The Materiality of Climate-Related Disclosures
Given the overwhelming range of issues under the ESG umbrella, it is common for companies to face the challenge of prioritization, especially when resources are limited. Many companies tackle this issue by focusing first on low-hanging fruit, an approach that can lead to some quick wins and mobilize resources within the company to do more.
Investors like BlackRock and State Street prefer that companies focus on the issues that are most material to their business model and operations. While materiality often varies across industries and sometimes even companies within the same industry, climate change has emerged as an increasingly salient issue universally. Climate-related risks can manifest in multiple ways, posing significant threats to companies across their business operations. For example, more frequent extreme weather events lead to physical or asset-level risks, new regulations targeting greenhouse gas (GHG) emissions may present compliance risks, and the increased cost of raw materials may create market risks.
The Two Degrees of Climate Disclosures
There are many elements to comprehensive climate reporting, but the two key areas that investors focus on are climate-related risk management processes and quantitative climate metric disclosures.
The first step in building an effective climate-related risk management process is to identify two categories of risk: the threats that climate change poses to the company and the impact of the company’s operations and assets on climate change. The foundation of any effective climate disclosure begins with the company’s ability to demonstrate that it understands the specific ways in which it may affect and be affected by climate change. A global lodging real estate investment trust might discuss the financial risks stemming from the impact of rising sea levels on its oceanfront properties. A regional bank might discuss the extent to which its loan portfolio supports extractive activities. Every company’s climate risk profile will be unique, but the identification and disclosure of these risks is becoming a standard shareholder expectation.
The second step is to establish a strategic plan to manage and mitigate the climate-related risks identified by the company. The best climate-risk management processes include qualitative and quantitative components, such as a set of climate-related goals, a description of the company’s strategies and programs for alleviating climate risks and quantitative targets that establish a pathway for achieving the company’s goals. By disclosing a comprehensive plan that include these elements, a company can assure investors that it is proactively addressing climate risks and building resilience within its business operations.
Companies struggle to report on climate change risks in line with investor expectations, and as a result, the quality and detail of current corporate climate disclosures varies. Among U.S. companies in the large-cap S&P 500 index, 46 percent publicly disclose climate change policies that specifically address climate-related risks, but only 28 percent clearly describe the impact of these risks on the company’s business, strategy and financial planning. Among smaller U.S. companies outside the S&P 500 but in the broad-market Russell 3000 index, these figures are even lower. Only 3 percent of these companies disclose policies that address specific climate-related risks, and 2 percent explicitly link these risks to business operations.
Investor reliance on quantitative climate metrics tends to vary by investor and by industry. Some investors view the presence of quantitative targets as a signal that the company acknowledges the existence of climate risks and understands their potential impact on the business. Other investors scrutinize these targets closely and look for the use of science-based GHG emission reduction targets. Incorporating quantitative climate-related metrics is especially important for companies in carbon-intensive industries like energy, utilities and transportation.
Concluding Thoughts on Corporate Climate Disclosures
Two concerns often arise when stepping into a sustainability leadership role and contemplating increased environmental or social disclosures of any kind, not just those related specifically to climate. The first issue is risk. Leadership teams might worry that disclosing climate risks or data could leave the company exposed to reputational or legal risk. Of course, companies need to ensure that its disclosures are accurate and comprehensive; however, for many investors increased transparency is the priority, and public disclosure of climate information would warrant credit, not criticism.
Companies may not always have access to the climate data, especially the quantitative emissions metrics, that many investors seek. This sparks the second concern that companies often cite: the cost of outsourcing the collection of climate-related data to third-party vendors. While it would be ideal to measure the extent of the company’s climate risks before developing a strategic plan to alleviate them, the cost of data collection is a legitimate obstacle, especially for companies with limited resources dedicated to tackling ESG issues. Companies in this situation should consider taking a multi-phase approach to climate reporting that will allow for disclosing the climate risk management process without incurring the potentially high labor and monetary costs of gathering emissions data.
Under a multi-phase approach, companies can begin to tell their climate story by identifying the specific climate risks that are material to their business model. Even if the company isn’t ready to go further with its climate disclosures, simply disclosing these risks will signal an evolving focus on climate issues. Once these risks are acknowledged and disclosed, companies can begin developing policies and strategies for managing these risks. These policies and strategies can then be publicly disclosed. Part of the strategic plan could include measuring GHG emissions and developing reduction targets. Incorporating measurement into the company’s strategy could provide more time to spread the costs of data collection.
About the Author:
Emmanuelle Palikuca is a Sustainability Advisor on the ISS Corporate Solutions team, where she is responsible for engaging with companies across industries to drive sustainable business practices through the improvement of their ESG disclosures and performance. Previously, Emmanuelle was on the climate team at the Interfaith Center on Corporate Responsibility (ICCR), where she specialized in methane research to advance key investor-driven engagements with companies in the energy industry. Prior to joining ICCR, Emmanuelle worked on the carbon asset risk team at Ceres in Boston, MA.
Nicole Bouquet is Head of Sustainability Advisory for ISS Corporate Solutions. This team of advisors works with corporate issuers to improve disclosures related to sustainability and social risks and consults on the formation of internal programs to manage these risks. Prior to joining the team earlier this year, she held a role in the ISS Institutional business as a product specialist team lead supporting the investor use case for ESG data and research. Nicole has held many positions across client service and sales for other ESG research providers prior to joining ISS and has helped many of the largest, U.S.-based investment management firms design and implement programs for integrating ESG into the investment process.