An environment of risk

In 2004, more than two years before Al Gore’s ‘An Inconvenient Truth’ hit movie theatres nationwide, Cinergy, now part of Duke Energy dedicated its annual report to the topic of climate change. John Stowell, Duke’s vice president for environmental policy emphasizes that this Fortune 500 energy company has always let the world know what’s afoot. ‘It runs in our DNA to disclose as much as we possibly can and to let the sunshine in,’ he says.

Three years ago, were investors clamoring for climate change disclosure? Not necessarily, but Cinergy/Duke views its role as partly educational. ‘We wanted to get everyone ready for the debate that was to come, to assure them we had a handle on this, a strategy, and a business plan,’ says Stowell.

Environmental risk has been a topic on companies’ radar since the early days of Superfund liability. But as the whole concept of disclosure has taken firmer root in corporate America, companies have begun publishing everything from sustainability reports to highly focused issue papers and MD&As that forthrightly confront environmental risk. This year, the topic assumed center stage as companies began to grapple with the risks – real and projected – of global warming.

‘Clearly, climate change has captured the public eye,’ says Jeff Smith, head of the environmental practice group at Cravath, Swaine & Moore. ‘It takes a catalytic-type event to move things along and create a sense of urgency. And something like climate change tends to scare people looking over the 20-year time horizon. It involves the potential shattering of a lot of financial and life expectations.’

Steven Humphreys, special counsel at Kelley, Drye & Warren agrees: ‘Every now and then you have watershed developments in law or society that give rise to a heightened level of concern, and global warming is a good example. It’s creating future regulatory uncertainty and potential liability.’

Half empty or half full?

This proxy season 45 companies faced resolutions concerning energy efficiency and climate change, according to Ceres, a national coalition of investors and environmental groups addressing sustainability challenges like global warming. Among the targets were ExxonMobil (with two global warming resolutions); Ultra Petroleum; General Motors; Bed, Bath and Beyond; Centex Corporation; and Kroger. Although the requests differ, better disclosure was a common thread.

On an issue like environmental disclosure, it’s often difficult to determine whether the glass is half empty or half full. No question, disclosure has improved. But while Smith contends that more companies than ever before are putting their environmental risks through rigorous controls processes and airing these risks more publicly, others say that current disclosure falls far short of the ideal.

In a January 2007 report commissioned by Ceres and Calvert entitled ‘Climate Risk Disclosure by the S&P 500,’ the authors reached the ‘overwhelming conclusion … that disclosure practices among the nation’s 500 largest companies are severely lacking.’ Nearly a third of respondents declined to share their answers with all investors, and most fail to meet the standards of the Global Framework for Climate Risk Disclosure, which is a statement of investors’ expectations for corporate environmental disclosure.

Worse still, the report finds that American companies are well behind their foreign counterparts in climate risk disclosure. For instance, only 47 percent of the S&P 500 completed the Carbon Disclosure Project (CDP) questionnaire, relative to 72 percent among the FT 500.

Of the S&P 500 companies that did respond, disclosure varied greatly by topic. For instance, 82 percent discussed actions taken to reduce, offset or limit greenhouse gas emissions; 72 percent described some level of risks and/or opportunities; and 57 percent disclosed information regarding corporate governance of climate change. But only 36 percent disclosed details of an emissions trading strategy, 26 percent disclosed specific emissions reduction targets and timeframes, and 16 percent described their responsibility with regard to addressing climate change.

What to disclose?

The SEC has always shown ‘a special solicitude’ toward environmental liabilities because they’re often considered ‘the ultimate, unknowable contingent risk,’ says Smith. ‘There’s a lurking sense that environmental problems create the sort of
surprise for investors that the SEC was invented to avoid.’ What’s more, he makes note that several parts of Regulation S-K specifically address environmental disclosure, setting much lower bars here than elsewhere. 

Carbon constraints are not the only risk that companies face in a world that’s heating up. Miranda Anderson, vice president for investor analysis at David Gardiner & Associates, an energy and climate consulting firm based in Washington, DC, observes that losses from weather events – almost certainly caused or exacerbated by climate change – have already been widely disclosed.

