With the books about to close on Q1, it is already clear that 2021 will be a year of progress for the climate feedback loop, a primarily market-based mechanism for driving action on climate change.
The feedback loop encompasses all of a company’s stakeholders — not just investors but also customers, partners, employees, communities, non-governmental organizations, regulators, and even elected officials. All these stakeholders are pushing for the same thing: reduction of the greenhouse gases (GHGs) that scientists agree are trapping heat and causing worsening storms, rising sea levels, humanitarian crises, and more.
Under pressure, growing numbers of companies are taking action to shrink their GHG footprints. As they do, they win increased stakeholder loyalty, which improves their financial performance, which prompts more climate action, which strengthens and accelerates the feedback loop.
Reliable information is vital for progress of the climate feedback loop
This loop rests on a foundation of reliable corporate climate information. However, while climate disclosure (or climate reporting) is more common than even five years ago, thanks to the Global Reporting Initiative (GRI), the Climate Disclosure Project (CDP), and numerous other organizations, it is still voluntary, patchy, and inconsistent. Today, many efforts are gaining momentum to improve the quality and consistency of climate disclosure, and sustainability disclosure more broadly, and make it easier for businesses to accomplish.
In mid-March, a new EU measure called the Sustainable Finance Disclosure Regulation (SFDR) took effect. It requires all participants in EU financial markets to disclose ESG issues according to a list of 60 indicators. Its purpose is to help investors sort through corporate sustainability claims and make better decisions about which investments can legitimately call themselves sustainable.
Key elements in SFDR are the concept of “principal adverse impact” and the establishment of “regulatory technical standards” to guide corporate disclosure of fund managers’ investment decisions on sustainability factors. Many details of SFDR need to be worked out in the real world, but the regulation could be a powerful force for transparency and against greenwashing.
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Also, in mid-March, the US Securities and Exchange Commission (SEC) weighed in by inviting input on climate disclosure from investors, registrants, and other market participants. This action followed a May 2020 recommendation from the SEC’s Investor Advisory Council, set up by the commission in an effort “to update reporting requirements for securities issuers to include material, decision-useful environmental, social, and governance, or ESG factors.” In December 2020, an SEC subcommittee recommended that the SEC “require the adoption of standards by which corporate issuers disclose material ESG risks.”
In a separate effort, an influential business organization called the International Financial Reporting Standards Foundation is expected later this year to launch a sustainability standards board to “harmonize and streamline sustainability reporting.” Management professor Robert Eccles, one of the pioneers of the field, wrote in Forbes magazine that the result would be “a set of standards for mandated reporting of the same rigor and relevance as those developed by the International Accounting Standards Board” for financial reporting.
In Eccles’s view, market forces are not sufficient to drive universal sustainability reporting, just as they were not sufficient to drive universal financial reporting. Fair point. But it’s also worth noting that the SEC was created in 1934, five years after the market crash that caused the Great Depression and utterly changed not only the global economy but how the world thought about financial regulation.
Back then, a broad set of stakeholders – including massive numbers of hungry people, governmental officials seeking to help, and businesspeople seeking stable growth – realized that financial regulation was necessary and made it happen. In other words, it took a feedback loop.
Climate change may be even more existential than a global depression. Fortunately, we’re seeing the same kind of feedback loop take shape.