The U.S. banking industry has come out strongly against the idea of using bank supervision and disclosure mandates to influence capital allocation or other policies that the industry sees as unrelated. In a June 23 letter to Congress and regulators, the American Bankers Association argued that environmental and social risks are already accounted for under the current rules and bank practices that assess and mitigate all types of risks.

The ABA’s plea came in response to a recent Securities and Exchange Commission proposal to mandate all U.S. companies to measure and disclose publicly both carbon emissions and other climate-related risks that could have a material impact on their businesses.

I agree with the ABA that disclosure rules are not neutral and that targeting corporate behavior with disclosure can often be pernicious and hence requires careful analysis.

But the ABA is wrong as far as climate disclosures are concerned, because greenhouse-gas emissions are an externality with major societal consequences. Given that a carbon tax is at present politically infeasible, greater disclosure is a welcome step in addressing the corporate sector’s role in climate change. The SEC is also right to consider that climate risk can have significant financial implications for companies including banks, and that investors need more data on these risks to make informed investment decisions.

Banks would be among the chief beneficiaries of greater disclosure. For one thing, they would obtain data they need to assess relevant climate risks of their clients and to allocate capital accordingly. In addition, better information on the carbon footprints of firms in portfolios could help banks attract environmentally conscious investors and customers.

In fact, the SEC’s proposal is too cautious in that it applies only to SEC registrants. It would not reach private companies, which rely heavily on bank finance. Thus, banks also require data about private firms in order to allocate capital effectively. Knowing their carbon emissions would help in assessing private firms’ exposures to future climate policies.

Moreover, limiting the mandate to public firms will open up an opportunity for regulatory arbitrage. Not only could private companies emit without consequence, but we could unwittingly encourage the movement of polluting behavior from publicly listed companies to private ones — for example, by going private or by public companies selling heavy carbon-emitting assets to private counterparts. That is why we should also require private companies to report their carbon emissions. It does not matter whether emissions come from private companies or public corporations. Either way, society pays for the associated climate damages.

To be clear, I am proposing that private companies should be required to disclose carbon emissions only, not the broader climate-related risks to their businesses, an extension that would take us further toward financial reporting for private firms, which is a separate matter. The SEC has traditionally shied away from mandating greater transparency for private companies, among other things, because they attract more sophisticated investors, rather than the retail investors whom the SEC is committed to protecting.

Clearly, requiring all but the smallest companies to report their carbon emissions would help us better measure emissions by the corporate sector. Private companies are an increasingly important part of the U.S. economy, and often large and well established. So, exempting them would give us an incomplete picture of the emissions landscape. A disclosure requirement would likely also spur emissions reductions and green innovation. Academic studies conducted for the U.K. and the U.S. estimate that the disclosure mandates for greenhouse-gas emissions led to a reduction in corporate carbon emissions by 8% to 15%.

I also suspect that private companies are more open to disclosing information on their emissions than on their financials. Firm-level carbon-emission data are not very revealing or proprietary. The private companies to which I talk tell me they are much more open to the idea of disclosing information on sustainability and ESG matters than they are willing to report their profits.

The banking sector has a critical role to play in the transition to a lower-carbon economy, considering it supplies much of the external funding to private companies. The capital-allocation decisions taken by financial institutions determine to what extent green investments are able to secure financing, and at what cost. In aggregate, these funding decisions shape the economy. Providing financial institutions with comprehensive data on greenhouse-gas emissions would enable them to consider the carbon footprints of public and private companies in their lending decisions.

In Europe, this idea is used more formally. The European Union has enlisted banks in its efforts to meet the objectives of the Paris agreement and the U.N.’s Sustainable Development Goals. Since banks will play a critical role in steering the transition to a lower-carbon economy, the EU has, for example, mandated a certain proportion of banks’ portfolios to be invested in green activities. These steps go much further than what the SEC is proposing or the disclosure mandate that I envision.

Another important consideration is that disclosures are costly, especially to smaller private firms or banks, so the smallest firms should be exempt. While details of the mandate will need to be hammered out, a reporting requirement need not necessarily place a huge extra burden on companies. Two ideas could help make sure the system is relatively straightforward and avoids “double counting” of emissions by different companies.

First, an emissions-reporting regime should require companies to disclose only “Scope 1” emissions, meaning the emissions they produce and control directly. To keep things simple, and transparent, companies should report gross emissions before any offsets.

Secondly, it is very important that emissions are verified and audited by a third party. To keep costs down, the U.S. could adopt an “accept or explain” approach, where companies are given an estimate for their Scope 1 carbon emissions based on an accepted third-party model that considers their size, industry and other relevant factors. A company is then free to accept this estimate and disclose it, or it can replace it with its own measurements with appropriate documentation and verification.

Climate change is too pressing an issue to allow the emissions of large swathes of the U.S. economy to go unseen. If we are to build an accurate picture of the emissions profile of U.S. businesses, we cannot leave such a large hole in our system of measurement.

Mandatory disclosure will not solve the climate crisis in itself. But it is a necessary first step to addressing it. Greater disclosure will shed more light on the subsidies that companies currently receive from society and nature by emitting carbon freely. It should also enable creative forces to think about potential solutions. That sort of innovation will make business more efficient, harness technology and place U.S. companies on a path to sustainable profitability.

Some would say that banks should focus exclusively on providing returns to shareholders. But even then, the SEC’s proposal would help banks avoid investing in companies that may incur a large regulatory burden in the future, as well as those that risk customer or investor boycotts. From that perspective alone, banks should welcome greater disclosure. And for their own benefit, they should push for a level playing field between public and private companies for reporting emissions.

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