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Whether we like it or not, the climate is changing. A personal example? I reside in the fine city of Seattle, where the mercury has reached 100 degrees Fahrenheit only three times in recorded history, and the all-time high temperature is a cozy 103. Until this weekend, that is. Much to my chagrin, we may see three straight days of triple-digit temperatures, with the potential for highs to reach a scalding 110 degrees. In a city where residential air conditioning is a rarity, it is not a fun situation!
What does that have to do with mergers and buyouts? Earlier this week, President Joe Biden met with SEC chairman Gary Gensler, Treasury Secretary Janet Yellen and other leading financial regulators to discuss a policy shift that would require public companies to disclose to their investors new information about their impact on the environment and other issues related to climate change.
The changes being discussed might not be groundbreaking. But they are certainly worth following, for public and private companies alike. Because this is the latest sign that ESG principles will become an increasingly important and unavoidable focus for businesses of all stripes in our ever-warming world.
I spoke this week with two executives from financial advisory firm Apex Group about what these new disclosure requirements could entail—and about what they could mean for companies and investors in the years to come.
If and when Biden and Gensler do add new disclosure requirements, they will probably start small. A likely model for the SEC is the Sustainable Finance Disclosure Regulation, also called SFDR, a new framework implemented by the European Union earlier this year that requires pension funds, asset managers, venture capital firms and other sorts of investors to disclose new information about the sustainability of their investments.
“I think they’ve got to be careful that they don’t overcomplicate it. What you’ve got to remember is that for so many companies, they’re at the beginning of their ESG journey,” said Andy Pitts-Tucker, the managing director of the ESG Ratings & Advisory sector at Apex. “My sense is, in the same way the SFDR is starting relatively lightly, [the SEC] is going to focus on greenhouse gas emissions, waste and water.”
One reason for the potential changes is that, so far, Biden has embraced the fight against climate change more than any president before him. But another, perhaps more important reason is that investors themselves are pushing for these changes. Pension funds, endowments, foundations and other institutional backers are all responding to calls from their constituents to pay an increasing amount of attention to the sustainability of their investments.
For now, the SEC is only talking about new requirements for public companies. But Georges Archibald, the head of Apex Americas, thinks private equity firms are kidding themselves if they think they won’t be affected. Because in some cases, their LPs are the same large institutional investors that are pushing for changes in the public sphere.
“Stakeholder pressure in the U.S. was maybe a little behind Europe, in terms of when it became important to a lot of institutional stakeholders. But they came up the curve quite quickly,” Archibald said. “If you’re a private equity sponsor and you own a private company, then you are going to have to actually drive change at those portfolio companies. Because your stakeholders are demanding those types of considerations before they invest.”
Climate change is highly complicated, and so is measuring a company’s environmental impact. Since the EU implemented its SFDR framework earlier this year, Pitts-Tucker said it has become clear that the corporate world has a long way to go before it is able to standardize the sorts of disclosures that investors and regulators are calling for.
“The reality is, if a company goes and asks 10 different carbon footprint companies to calculate its carbon footprint, it will probably end up with 10 pretty varied numbers,” he said. “The problem is, there’s a huge amount of subjectivity.”
At this point, then, don’t expect the SEC to come in with a heavy hand. The process of incorporating environmental issues into standard public disclosures will likely be a gradual one, with the SEC working alongside companies to establish the new norms rather than piling on immediate punishment.
“What’s enforcement going to look like? At some point, there’s no way companies and funds are going to be able to mark their own homework, so at some point I have no doubt that there will be a requirement for third-party auditing. But we’re not there yet,” Pitts-Tucker said. “If [the SEC] come in Day One and say, this is how it works, this is what you’re going to do, the problem is, you’re going to have a huge number of breaches.”
Some companies and investors believe that the calls for new disclosures are overkill. Their impact on climate change is so small, the thinking goes, that it isn’t worth the substantial time and effort that will go into tracking emissions and other variables related to sustainability. Those of this mindset think these new requirements will create a boatload of extra work with minimal real-world impact.
What does Pitts-Tucker have to say to firms engaged in that line of thinking? Take it up with your LPs.
“Without a doubt, there are still funds which simply don’t believe that the companies they invest in have enough material impact on climate change to warrant this potentially huge amount of data collecting burden,” he said. “Our response to those is, everyone has a responsibility, and your LPs are going to start looking at you even if you are in a sector that you don’t view as climate-sensitive. They are going to start asking you to disclose information, so you better get used to it.”