The sustainability surf is up in California
A state, where climate change is all too real, steps up
NOTE: I am not a lawyer, so make sure you read these regulations and consult with an expert!
While we’ve been dealing with an alphabet soup of consolidating ESG standards and frameworks for the past few years, three have captured the world’s attention: the SEC’s proposed climate draft, the EU’s Corporate Sustainability Reporting Directive (CSRD), and the International Sustainability Standards Board (ISSB)’s framework. The EU signed CSRD late last year, and the ISSB announced its framework and guidance this summer. The SEC hasn’t moved yet beyond the draft, with rumors pointing to a December release. All lead with helping companies create comparable data, an idea born out of ESG’s original intention of comparable investor-grade data.
Meanwhile, California has been ramping up ESG regulation and action, which it is currently unleashing on the world. Before jumping into what California is doing, it is essential to ask why. Climate risk is a problem everywhere, but California, the world’s fifth-largest economy, has some specific issues. Let’s begin with numbers from climate.gov.
In four of the last six years (2017, 2018, 2020 and 2021), California has experienced historically large and costly wildfires with losses well exceeding $65.0 billion.
Scientists are convinced of a link between this recent increase in wildfire scope and climate change and that it will only worsen over time. The physical damage from wildfires isn’t the only problem, as air quality and health are also impacted. Of late, insurers have pulled out of some states due to these increasing risks.
Still, wildfires aren’t the sole climate risk for the state. Rising sea levels and flooding could cause $100B of damage annually by 2100, with impacts felt as soon as 2040 (Scientific American). In January 2023, an ‘atmospheric river’ dumped a ton of rain on the state. Events like these significantly impact California and the US, as 16.9% of goods for the country pass through the state.
California finds itself in the same situation as many companies. The impact of climate change is looking to wreak havoc, not only on the company’s physical assets but also on its logistics and value chain. While the cost may not be $100B annually for any singular company, it could nonetheless be highly disruptive and costly.
And so, there are two things that governments worried about climate change can do. First, they can initiate an adaptation strategy for immediate and near-term issues. Second, they can start mitigating the effects of climate change directly and through its influence. Last year, California announced a Climate Adaptation Strategy that will be refreshed every three years. Its first report, outlining the progress of its six pillars and 350+ metrics, is available online.
But, in the last few weeks, California has focused on mitigation across several areas.
Litigation
Last week, I wrote about litigation out of California against five of the top fossil fuel companies globally for knowingly downplaying the effects of climate change. Litigation is just one tool to try and influence change, albeit a powerful one. One of the asks goes right after mitigation:
Prohibit oil companies from engaging in further pollution and destruction of California communities and natural resource
California is willing to take the lead to try and hold companies accountable.
Legislation
But there’s also been legislation as well. Two related climate bills passed the legislature the week of September 11th, which the Governor has agreed to sign.
SB 253 - Climate Corporate Data Accountability Act (link)
If you are a company that heeded the warnings to start getting your carbon accounting in order as those previous drafts were being discussed, this one is for you. If not, you best begin soon.
Companies formed anywhere in the US doing business in the state with revenues over $1B need to start disclosing their emissions, aligned to the GHG Protocol, as early as 2026. What’s interesting is this note:
The bill would require, in preparing the report, consideration to be given to, at a minimum, greenhouse gas emissions from reporting entities in the context of state greenhouse gas emissions reduction and climate goals.
This note reinforces that measuring isn’t solely about the reporting and compliance but the reductions and improvements.
There’s more to the bill, but it can be easy to overlook what isn’t explicitly said, namely the legislature’s influence on companies operating in California through their value chain. Since California’s economy is so large, many suppliers will get calls.
SB 262 - Greenhouse gases: climate-related financial risk (link)
This one is a little more interesting, asking companies formed anywhere in the US with revenues over $500M and operating in California to disclose their climate-related risk regarding transition and physical risks, which could result in financial risk.
As opposed to SB 253, which sits squarely in mitigation, SB 262 is a little bit of both. This bill appears to be the state mitigating its risks by requesting companies adapt to climate risk.
The word ‘financial’ appears 47 times in the bill, while ‘investors’ appears twice. Remember, the SEC, EU CSRD, and ISSB are focused on comparable data for investors. Here, the goal is more aligned with California’s resiliency.
Failure of economic actors to adequately plan for and adapt to climate-related risks to their businesses and to the economy will result in significant harm to California, residents, and investors, in particular to financially vulnerable Californians who are employed by, live in communities reliant on, or have invested in or obtained financing from these institutions.
Data isn’t the goal; the state is trying to prevent harm.
This is a crucial callout for companies. Today, reporting is focused on compliance, stakeholder communications, and comparable and consistent investor data. If a company collects and reports this information solely for external stakeholder analysis without leveraging it to improve, it will not mitigate risk and create risks for those in its value chain.
Investment
There is one bill that hasn’t passed as yet but will come up again next year.
SB 252 - Public retirement systems: fossil fuels: divestment (link)
While some conservative states have introduced bills to prohibit ESG as a consideration from state pensions, this bill would prohibit CalPERS and CalSTRS, the state’s Public Employee’s and Teacher’s pensions, from investing in fossil fuels. While the bill links climate change to fossil fuel production and its use, it does not call out what the other two bills do - the link between climate change and California’s risks.
Even without this bill passed, it isn’t unprecedented for California pension funds to divest from industries that materially impact the state or its pensioners. For example, CalPERS hasn’t invested in tobacco since 2001. While this move is punitive in the short term, other investors may pick up the slack, achieving little.
Another challenge is that investors lose the ability to influence when they divest. And so, investment is yet another tool in California’s box that it can currently wield to accelerate a transition, and they are using it. Last May, CalSTRS voted with most Exxon shareholders, calling on the company to audit the financial impact of a net zero economy.
A multifaceted approach with one key difference
California appears to cover several bases here, including working with major insurers to raise costs to cover insurance risk through new policies. But the one thing to take away, over everything else, is that they are leading with the right problem and, therefore, might get the right solution.
Many regulations are leading with gaining comparable data for investors so that those banks and investment firms can allocate capital accordingly. Ultimately, we will have comparable data and banks that do something. Granted, financing is a vital part of driving change.
Still, by leading with the problem here, California may achieve the goal we should all drive to - long-term emissions reduction, lowering everyone’s risks.
The question companies need to ask is, what will I do with this data today? If the answer is only reporting, then you might find your value chain will recognize the risk you represent and seek out others.