On June 26, 2009, when the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009, it set the stage for changes that could have a direct effect on corporate financial results. The Act has now moved to the Senate, where it could face significant hurdles. But strong White House support for the initiative and pressures from looming regulatory changes suggest that some form of climate related requirements will ultimately be enacted, with significant implications for companies’ carbon-related risk disclosures.
As reflected in a July 8, 2009 CFO.com article entitled "Clearing the Air on Carbon Disclosures" (here), the cap and trade system currently under Congressional consideration "contains the makings of a new asset class for affected companies" in the form of carbon emissions allowances. The likely corporate trading in these allowances could have a material effect on reported financial results – the CFO.com article cites analyses suggesting that carbon costs "could depress earnings before interest, taxes, depreciation and amortization by 5.5% for the S&P 500."
These potential financial impacts will, as the article comments, "likely cause investors to demand more information about carbon-related risk."
According to a June 2009 report from PricewaterhouseCoopers Transaction Services Division entitled "Capitalizing on a Climate of Change" (here), as the financial impacts of climate change issues rise, "investors, stakeholders and regulators will demand greater transparency and comparability of companies’ financial information."
As reflected in M&A examples cited in the PwC report, this process is already well underway. The report refers to Porsche’s recent bid to acquire a majority stake in Volkswagen, which, the report claims, was motivated in part by Porsche’s desire to "offset its fleet’s high emissions with the more efficient and low emissions VW line."
The PwC report suggests that "climate change considerations will likely be a key consideration in M&A activity" and that in more and more deals, "the potential impacts of climate change on earnings, cash flow, and target valuation, as well as any opportunities for cost reduction through synergies, will have to be thoroughly evaluated."
The likelihood that these kinds of considerations will become increasingly critical does not depend alone on whether or not Congress ultimately enacts a climate change bill; regulatory developments at the EPA and elsewhere could drive climate change related mandates, as disclosed at greater length in a prior post, here. Indeed, the likelihood that regulators will act if Congress does not is one of the strongest motivations for Congress to find a way to put something together rather than to cede field to regulators.
According to the PwC report, in light of these considerations, "companies should begin planning today for the elevated status this issue now commands." Climate change issues are likely to become increasingly material, and companies that fail to adapt could risk "penalties, less profitability and damaged reputations." as well as "missed opportunities for growth."
The disclosure-centered nature of many of these potential risks creates a context within which litigation could well arise. To cite one example from the PwC report, investors may become increasingly attentive to M&A-related climate change exposures, the presence or absence of which could significantly affect deal valuations. Whenever there is an opportunity for investors to later contend they were misled or not fully informed, there is a danger of possible litigation.
The current predominance of issues relating to the global financial crisis may make these climate change related issues seem relatively remote and unimportant. But the possibility of claims based on carbon-related disclosures is only a matter of when, not if.
For that reason, in my view, the constituencies that will be scrutinizing carbon-related disclosures includes not only investors and regulators, but will also include D&O underwriters. As best practices in this area develop, D&O underwriters will necessarily develop their own sense of what disclosure practices suffice. Just as there are risks for companies that fail to adapt to the climate change related issues, there will be risks for D&O underwriters as well.