United States.” The U.S. financial system has always relied on public companies being transparent about their risks, and our markets are healthiest when market participants are able to make well-informed decisions. Mandatory climate risk disclosure is a necessary first step in preserving market integrity and avoiding systematic disruption. Bringing climate data disclosure to the same level as other forms of financial risk will allow investors the access to relevant information to make informed investment decisions, consistent with the SEC’s explicit authority.
Climate change is eating the world, and investors need to know to what extent.
[1] Investment risk inherent to a particular to an individual asset (i.e. stock)
[2] Investment risk inherent to the entire market
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