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The Financial Materiality of Climate Change: Evidence from a Global Survey

This chapter presents evidence from a global survey of nearly 700 investors and companies on the materiality of climate risk for financial reporting. There are growing calls by investors and other stakeholders to expand the scope of materiality judgments and mandate the disclosure of climate-related financial risks. Field evidence shows that investors believe climate risk to be financially material and to represent heightened regulatory and litigation risk. The study further finds a misalignment of the materiality perception of investors compared with companies. Far fewer companies believe that they are exposed to climate risks and consequently do not make any disclosures about it. Investors state difficulties with identifying and quantifying risks due to the lack of disclosures as the main challenge in assessing the impact of climate change. The findings suggest that current disclosure practices do not provide investors with adequate information about climate-related financial risks.

1.1. Introduction

What constitutes material information for investors evolves over time. In recent years, various organizations have advocated for enhanced corporate disclosures in financial reports beyond traditional financial metrics to include material environmental, social and governance (ESG) information1. Specifically, the potential financial risks associated with climate change have attracted increasing attention. The World Economic Forum in their Global Risk Report rates risks related to climate change among the most likely and with the most damaging impact on economies and businesses highlighting their potential financial materiality (World Economic Forum 2020). Although the economic costs of climate change are increasingly being recognized (OECD 2015; TCFD 2016), it is unclear whether investors are being provided with sufficient disclosures by companies to assess the financial risks from climate change.

Over the past several years, momentum has been building to recognize the financial materiality of climate change and thus to require companies to disclose their exposure to and management of climate change risks. For example, in 2014, a group of large institutional investors, the Carbon Disclosure Project (CDP) and the UNEP Finance Initiative formed a coalition to raise awareness of climate risks among institutional investors. In 2015, the G20 Finance Ministers and Central Bank Governors mandated the Financial Stability Board (FSB) to review companies' disclosures of risks related to climate change. The FSB established the Task Force on Climate-related Financial Disclosures (TCFD), which in December 2016 published recommendations on voluntary climate-related financial disclosures2. The TCFD recommendations are being adopted in the United Kingdom and the European Union as the de facto standards for the disclosure of climate change-related risks3.

In the United States, the SEC in 2016 issued a concept release on the existing disclosure requirements in Regulation S-K asking for public comments. The concept release drew responses calling for improved disclosures of ESG information, particularly on climate change4. Moreover, in March 2022, the SEC approved a proposed rule to amend the Securities Acts requiring companies to disclose certain risks and impacts related to climate change in their annual report. Pressure is also coming from investors. The CEOs of the largest asset managers have warned their investee companies they would vote against management and directors if they did not improve their climate-related disclosures5.

A growing academic literature examines the financial impact of environmental risks and climate change and how companies disclose these risks and opportunities (Cho et al. 2010, 2012; Flammer 2013; Bernstein et al. 2019). Yet, it is still unclear whether current disclosure regulation provides investors with the necessary means to assess the risks of climate change and whether and how investors consider these risks in asset allocation decisions.

This chapter provides evidence from a global survey of nearly 700 institutional investors and listed companies on their views of the financial materiality of climate change. The study documents whether and why investors view climate risks as material for investment decisions and whether their views are consistent with the companies' own views and their disclosure practices. The study identifies the diverging views of investors and companies on the materiality of climate risk, and the types of risks climate change poses to companies, as one potential impediment to the efficient pricing of climate risks in capital markets. The findings in this chapter lend support to call on the IFRS and the SEC to require broader applications of materiality judgments and to expand current disclosure requirements to climate-related risks in financial reports.

This chapter contributes to the literature on the financial materiality of climate risk and to the large literature on environmental disclosures and financial performance more broadly. A growing number of studies find that climate risks might be mis-priced by financial markets and that climate change might expose investors to tail risks that are largely avoidable (Anderson et al. 2016; Khan et al. 2016; Bansal et al. 2019). The academic evidence also seems to support that mandatory climate-related disclosures are positively valued by investors (Krüger 2015). This study contributes to this line of research by providing field evidence on institutional investors' perceptions of climate risks and whether they believe climate risk to be financially material and why6. In contrast to concurrent surveys that focus on investor perceptions and the tools they employ to manage climate risks (Krüger et al. 2020), this chapter compares the climate risk perceptions and climate disclosure requirements of investors with the views and disclosure practices of companies. The field evidence in this chapter thus informs the academic, policy and practitioner debate on the information disclosure environment with regard to climate change.

1.2. Survey design and demographic data

1.2.1. Survey design

The survey questions in this study were developed based on a review of the academic literature and feedback from a group of six academic researchers in finance and accounting as well as a group of institutional investors and financial market organizations. An Internet-based survey instrument was then developed with the help of Institutional Investor Research Group, a financial market's survey design and execution specialist with the aim to reduce biases introduced by the wording and tone of the questions. The penultimate version was beta-tested with a small number of investors and financial market experts.

Although the survey was conducted anonymously, it allowed respondents to voluntarily reveal their names and institutions. About 40% of respondents chose to do so. Respondents could skip questions if they chose not to answer them.

The final version of the questionnaire was sent via email to a list of senior investment professionals at 4,523 asset-managing and asset-owning institutions and 2,171 listed companies compiled by Bank of New York Mellon and IPREO, a financial services data company. A total of 652 investors and 364 issuers responded, for an overall response rate of 15.2% (or 14.4% among investors and 16.7% among companies). However, across the survey questions included in the analysis for this study, the average response rate ranges between 7 and 16% for a total of 683 responses as some respondents skipped the questions related to this study or did not fully complete the survey.

1.2.2. Demographic data

Table 1.1 reports demographic information about the responding person and institution, summarizing the responses of investors in Panel A and of issuers in Panel B. Panel A shows that the survey captures a large distribution of investors in terms of AUM. On the one hand, 35% of respondents report AUM below 1 billion dollars, and, on the other hand, 15% report AUM of more than 100 billion dollars. The sample has a higher proportion of large investors from the United States and Europe and a higher proportion of smaller investors from other parts of the world, i.e. Asia, the Middle East and Africa. The larger institutions are also more likely to be asset managers than asset owners. Overall, the respondents' total AUM is approximately US $31 trillion7.

Table 1.1. Respondent characteristics