Mainstream media have recently noticed efforts by business interests to address potential risks to their business from a changing environment. As business entities assess potential risks, the drumbeat for disclosure of such assessments in public announcements grows louder. In addition, as discussed below, reporting companies should consider their disclosure obligations in this context in their risk factor disclosure and “forward looking statements” language.
Earlier this month, a former Securities and Exchange Commission member and a former deputy chief accountant, along with a London-based investor activist, called for the Financial Accounting Standards Board (FASB) to require companies with “significant fossil fuel reserves” to disclose information regarding assets that would be rendered “unburnable” by more stringent regulation (and become “stranded assets”).The authors suggest that such disclosure will permit investors to “pass judgment on the future viability of fossil fuel reserves.”
The theory underlying this petition for the FASB to adopt disclosure requirements is straightforward.
- Publicly-traded companies assign value to their fossil fuel reserves on the assumption the reserves can be combusted for energy recovery.
- Governments are adopting regulatory measures to reduce carbon emissions from the combustion of fossil fuels.
- Publicly-traded companies should disclose to investors the expected financial impacts of government restrictions on the combustion of fossil fuels.
This would be fine if the world were a seminar. But the number and scope of the uncertainties inherently buried in any evaluation would render disclosure functionally meaningless. For example, companies would have to assess and assign a likelihood that any of the following factors might occur:
- when regulatory requirements restricting fossil fuel use will be adopted
- what the content of those restrictions will be
- will some uses (e.g., electricity generation) be restricted more stringently than others (e.g., transportation)
- which countries will agree to adopt such restrictions and which will not
- which country’s restrictions will apply — the country in which the reserves are located, the country in which the raw fuel is refined, the country in which the final product is sold?
Of course, companies have, in recent years, included in their disclosures qualitative discussions of possible impacts of new regulatory requirements restricting carbon emissions. The step to a quantitative discussion, while certainly a laudable aspiration, remains to be achieved. To provide investors an opportunity to “pass judgment,” any disclosure would have to identify the assumptions underlying the disclosure and, perhaps, justify the selection of assumptions. Even then, while available models likely could produce precise figures to be included in disclosure documents, the uncertainties surrounding the accuracy of such figures severely discount any value added by the disclosure and could possibly create future hooks for securities litigation alleging false or misleading disclosures.
Notwithstanding these uncertainties, as calendar-year public companies approach annual reporting season, they should consider whether or not their current risk factor disclosures, as well as their “forward looking statements” language, are adequate in light of recent developments and any new regulatory requirements affecting possible “stranded assets.”
Issuers should approach the possibility of stranded assets as they would any other part of the business: if they are a significant factor that makes an investment in the company speculative or risky, then issuers should address it in their risk factor disclosures. Similarly, if a past occurrence or current risk of stranded assets is likely to have a material effect on operations or financial statements, then such incident or risk should be included in their Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Companies should also review their standard “forward looking statements” language to determine whether it could also use refreshing. In doing so, companies should consider whether or not the possibility of stranded assets posts a unique and material risk to their operations, and should discuss these risks in a way that avoids boilerplate language and statements of general risk applicable to all companies subject to government restrictions on the combustion of fossil fuels.