SEC Regulations: What Do Climate Risk Disclosures Mean for Wealth Advisers and Investors?
Tuesday, August 29, 2023
August 2023
SEC Regulations: What Do Climate Risk Disclosures Mean for Wealth Advisers and Investors?

Climate risk is financial risk. Increased regulation may help mitigate this risk and offer opportunities to companies who get ahead of it

by Alex Acosta, chief compliance officer at Ethic

Key Points

  • Climate risk creates serious financial risk for public companies. Yet current reporting by companies on climate risk is inadequate.
  • The SEC’s proposed Climate Risk Disclosures Rule for Public Companies would require SEC-registered public companies to include certain climate-related disclosures in their public reports.
  • Today, every public company creates its own rules — some are better than others. The SEC’s upcoming ruling will offer greater systemic transparency and accountability.
  • Executives of private companies — especially those in industries contributing the most to climate change or those operating in areas with high levels of physical climate risk — may want to start preparing today rather than wait for the SEC’s final ruling. 

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As chief compliance officer at Ethic, I’ve been getting a lot of questions about three proposed U.S. Securities and Exchange Commission’s (SEC) rules around climate disclosure, ESG, and sustainability:

  1. The Climate Risk Disclosures Rule for Public Companies, which would require public companies registered with the SEC to include certain climate-related disclosures in their public reports.
  2. The Amendments to the Fund Names Rule, which would expand the Fund “Names Rule” to require any fund that includes in its name “ESG,” “sustainable,” “green,” or any other term that suggests it is a sustainability-focused fund to have at least 80 percent of its investments focused on sustainability.
  3. The ESG Disclosures for Investment Advisers, which would require additional disclosures regarding an investment adviser’s ESG strategies, including how they consider ESG factors in their investment strategies and methods of analysis.

In this new series on our Insights page, “Our Take: ESG, Regulations, and Legislation,” I’ll discuss details about each of the proposed rule changes, starting today with the Climate Risk Disclosures Rule for Public Companies, which is expected to be finalized and released this October. And I’ll answer a few key questions: What might the new regulation require from public companies? What would these requirements mean for wealth advisers and investors? And how can wealth advisers and investors prepare for the rule change? Let’s take a look.

What Would the Climate Risk Disclosure Rule Require from Public Companies?

As the impacts of climate change accelerate, companies face new or mounting risks, including changing consumer preferences for products that claim to be environmentally and socially responsible, countries’ demand for addressing the reduction of GHG emissions, and the increased incidence of physical risk to company operations due to natural disasters, such as the recent fires in Lāhainā, Hawai’i and Hurricane Hilary, which swept up the West Coast of Mexico and the U.S. 

These climate risks create serious financial risks for public companies. Yet current reporting by companies on climate risk is inadequate. Only 0.4 percent of companies in 2023 (down from 1 percent in 2022) who submit climate change-related data to CDP, a nonprofit environmental disclosure organization, give investors enough information to assess whether they have a credible action-oriented and science-led plan for the transition to a low-carbon economy. 

Some financial institutions and wealth advisory firms, including Ethic, have asked the SEC for more transparent and mandatory standardized reporting requirements and a climate disclosure framework that could help investors better integrate climate risks and opportunities into their portfolios. In 2021, we sent this response to the SEC’s request for public comment on climate-related disclosures, stating that we believe specific, standardized disclosure rules around climate-related information — and more generally — would provide investors with long-term benefits.

In March of 2022, the SEC proposed rule changes requiring SEC-registered domestic and foreign companies to disclose certain climate-related information. The proposal contains three essential elements: 

  1. Task Force on Climate-Related Financial Disclosures (TCFD): In accordance with the TCFD’s risk framework, all public companies would be required to disclose information about climate-related risks. Specifically, the rule would require companies to disclose their governance over climate-related risks and opportunities, their methods of identifying and addressing climate-related risks in their business, and the metrics they use to identify, assess, and measure those risks. 
  1. Greenhouse Gas (GHG) Emissions: All public companies would be required to disclose their Scope 1 and 2 GHG emissions (emissions caused by their operations through direct combustion and purchased power or heat). As early as 2025, larger public companies (those considered "accelerated filers") would also be required to disclose their Scope 3 emissions, which are emissions from activities in their supply chain and the use of their products.
  1. Financial Statements: Companies would need to include a note in their financial statements about the financial impacts of climate-related events and transition activities on the line items of their consolidated financial statements.  

