The Hindu Business Line : Making impact disclosure mandatory

Despite the wide range of risks and opportunities that climate change presents to the corporate sector, the level of disclosure to investors and deliberation of corporate policies in this area are abysmally low. Regulators may well have to make climate change disclosures by corporates mandatory, says UMAKANTH VAROTTIL

Climate change, described as a problem with scientific origins, has recently acquired significant political overtones. A less deliberated aspect of climate change, however, is its impact on the corporate sector, and particularly on investors who are primary stakeholders in companies.

As businesses become increasingly vulnerable to climate change, there is a corresponding surge in investor interest for obtaining information pertaining to corporate exposure to these risks. As for the availability of such information, it appears, there is currently a wide gap. The appetite for corporate information on climate change is essentially whetted by socially responsible investors who seek to ensure sustainable development while earning returns, and who thereby exhort companies in which they have investments to improve their environmental and social governance practices.

That apart, climate change information is crucial even to hard-nosed financial investors, whether institutional or retail, as factors such as global warming and green house gases are likely to have a long-lasting impact on the way companies are managed, and consequently on shareholder value.

Risk factors

Several risks arising from climate change have an adverse impact on financial performance of companies. First among those identified is physical risk — rising sea levels, changing temperatures and more intense storms. Such natural calamities could cause physical damage to facilities, thereby resulting in direct and indirect losses to companies. The devastation caused to American businesses to the tune of several billions of dollars by Hurricane Katrina illustrates this risk.

The second is regulatory risk, which involves greater costs imposed on companies in complying with more stringent environmental regulation. This could result in major capital investments, product shifts and intense competition from environment-friendly technologies, all of which are likely to have a material bearing on the financial condition of companies.

Add to that the third factor, which is litigation risk that may expose companies to compensation and penalties for unlawfully causing damage to the environment.

Opportunities too

On a positive note though, climate change presents opportunities too. Companies that have a head-start in embracing environment-friendly and low carbon product lines will be favoured with a competitive advantage over those that are not as adaptive.

Several companies have already cashed in on carbon trading, which continues to present future business prospects with renewed global concern over climate change. Policies of companies in striking such opportunities would be of utmost interest to investors as they could enhance returns on their investments.

The pervasiveness of climate change in corporate decision-making is now unequivocal. Contrary to popular perception, its impact is felt beyond the sectors conventionally believed to be environment-sensitive, such as oil and gas, power utilities and other energy-consuming products such as automobiles; even the financial services industry including banks and insurance companies are becoming vulnerable to climate change owing to their lending exposure to, and coverage of, high-risk customers.

Inadequate disclosure

However, despite the wide range of risks and opportunities that climate change presents to the corporate sector, the level of disclosure to investors and deliberation of corporate policies in this area are abysmally low.

Although several companies voluntarily make climate change disclosures, those tend to be cursory in nature and lack consistency in the absence of any available benchmark.

This situation has been exemplified in the recently released first Carbon Disclosure Report (CDP) in India undertaken on behalf of 315 institutional investors representing over $ 41 trillion of assets under management.

Out of 110 of India’s largest companies who were sent a questionnaire by CDP, only 35 per cent responded, which itself demonstrates the lack of awareness of climate change implications among Indian companies.

The report also raises the concern for investors that it may be that the non-responding companies do not have adequate risk management strategies in place or are missing significant opportunities to benefit from the shift to a low carbon economy.

Since voluntary efforts are proving to be inadequate, regulators may well have to sound a clarion call for mandatory climate change disclosures.

Mandatory disclosures will not only help investors in obtaining better information about climate change risks and opportunities affecting their investments, but would also impel those companies that have fallen behind into action to put in place risk management policies and practices to deal with the situation, as failure to properly address climate change could affect their attractiveness with investors.

Global phenomenon

Movement towards mandatory climate change disclosure is also becoming a global phenomenon.

In the US, several state regulators as well as large pension funds and other investment managers petitioned the Securities and Exchange Commission in September 2007 to issue interpretive guidance to companies clarifying their obligations to disclose material information concerning the effect of climate change and regulation of greenhouse gas emissions upon their financial condition and business operations. Other countries such as Canada and the UK as well as the European Union are moving towards mandatory disclosure.

Indian publicly-held companies are obligated to make significant investor disclosures at two stages. The first is when companies access the markets by way of a public offering, wherein disclosure obligations are governed by the Disclosure and Investor Protection Guidelines issued by the Securities and Exchange Board of India (SEBI).

The second relates to ongoing reporting obligations in case of listed companies either as part of their quarterly financial reports or disclosure of material events affecting the business of the company, which are governed by provisions of the listing agreement entered into by listed companies with stock exchanges.

In both these cases, the reporting obligations are general and do not contain any specific disclosures relating to climate change and its impact.

SEBI has a role

Therefore, SEBI may consider devising specific climate change disclosure requirements, both at the time of a public offering of shares as also for disclosures by listed companies on an ongoing basis.

For example, significant risks may be identified and disclosed under risk factors, while in certain cases they may also qualify as material contingent liabilities that warrant a place in the financial statements.

In other cases, the impact of climate change and the measures adopted by companies to deal with that may be disclosed in a qualitative fashion in the management discussion and analysis (MD&A) section.

The growing understanding of climate change impact will enable investors to make careful and well-informed assessments rather than deal with disclosures on a broad-brush basis.

The far-reaching nature of climate change has staked its claim for specific incorporation of related risks and opportunities in disclosures by companies under relevant regulations, failing which investors will be deprived of information that is crucial to an analysis of whether companies are well-prepared to manage climate change.

(The author is a doctoral candidate, National University of Singapore)

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