The Role of the Securities Industry in Climate Change

The fossil fuel and timber industries, two of the leading drivers of climate change, have been able to operate and expand in part by issuing securities.

Despite the imperative to prepare for a low-carbon economy, fossil fuel companies have continued to incentivize growth and spend billions on exploration and production. Meanwhile, companies involved in forest-risk commodity supply chains continue to fund activities that put tropical forests essential to the climate at risk. These companies have been able to operate and expand in part by issuing securities, which allow them to raise capital.

While fossil fuel companies and deforestation-linked companies are the primary drivers of the climate crisis, the companies in these industries ultimately depend on banks and other financial institutions to buy and underwrite their securities. As such, these and other institutions serve as professional enablers for the industries fueling climate change.

Publicly-listed banks issue their own stock, but they also play a broader role in securities markets. Investment banks help companies issue new stocks and facilitate debt financing by helping companies find investors for corporate bonds. Investment banks evaluate the risk and assess the price of securities, buy or “underwrite” them, and then sell them to investors in the securities market.

Banks are also involved with the securities market through the sponsorship or indirect issuing of asset-backed securities. Banks provide loans and, through a process called securitization, bundle loans to create securities backed by those assets, known as asset-backed securities. Securities backed by mortgages are known as mortgage-backed securities.

Through loans and underwriting services, banks provide the financing necessary for fossil fuel companies to survive and expand. In the five years since the Paris Agreement was signed, the world’s 60 largest commercial banks have provided more than USD 3.8 trillion for fossil fuels through lending and underwriting. Through loans and underwriting, banks also provided at least USD 154 billion in financing for commodity groups linked to deforestation.

Asset managers like BlackRock and Vanguard, and the asset management arms of banks, are another crucial set of financial institutions. Asset managers help large institutional investors, such as corporations or pension funds, manage and invest their money. By buying securities, asset managers have significant influence in the securities market, and asset managers are the world’s largest investors in fossil fuels. In 2019, the three largest asset managers had a combined USD 300 billion investment in fossil fuels. Between 2016 and 2018, the largest asset managers increased their investment in fossil fuels by 20%.

Asset managers also invest heavily in the commodities driving deforestation. In 2020, the three biggest asset managers held USD 12 billion in investments in agribusiness companies linked to deforestation.

Fossil fuel and deforestation-linked companies also depend on insurance companies, not just to provide insurance but also as major investors. After asset managers, insurance companies are the second largest institutional investors in fossil fuels. In 2016, the 40 largest U.S. insurance companies owned investments worth USD 221 in oil and gas sector and almost USD 2 billion in coal companies.

Together, these industries form a robust securities market that enables fossil fuel and deforestation-linked companies to operate and expand – regardless of the climate consequences.

Climate Risk and U.S. Securities Law

To ensure that investors have access to accurate information, the U.S. Securities and Exchange Commission regulates the sale of securities and oversees securities issuers and those who sell and trade securities, including broker-dealers, investment advisers, and exchanges. There are also state-level securities laws and securities regulators. The Commodity Futures Trading Commission (CFTC) also regulates derivates such as commodity futures and options.

U.S. federal securities laws apply to all companies that raise capital from U.S. investors, which can include private companies. These laws also have broad extraterritorial application. In 2010, the Dodd-Frank Act amended the Securities Act of 1933 and the Securities Exchange Act of 1934 to provide federal district courts with jurisdiction over actions brought by the SEC or the Department of Justice for violations of securities laws involving either: “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside of the United States and involves only foreign investors” or “conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”

U.S. federal securities laws requires companies to file information with the SEC about themselves, the securities, and the offer, and to regularly report information about their business operations, financial conditions, and management. Companies can violate federal securities law is by using false or misleading disclosures to investors related to the sale of a security. Other securities law violations include market manipulation, insider trading, and breach of fiduciary duty.

Currently, securities issuers must disclose climate related risks if such risks are material to investors. In 2010, the SEC issued guidance to assist publicly traded companies in satisfying their disclosure obligations regarding climate change. The SEC provided examples of climate-related risks that a publicly traded company would need to report if they were material, including the physical effects of climate-related events such as severe weather.

