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How do we address the tragedy of the horizon?

June 13, 2022 Patrick Corr

In 2015, at a speech presented at the headquarters of British insurer Lloyd’s of London, Mark Carney, then the president of The Bank of England and chair of the G20’s Financial Stability Board (FSB), introduced a concept he called the “tragedy of the horizon.” He drew on the classic economic problem called the “tragedy of the commons,” which describes the tendency of those with access to a public (or “common”) resource to deplete that resource to the detriment of all. Similarly, the tragedy of the horizon describes the challenge of climate change – that its worst impacts will take place long after most of us are gone. As Carney put it:

“We don’t need an army of actuaries to tell us that the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix.”

Two months later, Carney led FSB’s efforts to create the Task Force on Climate-Related Financial Disclosure (TFCD), which went on to establish a list of environmental performance metrics publicly traded companies should be required to disclose to their current and potential investors. Making such data public, the TFCD argues, will give longer-term investors the knowledge needed to make informed decisions that factor in risks that could impact their bottom lines beyond their financial horizons – and potentially push them to turn toward companies whose operational decisions factored climate change into their business plans.

Translating words into action

TFCD’s work became the bedrock for rules proposed in March by the U.S. Securities and Exchange Commission (SEC) that would require U.S.-registered companies to include a number of climate and greenhouse-gas-related disclosures in their federal filings and public reports. Here are the highlights of what corporations would need to report in their registrations and periodic reports:

  • Climate-related risks facing the company and their actual or likely impacts on business strategy and outlook
  • How the company is assessing and managing those risks and whether those processes are tied into overall risk management approaches
  • Specifics on the greenhouse gas emissions related to the company’s operations, including:
    • Scope 1 emissions related to the company’s own manufacturing processes and other operations
    • Scope 2 emissions related to the energy the company purchases for those operations
    • Scope 3 emissions produced by its suppliers and by customers in their use of the company’s products. This reporting requirement is targeted toward those companies for which these emissions could be considered “material” (this is a bit vague) and those that have set greenhouse gas reduction targets that include Scope 3 emissions.

Also, if the company has set public climate-related targets or goals, they’d need to report:

  • What activities and emissions are included and the timeline for reaching the target
  • How the target is going to be reached
  • Relevant data indicating whether progress is being made toward the target and how that progress has been made
  • Whether carbon offsets or renewable energy certificates are a part of these emissions-reduction plans

Why rules are needed

Critics of the SEC’s proposal note that many companies are already making similar disclosures and that compliance would be both too difficult and too expensive for some companies to meet. Also, with many companies already making such disclosures, won’t market demand eventually push voluntary reporting over time?

The expense of the rules is a fact. The SEC estimates the plan would add an ongoing $420,000 annually, on average, to the cost for SEC rules compliance for a small publicly-traded company and $530,00 for a larger one. The need to put new data-collection and reporting systems in place would push first-year costs higher for those firms not already collecting and reporting this information.

However, the costs to investors for not having assurance the information companies are supplying voluntarily is accurate and comparable across companies and sectors could be, collectively, much higher. Several financial services companies have recently been hit with charges of “greenwashing” – that is, overhyping the environmental, social, and governance performance of companies in the portfolios of funds they sell. And in May, the Dutch airline KLM was sued by a Dutch environmental group on claims the company’s advertising misled consumers regarding the business’s long-term sustainability.

SEC Proposal’s future

The SEC’s initial public comment period deadline for its proposed reporting rules of May 20 has been extended to June 17. As of mid-May, the agency said it had received thousands of comments from a broad range of investors, climate activists, industry groups, and others. While the SEC says it has plans to put the new rules into place over the next two fiscal years, lawsuits could force delays in that schedule.

So, it could still be some time before real moves are made to supply investors with the information they need to make sound business decisions that consider the ultimate impact of current business practices on the planet’s environment and their own bottom lines years from now. But, as I said in a previous blog post, the fact that this issue has come to the fore for U.S. financial regulators provides hope that we might finally be addressing Carney’s tragedy of the horizon.