SEC’s climate risk disclosure rules to drive risk mgmt & transfer spend

As the US Securities & Exchange Commission (SEC) publishes a new set of proposed rules on climate risk disclosure, it’s becoming increasingly clear regulating for climate risk reporting is going to drive risk management and risk transfer spend, with ramifications and opportunity for insurance, reinsurance and insurance-linked securities (ILS).

Yesterday, the SEC published its proposals, saying that registrants will need to “include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements.”

The benefits to investors are clear, as climate related disclosure from corporations and other entities will help climate-appropriate investment decisions be made.

“I am pleased to support today’s proposal because, if adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers,” SEC Chair Gary Gensler explained. “Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions.

“Today’s proposal would help issuers more efficiently and effectively disclose these risks and meet investor demand, as many issuers already seek to do. Companies and investors alike would benefit from the clear rules of the road proposed in this release. I believe the SEC has a role to play when there’s this level of demand for consistent and comparable information that may affect financial performance. Today’s proposal thus is driven by the needs of investors and issuers.”

Analysts expect such rules will result in the development of significant revenues for consultants, accountants, compliance, data service providers and also insurance companies.

The reason being that, climate risk disclosure is expected to lead directly to better climate risk management and as a result more climate related risk transfer, or hedging, is expected to be required.

But, there’s one area of the regulation that is particularly relevant to the insurance-linked securities (ILS) market and that is where the SEC states that the proposed rules would require a registrant to disclose:

“The impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as the financial estimates and assumptions used in the financial statements.”

The disclosure of climate risk more broadly is expected to drive a massive shift in US markets, both in the process of disclosure itself and what that means for business strategies.

But it could be even more significant in how entities manage their climate risk exposure better over time, furnished with information and in order to align incentives, as well as how their counterparties use their disclosure information.

As part of the regulated disclosures, registrants are going to have to explain how they identify, assess and manage disclosed climate risk related items, which it seems will include severe weather and natural events (catastrophes) as well.

While this may boil down to a simple acknowledgement and explanation of the insurance an entity has in place, it also means they are going to have to make much clearer their exposure levels, which should trigger internal risk management processes, that ultimately may drive greater uptake of risk transfer, hedging, insurance and all kinds of alternatives (perhaps ILS as well).

Which takes us back to some of our very early discussions of climate risk disclosure and the need for it to be robust and encompass volatile risks such as weather.

Back in 2014, when a lot of the work that ultimately became the TCFD’s began, the goal was to press for globally active corporations and entites to report their 1-in-100 climate and natural disaster exposures on their balance-sheets. A move that would have significant ramifications for the insurance, reinsurance and ILS world.

Natural disaster gradually became less of a focus in these discussions, but it is encouraging to see this still mentioned in the SEC’s proposal.

It’s easy to see why the focus shifted onto pure climate risk disclosure, given the priority given to reducing warming and other climate impacts.

But it is still important to see globally active entities taking responsibility for the exposures embedded in their operations, assets, supply-chains and businesses, to protect their employees, the communities they operate in and serve, as well as to ensure resilience within global systems.

Climate risk is deeply embedded in so many asset classes and types, which are going to require increased financial protection and hedging tools in years to come, especially as they disclose these risks to their investors and stakeholders, and particularly if forecasts for climate change related impacts are accurate.

As a result, we expect spend on protection will rise, alongside disclosure and efforts to manage its impacts on balance-sheets.

As insurance, reinsurance and the ILS market, as well as catastrophe bonds, have significant roles to play here, the fact the SEC continues to call for disclosure of relevant natural peril risks is encouraging.

We’ve written numerous times about the opportunities ILS players have to assist asset owners and holders to carve out climate related exposure from their portfolios of physical and financial assets, or supply-chains.

This should all get the wave of parametric specialists and insurtech’s with that kind of focus excited too, as there is going to be a wave of demand for new risk transfer and hedging solutions which, powered by the data delivered through disclosure, are only going to become increasingly responsive and sensitive to their users needs.