Government regulators, financial industry standards agencies, nongovernment organizations and activist investor groups are advocating enhanced disclosure of the potential effects of business activity on the environment, or the disclosure of so-called environmental, social and governance (ESG) factors. The ESG factors measure sustainability and ethical impact of investing into a particular asset or business.
Climate change is an ESG factor that is increasingly drawing scrutiny in environmental disclosures. This factor encompasses impacts relating directly to climate change, such as oil and natural gas exploration and production, the financial impact of new and more stringent emissions limitations, and the potential for assets to become stranded. Indirect impacts related to climate change, such as the availability of water in drought-prone areas, must also be considered.
Fulsome disclosure of these factors allows investors to quantify the risks and opportunities associated with a particular asset, business or industry sector. Currently, there is little uniformity in either the form or the content of the disclosures. Companies use different reference points that lead to different quality of the disclosures, making meaningful comparison more difficult.
One little-noted aspect of the December 2015 climate negotiations was the participants’ discussions regarding the lack of uniform ESG disclosures. As a result, the Financial Stability Board (FSB), an organization that studies vulnerabilities affecting the global financial system, announced its establishment of an industry-led Task Force on Climate-Related Financial Disclosures (TCFD). The TCFD, chaired by former New York City Mayor Michael R. Bloomberg, will develop voluntary, consistent, reliable, clear and efficient climate-related financial risk disclosures. The Task Force’s recommendations should encourage companies “to align their disclosures with investors’ needs” in receiving complete information.
According to its January 2016 press release, the Task Force will conduct its work in two stages. The first stage will include determination of the scope and high-level objectives. This stage is planned to be completed by the end of March 2016. The second stage, which will last until the end of 2016, will develop specific recommendations for voluntary disclosure principles and best industry practices.
The recommendations developed by the Task Force, while voluntary, will likely establish de facto best practices for drafting environmental disclosures. Public companies wishing to remain in the forefront of sustainability efforts would be well-advised to follow the Task Force’s work and consider offering input to the standards that are ultimately adopted.