Climate Risk Disclosures Are As Important As Financial Disclosures

As scientists predict that July will be the hottest month in human history, the next 12 months could be make-or-break for efforts to address climate change through shareholder engagement.

To date, investor efforts have ensured that publicly traded securities lead the way relative to their private peers. A report from environmental consultancy CDP last year found that public companies lead the way in both disclosure and action, with 73% of public companies surveyed actively setting emissions-reduction targets, compared with just 37% of private enterprises.

A new research paper published this month by the Review of Financial Studies argues that institutional investors think climate risk disclosure is at least as important as financial disclosures. It also suggests that faith in current disclosures is low and highlights support for mandatory reporting standards.

Beyond merely showing support for mandatory disclosure, the research is helpful because it frames some of the reasons investors support climate risk disclosures, and some of the pressures that support can increase and decrease. For instance, it separates investors into categories with separate motivations: those following a quasi-legal fiduciary duty or stewardship obligation, those based in countries that place a higher importance on environmental issues, and large asset managers concerned about the externalities of climate risk on portfolio companies.

The paper also suggests investors weigh the cost and benefit to companies in their requests for climate disclosure, suggesting companies in high-competition industries face less demand and high-emitting industries face slightly more so. It uses the example of a French legal change requiring investors to disclose the climate risks of their portfolios to show a resulting increase in demand for climate disclosures from companies.

While those findings may seem obvious, this summer is potentially a crucial turning point for investor demands for climate disclosures. Demand for esg investment products may not have cratered but the rise of the anti-ESG movement has at least reversed efforts to put sustainability front-and-center for many fund houses.

Meanwhile, in the economy, competition for workers and profits is fiercer across many industries thanks to inflation and high-emission industries were given something of a pass thanks to the energy crisis and global downturn in stock markets last year. That led to a second successive decline in support for environmental shareholder proposals this proxy season at a point when there is much work left to be done.

According to Insightia's ESG 2023 report, high Scope 3 emission disclosure rates for the 500 largest U.S. companies are not reflected worldwide – just 10% of the 27,000 companies in Clarity AI's universe report so extensively.

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Energy prices are now dropping, and a small handful of regulatory and investor alliances could shape the future momentum of climate disclosures.

On the regulatory front, this month marked the culmination of the IFRS Foundation's takeover of the Taskforce for Climate-related Financial Disclosures (TCFD) with the publication of the International Sustainability Standards Board (ISSB)'s inaugural standards, IFRS S1 and IFRS S2.

These disclosure standards, which incorporate TCFD and SASB, also require further disclosures such as Scope 3, industry-based metrics, and use of carbon credits.

This year has also seen the revision of the European Sustainability Reporting Standards (ESRS), a step toward implementation of the EU's Corporate Sustainability Reporting Directive (CSRD), which still needs to be incorporated into member state law.

Changes to the ESRS between November 2022 and June 2023 led to critical feedback from investors, including a letter from the European Sustainable Investment Forum (Eurosif), the Principles for Responsible Investment (PRI) and the Institutional Investors Group on Climate Change (IIGCC).

Investor support for the ISSB standards, including consolidation with other standards, would help to accelerate disclosures worldwide, in contrast with shareholder proposals that focus mainly on the S&P 500 index and a few-high emission companies, or the Securities and Exchange Commission (SEC)'s proposed mandatory disclosures, which already appear dated in comparison.

Of course, targeted engagement has its place as a standard-bearer for investor demands. In this respect, the initiative to watch is Climate Action 100+, which launched“Phase 2” of its engagement plan recently. Having registered what it considered“the second most successful proxy season ever for corporate commitments to climate action,” thanks in part to 80 withdrawal agreements at companies facing shareholder proposals, the group wants to focus on emissions reduction.

Its agenda foresees its investor members taking a more public stand, both in leading thematic and sector-based engagements, and disclosing vote rationales for flagged resolutions. That may lead to more companies settling to avoid reasonable shareholder proposals or seeking an exit from the initiative's list, as 10 companies managed this year (14 were added, including six based in Asia).

Investor pressure may need to adapt to new forms to keep the pressure up, but it won't be going away.

Josh Black, Editor-In-Chief, Diligent, Formerly Insightia

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