Shareholders recently voted overwhelmingly to require increased attention to and disclosure of the future impact of climate change on ExxonMobil Corp.'s business expectations.
The vote follows a rocky and contentious 18-month investigation of ExxonMobil by the attorneys general of Massachusetts and New York regarding possible misleading disclosures of ExxonMobil‘s knowledge — or, more aptly, lack thereof — surrounding the expected impacts of climate change on the company's business.
This investigation and shareholder demand comes at an odd time for climate change. The Trump administration's decision to withdraw the United States from the Paris Accord, along with other regulatory decisions, has signaled to some a devaluing of the significance of climate change for business.
Yet independent actions by shareholders and states demonstrate that corporate obligations with respect to climate change remain. And the failure to meet those obligations creates risk.
All of this raises two ultimate questions: What are the climate change risks that investors want to understand? And how does a business disclose these risks and opportunities?
Climate change disclosure is nothing new. The Climate Disclosure Project (CDP) has been studying disclosures and making recommendations for years. The U.S. Securities Exchange Commission (SEC) provided guidance on climate change-related disclosures in 2010. Numerous governmental special reports address specific aspects of climate change risks, including security risks and supply chain risks.
More recently, the international Financial Stability Board has entered the discussion. The FSB views climate change, and the possibility of uneven impacts from change across the globe, as a risk to global market stability.
To help the market understand these risks, the FSB commissioned the Task Force on Climate-related Financial Disclosures (TCFD) to study the issue and provide recommendations to guide business responses to investor requests for disclosure. The task force is expected to release final recommendations for climate disclosure this summer.
Identifying the Climate Change Gaps in Corporate Disclosure
Broadly speaking, climate change risks and opportunities fit into two categories:
- Physical risks associated with the location of businesses, their supply chains, their facilities and their employees.
- Business risks, called "transition risks" by the TCFD, associated with the ability to turn a profit, the longevity of the business model and the effect of the changes on business capital and investment.
With all of the guidance out there, are companies providing the type of disclosures that investors find useful? The answer is largely no.
According to the FSB, the lack of "decision-useful" information is the key problem with current climate change-related disclosures. From a regulatory or litigation-risk perspective, many corporate disclosures currently recite greenhouse gas emission quantities and goals, and technologies and processes to reduce greenhouse gases.
This is certainly useful information. But an investor must be able to turn the data into information that can assist with an investment decision, and the reality is that most investors do not have the detailed knowledge to make the convert from complex climate-related data and modeling to business strategy. The lack of comparability from one company to another makes apples-to-apples investment decisions difficult, according to numerous investment groups.
Increasing the quality of information disclosed to investors increases the efficiency of the markets, according to the TCFD. Inadequate information leads to mispricing of assets and misallocation of capital, both of which can lead to economic instability.
Defining Corporate Disclosure Content
Once a business identifies a gap in its climate change disclosure, and prior to any disclosure, it must implement a process to evaluate and define what information should actually be disclosed. That information must then be converted into a business strategy that can be explained to the investor and managed by and reported to company management, including the board of directors.
Disclosing the strategy around climate change allows investors to compare companies, and develop their own investor strategies that take into account their world view.
Metrics and Targets
Businesses of all sizes can put a system into place that evaluates climate change impact. These systems are referred to as "metrics" or "targets."
In order to evaluate climate-related impacts, one has to know how greenhouse gases are generated directly or indirectly by the business. Analytic systems can be highly detailed, where greenhouse gas emissions are tracked through supply chains and into facilities, or qualitative, where impact is evaluated based on a series of assumptions.
Understanding the details of the evaluation system — the type of data collected and evaluated — assists investors in understanding the strength of a company’s evaluation.
Next, the company has to turn that data into useable information.
The TCFD report provides a matrix for determining risks and benefits with a quantification, or at least a qualification, of the financial impact for each point. To compare financial projections among businesses, the newest recommendation is that companies perform a "scenario analysis," and include the assumptions of the scenarios analyzed in their disclosures.
Scenario analysis identifies a set of hypothetical conditions and, using various tools, describes how the scenario might impact the business. For physical risks, using the "2° C" climate-related changes will provide a means of comparing the long-term risks for companies. Moreover, the scenario analysis can provide strategic direction for a company.
Transition risks focus on the nature, speed and focus of a changing business environment and include:
- Policy and legal risks, such as a carbon tax or "price" from a regulation; litigation from people who claim injury from climate-caused issues.
- Technology risks, such as adoption of less-polluting products; failure of a new technology investment.
- Market risks, such as customer rejection of a product or the changing supply chain costs.
- Reputational risks, such as perception of a "polluting" product or the failure of a product.
Physical risks can be acute, such as storm-related impairments, or chronic, such as precipitation pattern changes leading to drought or inundation. Physical risks can also affect the supply chain, the physical status of an asset or the employees of the business.
Evaluation and Exploitation of Opportunity
As with climate-related risks, changes in the climate may create opportunities such as:
- Using resources efficiently through new equipment, building modifications, recycling and the like.
- Lowering greenhouse gas-emitting energy use, and thereby cutting costs, through distributed energy sources, operational changes and buying "green" energy.
- Developing new products and services as markets and preferences change.
- Increasing the long-term viability and resilience of the business by exploiting new market opportunities and protecting the business from changing climate conditions.
There are a number of metrics companies may wish to consider when evaluating whether a disclosure is warranted:
- Whether executive pay is linked to the item being disclosed, such as greenhouse gas-reduction targets or other sustainability targets.
- Whether business strategies are analyzed against possible global temperature increases (scenarios) and whether those strategies are influenced by the outcome of the scenario analysis.
- Whether a "carbon price" is integrated into business projections and whether the price has an impact on business strategy, costs or policy choices.
- Whether the business decides to engage in public policy discussions in order to better implement a particular business strategy.
The ultimate decision of whether internal data and strategy warrants specific disclosure in investment documents undoubtedly requires careful consideration and balancing a number of risks and benefits to a company‘s business needs.
But the risk of non-disclosure is real. Companies should take notice of the risks faced by ExxonMobil for disregarding known climate change risk, and consider using the information and resources now available to evaluate the impact of climate change on their business.