Companies are currently not required to explicitly disclose specific climate-related information, and this lack of specific disclosure requirements could leave investors unaware of new risks.

As the world seeks to meet the goals of the Paris Agreement, companies and financial institutions invested in carbon-intensive assets will face “transition risks,” losses due to changes in law, policy, technology and markets related to the transition to a low-carbon economy. As climate change intensifies, a wide range of assets will also be impacted by “physical risks” from rising seas, intensified heat, droughts, floods, storms, and wildfires, and other physical impacts of climate change.

Without adequate disclosure requirements for publicly-listed companies on climate-related risks, companies could deceptively hide these risks from investors, regulators, and the public. In July 2020, NWC released a report, Exposing the Ticking Time Bomb, detailing deception regarding climate-related transition and physical risks by fossil fuel companies, most of which are publicly-traded in U.S. and international securities markets.

By failing to account for climate change, the report found that fossil fuel companies could be overstating the value of their assets, understating their environmental liabilities, understating physical risks to infrastructure, and thus failing to disclose the risks to the global financial system.

As the report describes, the failure to disclose climate risks could take place not just at fossil fuel or deforestation-linked companies but also at publicly-listed banks and other financial institutions. Banks could mislead investors and regulators about the level of exposure to climate-related risks in their lending portfolios. A failure to fully account for climate risks could also lead financial institutions to underprice risk in asset-backed and mortgage-backed securities. These risks could affect not just individual companies but the entire financial system.

Significant risks across the financial sector could have ripple effects that turn climate change into a systemic risk that threatens the stability of financial markets.  While fossil fuel use and deforestation are the primary drivers of the climate crisis, fossil fuel companies and deforestation-linked companies ultimately depend on banks and other financial institutions to provide them loans, buy their stocks, and underwrite their expansion. As Bill McKibben explained in the New Yorker, “money is the oxygen on which the fire of global warming burns.

The Current State of Disclosure Requirements

Europe has been leading the way on mandatory risk disclosures to date. The European Union’s new Sustainable Finance Disclosure Regulation requires fund managers, financial advisers and certain other regulated firms to disclose information on environmental, social or governance considerations to potential investors and on their websites. This will go into effect in March 2021. The United Kingdom’s Financial Conduct Authority announced mandatory climate-related financial disclosures consistent with the TCFD recommendations, which are applicable to accounting periods starting with January 1, 2021.

On climate risk regulation, in recent years the U.S. appeared to be falling behind. In an August 2020 letter, Senator Elizabeth Warren wrote to the SEC, stating that “investors and the public currently lack sufficient information about the threats of the climate crisis on their investments, though the risks to our economy posed by the climate crisis continue to grow.” Citing NWC’s climate risk report, she highlighted the risk of fraud and urged the SEC to require public companies to disclose information about their climate-related risks.

In September 2020, Commodity Futures Trading Commission published a widely praised report encouraging financial regulators to consider the risks that climate change poses to the U.S. financial system. One of the report’s key findings is that improved company disclosure of information on material, climate-related financial risks is an “essential building block” to any program addressing the threat to the financial climate.

In a statement about the CFTC report, Senator Brian Schatz called the report a “wake-up call,” and said that “We need the Federal Reserve, the SEC, and our other regulatory agencies to immediately move forward with the recommendations in this report – including climate risk stress testing and mandatory public company disclosures of climate risks and emissions.”

The SEC has recently signaled that it will increasingly focus on climate risks. On March 4, 2021, the SEC announced the creation of a Climate and Environmental, Social, and Governance (ESG) Task Force in the Division of Enforcement in order to develop initiatives to identify misconduct in issuers’ disclosures of climate risk and ESG information. Notably, the SEC emphasized that it would be relying on whistleblowers in identifying material gaps and misstatements in these disclosures. The National Whistleblower Center (NWC) strongly supports the creation of this task force. As part of this process, on March 15th the SEC announced a 90-day public comment period on climate change disclosure, requesting information from investors, registrants, and other market participants.

You can learn more about the work that NWC is doing to strengthen disclosure requirements here.

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