Let’s take a look at what has been occurring over the past decade. Many states and local governments have enacted their own legislation resulting in greater regulation of greenhouse gas emissions (GHG). GHG legislation on climate change is currently pending in Congress after the House of Representatives approved a bill, later amended in 2009 by the Senate, to limit a company’s emissions of greenhouse gases through a system of “Cap and Trade”. Even the EPA has begun to require large emitters to disclose and report their data.
Since the 1990’s, 186 countries have supported the efforts of the Kyoto Protocol, and the European Union Emissions Trading System (EU ETS) which is the mechanism that controls the Cap and Trade system of allowances and credits for carbon and other greenhouse gases. While the U.S. has never ratified this treaty, U.S. companies doing business in those countries are required to comply.
Climate change risk has not gone unnoticed by the insurance industry. In their 2008 report, major investment firm Ernst & Young stated that climate change was the top strategic risk. They explain it as being, “long-term, far-reaching, and with significant impact on the industry” (Climate Change Greatest Strategic Risk to Insurance Industry). It remained on the top 10 for 2009 (Top 10 Risks Most Likely to Affect the Insurance Sector During 2009). Partially as a result of these reports, the National Association of Insurance Commissioners (NAIC) created an industry standard of mandatory disclosure. Designed for state regulators, it highlights potential financial risks due to climate change as well as actions taken to mitigate them. New actuarial models are in development along with new products specifically designed to cover these new risks.
So what are the risks to a public company? Legislation and new regulations can certainly have a significant effect on capital expenditures. Cap and trade allowances could also force a high emitter to buy credits, creating a negative effect on cash flow. Even companies not subject to new regulations could be affected if their own supplies and services are suddenly only available at a higher cost. As with any challenge, there will be companies well-positioned to benefit from current and proposed legislation. For example, those with “credits” (businesses emitting below their quota) may be able to sell them as investment instruments to improve their own capital position.
Let’s not forget the potential physical effects of climate change. Sea level rise, melting of permafrost, availability of clean water, greater temperature extremes, and increase in storm intensity can all have deleterious effects on a company’s operation and even demand for their products. For example, warmer winters may reduce seasonal demand for heating supplies, while a burst of extreme cold can overwhelm distribution infrastructures; banks holding significant debt in coastal properties could be at higher risk; drought or flooding could negatively impact agricultural firms.
According to the SEC, the new disclosure guidance is simply an extension of regulations pertaining to environmental issues implemented in the early 1970’s. Focused primarily on disclosure guidelines, the original rules sought to monitor compliance regarding material discharge and environmental protection, for use in potential litigation. The current standards have evolved to “provide that information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or, put another way, if the information would alter the total mix of available information.” (SEC Release #33-9106 (PDF))
To the CFO, properly assessing risk can be a complex issue, especially when considering the effect climate change may have on future company operations. Granted, there is a delicate balance in disclosure between compliance and stock valuation and demand. Currently, companies who are making some efforts on disclosing climate change risks are simply “burying” them in their 10-K form. It appears this practice is no longer acceptable with the new guidance requirements.
Are there any actions a company facing climate change risks may employ to comply with the full disclosure requirements and still show the company in a positive light? One method suggested is certification, primarily through an internationally recognized program and certification body. The International Standards Organization (ISO) has developed their ISO 14001:2004 Environmental Management System to assist companies in developing or transitioning to more sustainable systems and practices. Their newly developed standards ISO 14064 and 14065 provide an internationally accepted framework for measuring GHG emissions and verifying claims.
In our next article, we will examine the details and requirements of the new SEC guidance, discuss the potential benefits of a certification program, and also measure the relevance this action has on non-public companies.
Keith Winn is the VP Marketing/COO of GreenProfit Solutions, Inc. a sustainability consulting, certification, and contracting firm. You may contact Keith at 1-800-358-2901 or email kwinn@greenprofitsolutions.com.