TechTalk Blog - US GAO Issues Report on State of Climate/ Non Financial Disclosures in the United States & US SEC Efforts to Monitor & Enforce to Protect Investors

By David Colgren posted 04-10-2018 11:58 AM


Yesterday at a summit of central bank governors in Amsterdam -- the governor of the Bank of England warned that climate change could have a "catastrophic impact" on the global financial system. Speaking at the summit -- Mark Carney reiterated previous warnings that the global financial system could be at risk from both physical climate impacts and a 'carbon bubble' where efforts to de-carbonize leave carbon intensive assets stranded.  He said markets could experience a "climate Minsky moment", referencing the work of economist Hyman Minsky who has studied how banks failed to predict the 2008 financial crisis that disrupted the world economic growth. At the summit -- Carney again called for improved disclosure of climate risks from listed firms to help ensure investors can respond appropriately to this growing international crisis.

Mark Carney’s comments at the summit echoes several of the conclusions of a US General Accountability Office (GAO) report late last year that stated climate change is already costing U.S. taxpayers billions of dollars each year, with those costs expected to rise as devastating storms, floods, wildfires and droughts become more frequent in the coming decades. 

A Government Accountability Office report said the federal government has spent more than $350 billion over the last decade on disaster assistance programs and losses from flood and crop insurance. That reported costs do not include the massive toll from 2017's three major hurricanes and wildfires, expected to be among the most costly in the nation's history.

The GAO report predicts these costs will only grow in the future, potentially reaching a budget busting $35 billion a year by 2050. The report says the federal government doesn't effectively plan for these recurring costs, classifying the financial exposure from climate-related costs as "high risk."

"The federal government has not undertaken strategic government-wide planning to manage climate risks by using information on the potential economic effects of climate change to identify significant risks and craft appropriate federal responses," the study said. "By using such information, the federal government could take the initial step in establishing government-wide priorities to manage such risks."

The report's authors reviewed 30 government and academic studies examining the national and regional impacts of climate change. They also interviewed 28 experts familiar with the strengths and limitations of the studies, which rely on future projections of climate impacts to estimate likely costs.

It is clear -- trillions of dollars from BOTH Government and the private sector will be needed over the coming years to minimize this growing global crisis and disclosures will be an important tool for better transparency and accountability and help the capital markets become more efficient in addressing this global crisis.

But what can the capital markets do to both minimize public company risk and create a mechanism to provide funding to support new solutions created in the private sector to deal with this growing crisis?

The GAO just issued a report in February 2018 that looks at public company disclosures related to climate change -- why they are important and what both the US SEC and companies can do to address this growing environmental and economic crisis facing all nations. 

Key findings of the GAO report:

The Securities and Exchange Commission’s ability to assess the accuracy of corporate climate risk disclosures is limited, the General Accountability Office said in its report. The SEC reviewers may not have access to the detailed information companies use to arrive at their determination of whether climate-related risks is material. The report also noted that unlike the financial data that is disclosed by a company – the climate change data is not reviewed by an external, independent auditor. Also, the report noted SEC examiners don’t have power to subpoena company information to find if the disclosures are truthful. However, the agency’s enforcement division can subpoena climate risk information from firms by obtaining a formal order of investigation from the SEC Commission.

The GAO report also said that it is also difficult for investors to find the information they are looking for because it is in different places within the report. (Most non financial disclosed data is in PDF format and extracting and analyzing this data is very difficult. It is not normalized and therefore not useful to the investment community unless the disclosed data is in a machine-readable format.) Complicating corporate climate disclosure is the fact that investors have not yet reached or the securities regulators have not – agreed upon a global standard on what information should be mandated to better measure a company's response to these external issues of interest to the investment community.  According to the US SIF Foundation’s 2016 Report on US Sustainable, Responsible and Impact Investing Trends, as of year-end 2015, more than one out of every five dollars under professional management in the United States—$8.72 trillion or more—was invested according to Sustainable, responsible and impact investing (SRI) strategies. But yet the investment community can't access this information is a usable format for analysis. 

What are US companies doing now regardless of not having any mandates or a regulatory structure in place to capture and review non financial disclosures?