‘If you look at the securities filings of the S&P 100 in 2005 after the hurricane season, you’ll see that companies in nearly every industry took significant, below-the-line write-offs for losses or damages to operations or sales because customers left their market or because of damages to infrastructure,’ she says. For instance, JP Morgan Chase reported a $400 million special provision related to hurricanes in the third quarter of 2005, and BellSouth suffered over $100 million in losses from hurricane-related damage.

Ideally, investors would like to see companies view ‘changes in weather patterns as a longer-term strategic issue,’ rather than taking a one-time write-off after a catastrophe, says Anderson. ‘The corporate law of physics is that what gets measured gets managed,’ she continues, adding: ‘Investors have found that companies examining the impact of climate change on their profitability and competitiveness are more likely to be managing those risks and opportunities than companies that are not.’

Arguably, management foresight in environmental disclosure extends to other areas as well. Anderson therefore emphasizes the importance of providing specific data concerning the environment with clear timelines. ‘Investors need the same kind of quantitative data when it comes to climate change as they do when they’re looking for sales goals,’ she says.

Anderson recalls that one client divested from Tyco a year before any whiff of scandal because the company was not adequately managing its environmental footprint. If you don’t discuss climate change and other risks, ‘how,’ she asks, ‘do investors know you really have a handle on all of the risks that may exist but not be on the balance sheet?’

New disclosure venues

Today, says Anderson, companies are facing ‘a patchwork quilt of regulation and disclosure mechanisms.’ To bridge the gap, some public yardsticks have emerged that will make disclosure easier. In early May, for instance, 31 states agreed to standardize their climate registries so that companies in high-emitting industries can voluntarily disclose their greenhouse gas emissions more consistently.

Over 1,000 companies worldwide now report their emissions at www.cdproject.net through the Carbon Disclosure Project, a coalition of global investors with more than $41 trillion in assets under management. Anderson describes the eye-popping pool of capital controlled by CDP members as ‘a huge market signal to companies that investors need this information to make investment decisions.’

Companies trying to disclose more transparently have two excellent sources, says Anderson. The first is the guidelines developed by the Global Reporting Initiative (GRI), which she calls ‘the global standard for sustainability reporting.’ The second indispensable resource is ‘The Guide to Using the Global Framework for Climate Risk Disclosure’ (www.ceres.org/pub/docs/GuidetoFramework.pdf).

As new avenues for voluntary disclosure emerge, some corporate secretaries are asking: Is it possible to disclose too much, raising red flags that shouldn’t necessarily be publicly flown? Humphreys believes that the amount of disclosure should be determined by what regulators are demanding. ‘Companies don’t want to alarm their investors and chill investment in the company by blowing things out of proportion,’ he says. ‘There’s usually a desire to take a very tailored approach and look at what the obligations are for disclosure, and try to meet those obligations on a case-by-case basis.’

Karin Kane, director of strategic research at Thomson Financial offers a slightly different take,  arguing that disclosure in and of itself is generally well regarded. She does, however, caution against presenting so much information that you overwhelm your audience. ‘If you disclose too much information, it’s impossible for investors to find what is material and what is not. Some companies use the annual report as a data dump and so it’s difficult to find the most relevant information.’

When asked how to determine when an environmental risk scenario warrants disclosure, American Electric Power uses its own internal conversations as a gauge. ‘If management is thinking about these issues and beginning to turn its general thoughts into actions, that’s the time to start talking,’ says Jack Keane, American Electric’s senior vice president, general counsel and corporate secretary.

Where to disclose?

Environmental risk can be disclosed in various places within an annual report or proxy, according to Jim Coburn, program manager at Ceres. Sections dedicated to ‘legal proceedings’ or ‘capital expenditures’ are likely candidates, as is the MD&A.

Smith contends that the MD&A is particularly well suited to explaining ‘risk with a capital R because you can take a long, considered look through management’s eyes and say, Here’s how we see the next three to five years shaping up.’

