On January 27, 2010 the ground moved underneath our CFOs when the Securities and Exchange Commission (SEC) instructed publicly held companies to “…consider the effects of global warming and efforts to curb climate change when disclosing business risks to investors.” Gina-Marie Cheeseman posted an excellent article entitled “SEC Issues Guidance On Climate Change Risk Disclosure” on Triple Pundit on January 28 that provides more details about this ruling.
This article surfaces some of the issues now confronting CFOs.
Early in my energy industry career, one of the “pop questions” often asked of junior staff in the finance department was: “Who is most important: the investor, the customer or our associates?” In finance, the answer is always the investor, according to the narrow interpretation of incorporation law. Otherwise, one would have violated the concept of “fiduciary responsibility.”
The SEC guidance for reporting climate change risks is a milestone event in the definition of fiduciary reporting for a CFO. This “guidance” expands a CFO’s disclosure requirements when reporting financial results in documents like an annual report, 10K, 10Q and 8K, where a failure to adequately discuss or reveal risk could expose a company to investor lawsuit and regulatory action. One significant ramification of this SEC action is that CFOs will now need to take the initiative in identifying and reporting the risks that climate change may have upon their company’s investors. This is a sea change in CFO fiduciary responsibility.
Here’s one potential example of how climate change risk management has gained the strategic attention of the CFO:
Let’s assume a utility, car company or grocery store has a higher carbon footprint than its industry peers. The new SEC guidance implies a CFO would now need to discuss the ramifications of this “material issue.” Prudence would suggest that in doing so, the CFO would also need to identify and discuss risk mitigation options including their capital requirements and cost impacts.
The ramifications on this are many. First is that a company will need to define and track its GHG emissions. A second is that it will be prudent for them to also assess its performance. (In my example, compared to industry peers.) Finally, it would appear prudent for the CFO’s office to report on which financial and other diagnostic tools the company now views as applicable in assessing climate change risk to investors.
From my experience prior to January 27th, a typical CFO capital investment criterion for a “non-strategic” capital investment that reduced GHG emissions was a two year payback analysis–meaning the cost savings from the investment must return the invested capital within 24 months. The “what’s and how’s” for conducting financial risk management assessments of climate change that satisfy the SEC’s disclosure requirements will be defined through an evolutionary process of professional dialogue among CFOs, CEOs and SEC-specialist lawyers. However, an implication of this ruling suggests the narrower two year payback analytical tool could be too limiting in assessing the broader investor risk assessment now required by the SEC.
Here’s a hypothetical example. Roof-top solar power systems typically have payback periods that can range between 5-15 years and use of a two year payback period criterion would result in this investment not gaining CFO approval. However, given the new disclosure requirements, the CFO’s adoption of a lifecycle analysis could qualify a solar system as a strategic path for managing climate change risks to investors.
Stretching this example further, if companies across America began installing roof top solar systems as a key element in their climate change risk management plan then this is a “material risk” that electric utilities would need to report. In doing so, this will trigger the need for the utility’s fossil fuel suppliers to also report this material issue. The chain reaction of this reporting upon how investors view individual companies and industries holds the potential to be telling and expansive with increased potential for “winners and losers” among industry segments and within industry segments as investors use these discussions to make investment decisions.
The next question is: How ready are CFOs for this new reporting requirement? Enviance is a company that supplies software for tracking GHG emissions. It conducted an “on the ground survey” among attendees at EUEC 2010, an energy/environment conference. The survey found that 61 percent of respondants did not have a process for measuring GHG emissions. More telling, in terms of the concept of fiduciary reporting responsibility, is that 46 percent of respondents commented that their company will need to dramatically reduce their GHG emissions in response to the pricing of emissions by government.
Last spring, I chaired a CFO conference with a prestigious financial association. Much of this conference’s attention was focused on how cutting emissions can also achieve costs reductions that positively impact a company’s bottom line. The conference posted this question: What does climate change mean to a CFO? With this new SEC rule-making, CFOs will need to take a much broader, strategic and more profound approach at answering.
Are there CFOs who are ahead of the curve in reporting climate change risks to investors? Please post a comment if you know of a CFO who could be a best practices example. Thanks!
Bill Roth is the author of The Secret Green Sauce that profiles best practices of actual companies growing “green” revenues and founder of the Earth 2017 website providing free tweets and posts on green business success.