How the SEC can solve Climate Change

Recently, I've been trying to get answers to what I assumed would be simple questions. I wanted some numbers to lead with for this post and I assumed they've be easy to find in the usual places. What I was looking for were these:

  1. the number of companies disclosing their climate-related risks in their annual filings
  2. the number of companies regulated by the SEC and
  3. the % of one to the other.

Those three questions have proven surprisingly hard to answer and that leads me to the my premise:

The SEC is the world's greatest threat to climate stability and the world's best hope for averting sever global warming.

If you're reading this and you don't know, the SEC (Securities and Exchange Commission) is the government body responsible for oversight of our financial exchanges. Specifically its charter requires the SEC to do three things:

  1. Protect Investors

  2. Maintain Fair, Orderly, & Efficient Markets

  3. Facilitate Capital Formation

This is done principally by requiring that companies disclose large amounts of data relating to their operations. This is a good thing because it allows investors a reasonable chance to evaluate the risks involved in their investment choices. Unfortunately there's a giant hole in the middle of this process that's been exposed in the last few years.

The Underlying Assumption

The assumption is that transparency and disclosure allow for smart investing. While that's certainly true the wise investor also wants another piece of data: the health of the marketplace. History is littered with examples of healthy companies killed off by changes to the market. War, famine, banking crisis, natural disaster, pandemic.  All of these are examples of disruptions to the health of the marketplace which couldn't have been predicted by disclosure. For this reason the SEC appears to have bought into the fallacy that systemic risks can't EVER be avoided by disclosure. This is how climate change is different. All is not well.

All is Well... All is Not Well


The 2010 Climate Disclosure rule

One of the documents that companies are required to file with the SEC is called a "10-K". The purpose of the 10-K is to disclose "material risks" to a company that a reasonable investor should be aware of. Things like debt, legal proceedings and problems with cash flow show up here. Four years ago new rules began to require that companies disclose their vulnerability to climate related risks on this form. How will a business be impacted by rising sea levels? hotter days? water shortages? massive migrations of climate refugees etc.? What exposure do they have to carbon pricing or energy costs? All of these and more fall under this one rule. This is spectacular news because for the first time EVER the market is being forced to evaluate a systemic threat in advance. Investors will have more data and can reward companies that hedge against this completely predictable and avoidable disaster. For this reason the SEC has more power than any other body on earth to motivate capital in ways that will mitigate global warming.

More Honored in the Breach

So the climate crisis is solved right? Wrong. Unfortunately, there have been stunningly few companies that have complied with this rule. In fact, reports indicate that fewer than 4% of corporate disclosures do anything more that acknowledge that climate and carbon related risks exist and the majority don't even go that far. This should disturb you.

It would be one thing is there wasn't good data on climate risks but there is. Reports are generated daily by a host of authoritative sources seeking to inform the public and business community about what they're in store for. It's another thing entirely for the SEC to allow this breach to continue unaddressed. Everyone reading this article should be concerned that the companies we've invested our retirement saving in haven't been given a push on this. To date no companies have been fined for their breach of reporting and only a scant few have been warned to correct their lack of data.


Because they don't know any better

At it's core this problem is everyone's fault. What we're asking is totally new. The SEC has no history with a process like this and no uniform standards exist for evaluating the risks involved. For their part companies are in the dark as to what constitutes compliance and where their risks actually lay. Global Warming is a multi-front conflict and risk managers have a long list of potential beachheads to guard against. What's needed is greater guidance on precisely where a company should spend it's time and money. 


A Final Recommendation

What the SEC should do is lay out rules for modeling the systemic shifts all companies will face. As the rules stand now the topic is too broad. It's well within their mandate to lay out clearer models and scenarios for companies to plan for and they can do this by soliciting feedback from members on what rules should be sector by sector. The market doesn't knowwhat it doesn't know. In the same way the Federal Reserve planned out stress tests for big banks following the crisis the SEC can plan out scenarios for businesses . A good place to start would be to issue rules endorsing the IPCC reports as accurate models for the future and suggesting those reports be considered by risk managers. In them you have several different scenarios under which a company could structure it's risk management planning and a uniform set of concerns everyone is addressing. That results of these considerations would give a big signal to the marketplace about the aggregate risk profile of the entire business community (and the nation by proxy). Capital would shift and reward companies that lower their risk and by default adjust our combined risk.

Over the weekend, an incredibly talented, thoughtful colleague was talking about how risk management is more art than science. He's a data driven guy but ultimately you need to make a judgment call on what kinds of problems you want to apply data to, what scenarios to prioritize and how good you think the data is. In the end the shame of it all is that the SEC has enormous power to motivate markets to consider global warming more seriously. When they do amazing things will happen... and they'll happen faster than anyone now predicts.