Green Shift in the Market: Navigating the New SEC Climate Disclosure Landscape

Green Shift in the Market: Navigating the New SEC Climate Disclosure Landscape

Investors are increasingly demanding detailed information from companies about how they manage the risks to their real estate portfolios from climate change. This shift isn’t just a regulatory trend but a strategic necessity. If implemented, the guidelines from the Securities and Exchange Commission (SEC) for climate disclosures could transform the investment landscape, with significant implications for the investment industry including real estate investment trusts (REITs) and their investors. The implementation is subject to legal challenge. This blog examines the challenges SEC’s disclosure rules could pose for investors.

The Rising Significance of Climate Risk Disclosure in the Financial Sector

The global financial sector is adapting to the growing demands of climate-related disclosures. Institutional investors are seeking greater transparency on how climate change impacts their investments. A Science study highlighted mandatory climate risk disclosure as essential for investors to effectively manage these risks, impacting how public firms measure, report, and address climate-related concerns. Several countries, including France, Japan, New Zealand, and the United Kingdom, have already mandated such disclosures for large public companies. The SEC’s climate disclosure requirements first drafted in March 2022 mark a significant step in the US. They require all publicly traded firms, regardless of size or country of incorporation, to report on climate-related financial risks.

The Main Requirements and Challenges of SEC Climate Disclosure

The new guideline seeks to standardize the measurement, reporting, and management of climate risks across U.S. financial markets. This comprehensive framework mandates disclosures on governance structures, climate risk integration in company strategy, and the potential impact of these risks on business operations and financial conditions. The compliance timeline considers company size and acknowledges the varied capacities across different entities. The guidance is less ambitious than when first drafted. Companies are now required to disclose Scope 1 and 2 emissions. The initial draft had also required the disclosure of Scope 3 emissions, but this has been dropped.

Compliance with these requirements could be multifaceted, particularly in data collection and assessment of environmental impacts. Aligning internal reporting with SEC standards will involve standardization and often third-party verification. Assessing the financial impacts of climate risks adds another layer of complexity. Furthermore, the costs for compliance can be significant. The SEC has made various earlier estimates, from an average annual cost of around $420,000 for small firms and $530,000 for larger firms. These costs could escalate for firms new to climate reporting due to the need for new systems, staff, and consultants.

REITs will face specific challenges if these guidelines are implemented. One of the most significant is data acquisition for long-term leases. Since REITs often deal with multi-year leases, obtaining accurate, up-to-date information on the climate impact of their properties can be complex. This is further complicated by the diverse nature of real estate assets and the varying degrees to which they may be affected by climate change. Additionally, REITs must absorb the costs of these disclosures. Implementing systems for regular, detailed reporting can be resource intensive. Moreover, adapting properties to be more climate-resilient, or divesting from those that pose high climate risks, can have significant financial consequences.

Moving towards a more transparent and climate risk-aware investment framework

The climate disclosure rules would introduce considerable changes for investors. Assessing detailed disclosures across numerous firms can be daunting, especially with the current emphasis on assessing transition risks. The academic and policy spheres are actively discussing these risks and the role of climate policies and sustainable finance instruments. The financial implications of the climate disclosure rules are at the forefront of the debate about their introduction. Businesses and politicians have raised concerns about the costs associated with requiring companies to quantify their environmental impact and assess the risks posed by climate change.

The SEC has scaled back of some aspects of the rules, specifically the Scope 3 greenhouse gas emissions requirements. This modification could influence the depth of environmental data available to investors, highlighting the ongoing debate about the financial implications of these climate disclosure rules. For REITs and investors, navigating this evolving landscape requires a nuanced understanding of the data and its implications for financial risks and opportunities.

Nevertheless, the SEC’s initiative is demanding in terms of compliance but is a crucial step towards providing investors with a more transparent and climate-resilient financial system. The guidelines are being challenged in court by a coalition of state Attorney Generals who believe the rules are unconstitutional. Consequently, the uncertainty in the US climate risk regulatory landscape will continue for companies and investors for the foreseeable future.

Disclaimer

The views presented in this article reflect the views of the GREEN Secretariat but do not necessarily represent those of the individual GREEN members.

Academic References

• Bolton, P., & Kacperczyk, M. (2023). Global pricing of carbon‐transition risk. The Journal of Finance, 78(6), 3677-3754.
• Carattini, S., Hertwich, E., Melkadze, G., & Shrader, J. G. (2022). Mandatory disclosure is key to address climate risks. Science, 378(6618), 352-354.
• Krueger, P., Sautner, Z., & Starks, L. (2020). The Importance of Climate Risks for Institutional Investors. Review of Financial Studies, 33, 1067-1111.