What Will Be in the Final Rule? What Will It Mean for Wealth Advisers and Investors?

We can’t be certain what the SEC will include in the final rule, but we do have some indication of what might be left out. A couple of controversial items that SEC chair Gary Gensler is considering scaling back include Scope 3 emissions and financial statement disclosures due to the high probability that the new rule will face steep legal challenges

Some companies may wait to see the final rule rather than take action today. But climate disclosure isn’t going anywhere — companies will eventually need to tackle it. Doing so now would signal that companies want to do good for their own bottom line and help investors better position their portfolios. Therefore, Ethic believes that executives of private companies — especially those in industries contributing the most to climate change or are located in areas with a high level of physical climate risk — may want to embrace climate disclosure as a top priority. 

Ethic Can Help Wealth Advisers and Investors Prepare

How can Ethic help wealth advisers and investors prepare? First, it’s important to understand some of the fundamental ways we serve our clients. We assess companies not only on traditional financial metrics but also by understanding how they impact people and the planet. Our Sustainability Model helps us evaluate the actions of specific companies, while our proprietary platform tracks popular indexes through our direct indexing approach. We’re committed to helping investors reduce their portfolios’ emissions by making investment decisions that are aligned with their personal values. To date, we’ve helped clients reduce the carbon footprint of their investment portfolios by an average of 62 percent when compared to benchmarks — the equivalent of about 217,000 metric tons.

It’s important to continuously think through how data, research, and technology can improve how people invest and help companies make better decisions. But while the individual actions of companies are important, our industry as a whole can do better. 

Today, climate disclosure is a little like the Wild West: each company creates its own rules. The SEC’s upcoming ruling will offer greater systemic transparency and accountability. This is good for the entire economic landscape — as I’ve already mentioned, climate risk is financial risk. The sooner companies begin to mitigate these risks and take advantage of the opportunities, the more resilient they’ll become. Companies will be held accountable for climate disclosures and the data they use in their reporting, which will help investors — who are increasingly demanding corporate accountability for impacts on the world — make more informed decisions. 

Don’t wait. Contact your relationship manager to learn more about how Ethic can help you and your clients prepare for climate disclosure.

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Sources and footnotes

Ethic Inc. is a Registered Investment Adviser located in New York, NY. Registration of an investment adviser does not imply any level of skill or training. Information pertaining to Ethic Inc’s registration or to obtain a copy of Ethic Inc.’s current written disclosure statement discussing Ethic Inc.’s business operations, services and fees is available on the SEC’s Investment Adviser Public Information website – www.adviserinfo.sec.gov or from Ethic Inc. upon written request at support@ethicinvesting.com. Information provided herein is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Any subsequent, direct communication by Ethic Inc. with a prospective client shall be conducted by a representative of Ethic Inc. that is either registered or qualifies for an exemption or exclusion from registration in the state where a prospective client resides. Information contained herein may be carefully compiled from third-party sources that Ethic Inc. believes to be reliable, but Ethic Inc. cannot guarantee the accuracy of any third-party information.

Ethic Inc. does not render any legal, accounting, or tax advice. Ethic Inc. recommends all investors seek the services of competent professionals in any of the aforementioned areas. Ethic Inc. cannot provide any assurances that any investment strategies, simulations, etc. will perform as described in our materials. ALL INVESTMENTS INVOLVE RISK, ARE NOT GUARANTEED, AND MAY LOSE VALUE. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY.

Contributors

Alex Acosta is Ethic's chief compliance officer. She holds a BBA from Florida International University and a JD from Fordham Law School. Throughout her career, she has worked in various legal and compliance positions within the asset management industry. Alex is licensed to practice law in New York.

Travis Korte is the associate director of Sustainability Research & Data at Ethic. Previously, Travis organized civic-minded technologists at Hack for LA and advised a wide range of clients on data science, data policy, and quantitative methods. You can follow him on Twitter at @traviskorte.

Melissa Banigan is a content strategist with over 15 years of communications experience working with global companies and nonprofits. Also a journalist and author, her work appears in The Washington Post, CNN, the BBC, NPR, and the Independent, among other publications, and she's written three books for youth.