Often, companies facing environmental resolutions are asked to produce either a sustainability report or a separate document on air quality, climate change or some other environmental issue. Coburn estimates that today half of the S&P 100 companies produce such reports – proof that ‘voluntary reporting has become pretty routine.’ That said the same level of disclosure is significantly less common among smaller companies. In general, he says, only perhaps ten percent of all public companies write sustainability reports.

In 2006 American Electric Power (AEP) highlighted environmental risk in its first ever sustainability/corporate responsibility report, says Keane. Two months after they decided to create the report, the City of New York Office of the Comptroller sent AEP a shareholder proposal requesting just such a written account. ‘I called and said, You’re too late, we already agreed,’ recalls Keane. ‘So the proposal was withdrawn. We didn’t need the stimulus of a shareholder proposal to commit to doing this.’

Finally, stellar disclosure need not necessarily be published. Duke Energy regularly visits with state regulators to discuss climate change and explain the company’s various positions.

And Duke has even begun rolling out a ‘Climate 101 presentation’ to customers and employees. Stowell says that through large group presentations, staff meetings and the corporate intranet, Duke hopes to meet its goal of informing all 20,000 employees by year-end on its climate-change strategy. Duke is also showing a version of the same presentation to large customers: ‘We talk about cost impacts and try to get them to think about what they should be doing in their own businesses to get ready for carbon constraints,’ he explains.

Coburn emphasizes the ‘reputation benefits’ for companies perceived as particularly forthcoming in terms of environmental risk. He also notes that ‘a thoughtful discussion of climate change might easily lead to an explanation of new market opportunities.’ Anderson is also convinced that a nuanced conversation about opportunities has been missing from much of today’s environmental risk disclosure.

Breaking new ground

How adept management is at speaking about environmental risk typically varies by industry. Kane points out that insurers and companies with a large carbon footprint are on the frontlines of the global warming situation and so have been framing these discussions for quite some time. Smith, however, notes that some companies that joined the debate more recently ‘opened the bidding with very robust disclosure.’

Even when companies want to be forthcoming, they often struggle with a lack of regulatory standards and internal confusion as to who should be heading the environmental disclosure charge. One problem is that there’s no single individual – or function – that is specifically responsible for the disclosure of environmental risk. ‘It’s different strokes for different folks,’ says Smith.

At Progress Energy, there’s a board committee dedicated to environmental and health and safety issues, says Caroline Choi, director of energy policy and strategy. In addition, eight-to-ten employees work on environmental risk disclosure.

When it comes to environmental risk disclosure, more is usually better. ‘Be as transparent as possible,’ recommends Kane. ‘We’ve seen that shareholders are not so concerned with what the environmental risk is – they’re more concerned with seeing more transparency.’ She adds, ‘One of our studies has shown that even if shareholders are not necessarily activists, they’re happy to have this information. Even some of the mainstream investors like to see this sort of thing because it presents a more complete picture of the company.’

Smith agrees: ‘The biggest no-no today is to surprise the markets. You want to give signs and indications and all sorts of this twitchy stuff to warn the market as to what’s coming.’

Perhaps more than anything environmental risk disclosure should be designed to convince stakeholders that companies understand the risks they face and are acting appropriately. Smith admires candor and rigorous thinking, noting that he’s most impressed when a company lays out a problem, explains the cause and then presents a strategy without ‘a lot of fluffy optimism.’ He continues, ‘From a straight public relation’s standpoint, you really don’t want to look like a dope who doesn’t get it.’

Duke believes that educating stakeholders will, in the end, pay off. ‘Early on, maybe some investors were wary about what was considered to be our out there position,’ says Stowell. However, he also says that the company made a pragmatic argument that carbon regulation should occur sooner not later so that companies like Duke could then begin constructing for the generation needs that lie ahead – and Wall Street understood. ‘Disclosure isn’t just a nice-guy thing to do,’ Stowell concludes, ‘it’s a real business strategy and it makes a lot of sense.’