According to Pension and Investments Magazine -- 
More U.S. corporations than ever are addressing sustainability, but there is still progress to be made, according to a new report from non-profit sustainability organization Ceres. The report, "Turning Point: Corporate Progress on the Ceres Roadmap for Sustainability,"analyzes the data of 600 corporations and compares the progress they have made against Ceres' Roadmap for Sustainability released in 2010. The road map established 20 goals for corporations in the areas of governance for sustainability (which includes board oversight and management accountability), stakeholder engagement, disclosure and operations. In the operations category, for example, Ceres had established a goal that corporations should reduce greenhouse gas emissions by at least 25% by 2020. Of the 600 corporations analyzed for the new report, 64% have committed to reduce greenhouse gas emissions. However, of that population, only 36% have set "time-bound" quantitative targets, and only 25% of those companies are working toward reducing emissions by 2020. In the category for governance for sustainability, the report said 98% of companies that had set targets for the reduction of greenhouse gas emissions have a senior executive responsible for sustainability performance, displaying a sense of management accountability. The original road map said the CEO and company management should be "explicitly accountable for achieving sustainability goals."

Need for XBRL for Non Financial Reporting Data to Make Data More Accessible and Usable to the Capital Markets 
XBRL is a global, freely-available, open business reporting data format used in more than 70 countries and by more than 140 regulators including the US SEC and the FDIC in the United States for finanical reporting. So unlike the financial information that is reported by public companies using XBRL in the United States for example – the sustainability data is not in a machine-readable format for data analytics. If this climate-change data could be tagged liked the financial data in XBRL the data could be linked and financial and non-financial disclosed data can be “integrated” for de facto “integrated reporting” – so financial performance can be connected to climate change actions to help investors make better decisions. Investors can see what companies are doing related to climate change - match this to finanical performance and direct capital to organizations that are engines for change. Like the XBRL data for finanical statement information -- the US SEC can make non finanical disclosed data available on the US SEC EDGAR SYSTEM portal for investors world-wide in this machine-readable format. The US SEC has a viewer for financial data in XBRL and can re-position this viewer to also be used for non financial data. Currently the EU is in the process of building out its financial transparency gateway (FTG) to create the next generation US EDGAR System using XBRL and blockchain technology to support greater transparency and accountability. Positioning non financial data in XBRL on both these open -- free public access platforms will help discovery and analysis efforts for better investment decisions.   

GAO: Companies are disclosing different types of information but it is not uniform. (In addition, unlike the financial information that is reported by public companies – the sustainability data is not in a machine-readable format for data analytics using such standards as XBRL. If this climate-change data could be tagged liked the financial data in XBRL the data could be linked and financial and non-financial disclosed data can be “integrated” for de facto “integrated reporting” – so financial performance can be connected to climate change actions to help investors make better decisions.

As the GAO report states: “We found, for example, one beverage company reported its goal to reduce greenhouse gas emissions in the business description section of its filing while another beverage company reported a similar goal on carbon footprint reduction in the risk factors section of its filing."

The study’s authors said two investor associations (the Council of Institutional Investors and Ceres) have said SEC-mandated climate disclosures are inadequate while five industry groups have said they’re sufficient.

The GAO report did not have any recommendations on which CSR/ESG standards should be disclosed but did say: “The impacts and costs of floods, droughts, and other weather events will increase in significance as what are considered “rare” events become more common and intense.” As an example, the report said 2012’s Superstorm Sandy cost an estimated $70 billion in direct damages and lost economic output.

The GAO report also said the SEC has no current plans to modify its climate-related disclosure requirements. Meanwhile the EU is moving full force with climate disclosure and also including other non-financial reporting data such as gender pay, human trafficking, child labor and diversity/inclusion data for more than 6,000 public companies located in Europe. The UK just finalized its first disclosure cycle for investors -- and stakeholders in the US are getting glimpses of this information about US companies operating in the UK to look at this data and the results are amazing. 

Stephen Haddrill, CEO, UK's Financial Reporting Council, said: “The UK’s deserved reputation for good corporate governance, earned over the last 25 years, has underpinned British business success. How we develop the framework will be key to boosting competitiveness, transparency and integrity in business particularly after Brexit. Successful and sustainable business are not just good for the economy, they support wider society by providing jobs and helping to create prosperity.

The FRC is undertaking a fundamental review of the UK Corporate Governance Code. The Government’s feedback will help inform the development our consultation later this year. Large private companies are integral to the UK economy as significant employers and supporters of communities and families. It is right that we develop a set of corporate governance principles to enhance confidence that they act in the public interest.” 

