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Additional Comments on the SEC Proposed Climate-Related Disclosures
Yesterday we submitted a comment to the U.S. Securities and Exchange Commission regarding their Proposed Rules to Enhance and Standardize Climate-Related Disclosures for Investors. The comment suggested that reporting should focus on Scope 1 and 2 emissions, and defer attention to Scope 3 work.
Today I submitted a second comment to do with risk, acceptable risk and inconsistencies associated with predicting the future. The comment is shown below.
The proposed rule makes frequent use of the word ‘risk’, but it does not properly define the term. The proposed rule states,
The proposed definitions <of risk> are substantially similar to the TCFD’s definitions of climate-related risks and climate-related opportunities. We have based our definitions on the TCFD’s definitions because they provide a common terminology that allows registrants to disclose climate-related risks and opportunities in a consistent and comparable way.
As proposed, “climate-related risks” means the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole.
The rule raises three concerns when it comes to understanding and managing risk.
The first concern is that the TCFD does not provide an adequate definition of the word ‘risk’ as a basis for the SEC rule.
Risk is made up of three components: a hazard, the consequences of that hazard should it occur, and the likelihood of occurrence. There is generally an inverse relationship between the severity of the consequences and the likelihood of occurrence. For example, a facility on the Gulf Coast of Mexico may experience severe rain storms many times a year, but hurricanes just once every few years. The proposed rule does not call on companies to distinguish between rare/high consequence events, and more frequent/lower consequence events. Indeed, the rule seems to conflate the words ‘risk’ and ‘consequence’.
A second concern is to do with the topic of ‘Acceptable Risk’. Risk is never zero: there are always hazards with their associated consequences, and those hazards always have a finite chance of occurrence. What is the cut-off point?
The third concern is to do with the forward-looking nature of risk. No matter how sophisticated our models, the reality is that any estimation of risk is highly subjective and prone to error. Hence, the goal of consistency and comparability between companies will be very difficult to achieve.
In her comments of March 21, 2022, Commissioner Peirce said,
The proposal does not just demand information about the company making the disclosures; it also directs companies to speculate about the habits of their suppliers, customers, and employees; changing climate policies, regulations, and legislation; technological innovations and adaptations; and changing weather patterns.
Predicting the future is always very difficult, but, with regard to climate change, predictions are extraordinarily tricky. The climate is affected by many factors that include loss of biosphere, energy shortages, the choice of “green” technologies, the feasibility of carbon capture and sequestration, population levels, and — most important — human behavior.
In an earlier comment, I suggested that companies focus on Scope 1 and 2 emissions, and defer work on Scope 3. The above remarks to do with the nature of risk and the subjectivity associated with predicting the future lend weight to that comment.
I concluded yesterday’s post with the following sensible words from the U.S. Environmental Protection Agency.
Scope 3 emissions for one organization are the scope 1 and 2 emissions of another.