Don’t Worry, Newly Proposed SEC Climate Change Rules Could Boost Your ERM Strategy. Here’s How

The SEC maneuvered ESG factors further into the risk category with its recently proposed rule.
By: and | April 22, 2022

The SEC maneuvered ESG factors further into the risk category with its recently proposed rule: “Enhancement and Standardization of Climate-Related Disclosures for Investors.”

Material consequences of these rules include:

  • Risk: Risks to a business from climate change are material and must be disclosed;
  • Risk Management: Managing risks to a business from climate change is prudent, material and must be disclosed;
  • Risk Management Investment: Costs of compliance, including audit, risk disclosure, risk management process development and disclosures, are currently projected by SEC to cost $4.3 billion collectively.

Unfortunately, the return on investment for this new $4.3 billion compliance cost is zero.

Risk management professionals in firms that file 10-Ks or are pre-IPO may view the SEC’s proposed rule as an expensive, irritating new compliance challenge in line with recent OCC and FDIC rules.

But it also presents an opportunity.

Risk managers can seize this moment to augment ERM into a disclosable ESG solution that can boost enterprise value and generate a material ROI. This could actually be the greatest high-profile opportunity for risk managers to add value to their company since the surge in D&O liability in the 1980s.

Understanding the SEC’s Stance

First, some context.

Nir Kossovsky, chief executive officer, Steel City Re

The prevailing arguments in favor of these new rules are that investors need access to reliable information about firms’ exposures to climate changes so that they can make better investment and voting decisions.

But in reality, current rules already require companies to disclose all environmental stewardship, social justice and dutiful governance (ESG) risks that may be material to a business’ prospects.

The quantifiability of carbon, greenhouse gasses, etc., made climate the first of the three ESG pillars to be subjected to disclosure rules that are enforced through securities and derivative litigation.

This quantitative bias favoring climate began surfacing in 2005, when the spectrum of “extra-financial information” that underpinned reputation value began to take form.

Marketers packaged the reputation-enhancing features into stories of corporate social responsibility. The risk community stuck with the term “reputation” and crowned it “the risk of risks.”

At this very moment, most companies are mobilizing the compliance arms of their legal departments to develop strategies that will meet the demands of these new regulations, while minimizing the risks to boards of being second guessed and falling prey to litigation.

To put this risk in high relief, when things go wrong everything will be proof of greenwashing, and greenwashing is securities fraud.

Now, the SEC is putting its thumb on the risk side of the scale with respect to climate, but it’s hard to imagine them stopping there. ESG comprises an array of activities, from diverse hiring practices, to serving disadvantaged communities, to supporting developing countries.

Eventually, the SEC, following in the footsteps of the European Commission, is bound to propose rules requiring formal disclosures of other ESG eligible activities and risk managers need to be prepared.

The Risk Manager’s Role

There are several ways risk managers can materially contribute.

First, they should work with their legal departments to set up validated risk management processes. The reputation risk management framework should weave what we call a “reputation leadership team” of enterprise leaders into the overall risk management structure.

Denise Williamee, vice president of corporate services, Steel City Re

Then, strategic ESG and reputation insurances should be obtained to authenticate the quality of the risk disclosures, risk management processes and risk governance. The insurances will protect the board strategically just as did D&O insurance in the 1980s.

The final step?

Rather than surrendering some of their CSR budget to compliance, the marketing department should repurpose it to publicize this newly-minted risk management apparatus.

By enabling all stakeholders to appreciate and value risk management, they can magnify the equity boosting value of the entire enterprise reputation risk governance and management effort.

These moves will provide what compliance with the rules alone will not: ROI.

Our firm recently reported that companies with ESG and reputational risk protection strategies have seen their stock prices rise 5% above the market within two weeks of a reputational challenge, and that premium nearly doubling for companies that have publicly shared and validated those strategies.

We also found that stock prices of firms that managed, validated and publicized ESG and reputation risk management strategies on average gained 9.3% over the subsequent seven months after a reputation-challenging event.

This was persistent over 35 years with respect to the mission-critical process that underpinned a firm’s reputation.

Firms in which such risk management processes were assumed by shareholders to be in place gained 4.3% on average.

Companies that failed to institute, validate and communicate risk management strategies lost 13.2% of their stock value over those seven-month periods, and they underperformed their peers by an average of 23.3%.

Some examples:

  • Johnson & Johnson (NYSE:JNJ) outperformed the market by 16% ($1.7 billion) when its much publicized strategic supply chain security and product safety processes were proven effective in 1986.
  • PNC Financial Services Group Inc. (NYSE:PNC) outperformed the market by 32% ($3.9 billion) when its risk management process protected it from taking part in the mortgage derivatives market in 2008.
  • Rolls Royce (OTCMKTS: RYCEY), whose board defined its risk governance mission as protecting the reputation, viability, and profitability of the firm, outperformed the market by 14.9% ($3.4 billion) after it proved the quality of its safety controls throughout its supply chain in 2011.
  • CVS (NYSE:CVS) outperformed the market by 9.3% ($8.6 billion) when, anticipating the ESG movement, it pursued shunned tobacco products in 2014. It outperformed rivals Walgreens (NYSE:WBA) and Rite Aid (NYSE:RAD) by 16.6% and 24.8% respectively.
  • Apollo Global Management (NYSE:APO) outperformed the market by 16.6% ($1.9 billion) after it announced an ESG-focused governance reorganization and presented in 2021 and independent validation of a 3-year investment in reputation risk management.
  • Apple (NADQ:AAPL) outperformed the market by 24% ($505 billion) after introducing innovative ethical privacy features that addressed a critical ESG concern in the technology sector in 2021. It outperformed Meta (NYSE:FB), facing a range of privacy challenges, by 34.9%.

Firms that embrace the new SEC disclosures in the context of compliance will enhance shareholders’ investment and voting decisions. Companies whose sophisticated risk managers seize this opportunity to upgrade their enterprise reputation risk governance and management processes will enhance shareholder wealth.

That’s something every board, C-suite and colleague can appreciate. &

Nir Kossovsky is CEO of Steel City Re, which mitigates the hazards of reputation risk with parametric reputation insurances, ESG insurances, and risk management advisory services. Denise Williamee is Steel City Re's Vice President of Corporate Services, where she heads client relations and education for reputation leadership teams.

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