What is also clear is that the United States (which represents about 4% of the world’s population of world's 7.5 billion people are using approximately 24% of the world’s current resources). The question arises – is this sustainable and are efforts underway to make US companies more sustainable and supportive of the communities and stakeholders they serve like what is being done in the UK, EU and Japan to name a few in enhancing their reporting outside of just issuing financial statement data. For many years – just the financials were important enough to demonstrate this commitment – but efforts are underway on a global perspective to have companies include both financial and non-financial reporting to show how they support communities and society they serve -- THE PUBLIC LICENSE TO OPERATE.

Can management accountants play an important role in this transformation using XBRL, cybersecurity, privacy, blockchain, distributed ledgers, and smart contract to make this disclosed information more accessible to the capital markets?

IMA and Leveraging COSO Internal Controls - Ingrated Framework (ICIF) to Improve Confidence in Sustainability Performance Data 
Former FASB Chairman Robert Herz, IMA (Institute of Management Accountants) President and CEO Jeff Thomson, and sustainability reporting expert Brad Monterio of Colcomgroup, released a jointly authored thought paper late last year, “Leveraging the COSO  Internal Control – Integrated Framework (ICIF) to Improve Confidence in Sustainability Performance Data.” Given the rising demand for sustainability performance data to support internal and external decision making in creating, growing and reporting value, the paper asserts that confidence in this type of information is strengthened by the application of the COSO ICIF, a robust and globally recognized framework designed to apply to both financial and non-financial information. 

“Confidence in the accuracy, timeliness and relevance of performance data is critical to effectively optimizing corporate activities and communicating reliably to the capital markets,” says co-author Robert Herz, who currently serves as a Sustainability Accounting Standards Board (SASB) Foundation board member. “In the financial reporting ecosystem, confidence is bolstered in part by the implementation and application of effective, integrated internal controls – controls established using the Framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).”

Originally created in 1992 and refreshed in 2013, the COSO Internal Controls Integrated Framework aims to enable organizations to effectively and efficiently develop and maintain systems of internal control. The Framework enhances the likelihood of achieving the entity’s objectives and ability to adapt to changes in the business and operating environments. It emphasizes the importance of management judgment in designing, implementing, and conducting internal control, and in assessing the effectiveness of a system of internal control. The authors believe that “the COSO principles on effectiveness – controls that are present, functioning, and integrated – could apply to all types of performance data, including sustainability information, using professional judgment.”

While the paper demonstrates how the COSO ICIF principles would apply to sustainability data, the authors took a practical approach to the thought paper. This was accomplished by leveraging many third-party resources (such as SASB’s sustainability knowledge domains), conducting interviews and soliciting corporate case studies from organizations that are pioneering the use of effective internal controls around sustainability data. These examples demonstrated that investors and analysts are requesting, and many companies are beginning to integrate, better controls into their internal management processes.

Integration of sustainability data in governance, controls design, and performance management, rather than isolation, is key.

“This paper was simply meant to expand and accelerate conversations occurring globally on the use of sustainability performance data in value creation, growth and reporting, thereby strengthening organizational capability and informing the capital markets in a more holistic, forward-looking manner,” says co-author Jeff Thomson, CEO of IMA.

“In the process of writing this paper, we found that the body of knowledge and practice around development of effective internal controls for sustainability data is just beginning to emerge,” says Brad Monterio, co-author and a former global board member of IMA. “As demand for this information increases from investors, analysts, and the markets – and the need for confidence in that data rises – companies already advancing in this area may gain competitive advantage as well. This could include lower cost of capital, lower risk premiums, and enhanced reputation and brand value.”

I am confident the United States will become the leader in the development of a non-financial reporting framework and standards to help create efficiences in the capital markets to direct capital into new technologies and business models to support a sustainable and responsible marketplace by effective disclosure. Knowledge is power and when information is disclosed it helps to drive better investment decisions. Democratic government depend on trusted knowledge and an enlightened marketplace helps to advance the marketplace into these new areas of opportunity. Key is a united regulatory, business and investment community eco-system to keep the capital markets relevant to political, economic and social changes occuring around the world. Management accountants are and will play a key role in transformations beyond just the management of financial data -- the CFO and his/her team are moving into the management of non-financial data being requested from both internal and external stakeholders to become the most trusted advsior within the company operation including its supply chain. 

Become a member of IMA's Technology Solutions Practice Committee to learn more about new technologies and what management accountants are doing to make a difference.