The 5th Annual Oxford Business Law Blog Conference took place online in May 2021 to discuss the role of business law and the transition to a net zero carbon economy. A brief summary of all sessions and discussions is provided below. Please note that the views expressed by paper presenters, discussants and practitioners are personal and do not represent the views of any organisation.

First Session: Disclosures and Credible Commitments

1. A machine learning assessment of climate risk disclosures

Professor Eric Talley (Columbia Law School) presented a study co-authored with Professor Julian Nyarko (Stanford Law School), that, with the help of machine learning algorithms, aims to (i) identify climate related disclosures within companies’ reports, (ii) develop a ‘climate factor’ to identify which companies should disclose given their climate-related exposures; and (iii) assess the extent to which the ability to identify disclosures and those who should disclose could produce a shift in these companies’ climate-related disclosures.

By using data from mandatory reports and machine learning, the study achieved a high level of accuracy when identifying climate-related disclosures. The authors developed a ‘climate factor’ or ‘climate beta’ by combining information on world temperature variations, major weather events and climate disclosure and litigation data. Using this factor, the study found a set of companies that, given their risks and sensitivity to climate factors, should make climate risk disclosures under the existing SEC guidance. Professor Talley then addressed the question of whether these tools—if successful—would have a positive effect in prompting companies to make better climate risk disclosures. He stated that it is uncertain whether this is going to be the case. On the one hand, the tools described above would bring greater transparency and would help detect the lack of seriousness on the part of issuers, incentivising good disclosures. On the other hand, the SEC’s mandate is still centred on investor protection, which means that unless carbon reduction measures are financially material, they will not be a concern for the SEC. One way of dealing with this issue would be to widen the mandate of the SEC, but the authors are sceptical about this solution, given how broad the SEC’s mandate already is. Another option would be to make climate-related disclosures financially material whether via stronger environmental regulations and penalties or by encouraging the use of green financial instruments.

The discussant, Professor Madison Condon (Boston University School of Law), started by noting that there are more voices now envisioning a financial stability mandate for the SEC beyond investor protection. Regarding Talley’s presentation, Professor Condon pointed out that the methodology proposed by the authors relies exclusively on SEC filings, and yet many useful climate-related disclosures are made in different corporate disclosures, such as sustainability reports and energy outlooks. Concerning the climate factor, she added that the disclosures rarely contain an asset-level analysis, making it difficult to construct a precise climate factor. Finally, Professor Condon pointed out that there are several ways of informing the market about climate change which need not rely on terms such as climate, raising concerns about the accuracy of the authors’ methodology for the purpose of identifying climate-related disclosures.

2. Making corporate carbon commitments credible

Professor John Armour (University of Oxford) presented a joint project with Professor Luca Enriques (University of Oxford), and Professor Thom Wetzer (University of Oxford), titled ‘Corporate Carbon Reduction Pledges: Beyond Greenwashing’, which addresses a relatively small number of corporate and state entities dubbed ‘systemically important carbon emitters’ (SICEs) and the credibility of their climate pledges. The authors describe three potential motivations for making carbon-reduction pledges in these companies. Firstly, there can be a business case, as the costs of continuing to emit are higher than a transition to renewable energy or the expected returns from shifting their business model from fossil fuels to renewables and other forms of green energy are higher than those associated with remaining on their original path. Notably, this crucially depends on the cost of carbon emissions. Secondly, there may be pressures from shareholders due to wider preferences of investors that might support initiatives designed to reduce carbon emissions even if it is not clearly profit-maximising for the firm, successfully pushing for change even where a purely financial business case is lacking. Finally, a third motivation may be greenwashing, that is, the idea that SICEs may try to achieve reputational gains by claiming to do something the company is in fact doing only partially or not at all.

The carbon-reduction pledges raise the question of their credibility, that is, how easily firms might renege upon them. This problem arises because firms are likely to have a time inconsistency problem regarding their pursuit of their green objectives. Firstly, the business case motivation depends on the price of carbon: if this is not high enough, the maximization of profit would push the company to abandon its pledges. Secondly, in the case of wider investor motivations, the carbon-reduction pledges will only be honoured so long as the coalitions supporting them have control over the shareholder meeting. In other words, to the extent that making a climate pledge is driven by a desire to meet the preferences of ESG investors, the firm’s commitment will be conditional on the shifting sands of its shareholder register.

To achieve a credible commitment by the firm, the authors propose a ‘Green Pill’, a debt instrument issued by the firm that includes a penalty (in terms, eg, of a higher interest rate) should the firm breach its carbon-reduction pledges. The authors note that the penalty payment may create incentives for the security holders to push for abandoning the pledges and trigger the penalty payments. Nonetheless, it is possible to mitigate this risk if the Green Pill is structured in such a way that the additional payment is made not to the holders of the instrument, but to a third party with no ability to influence the firm’s behaviour (like an environmental charity or an NGO). In this manner, the firm could credibly commit itself to climate targets up to the cost of the undertaking.

The discussant, Professor Jill Fisch (University of Pennsylvania Law School), pointed out that the green pill functions as a type of voluntary carbon tax by requiring a company to pay a penalty if it fails to live up to its climate-related commitments. Professor Fisch indicated that the adoption of a Green Pill requires corporate decisionmakers to set climate goals, a subject the authors do not address but that she views as critical because these goals will be embedded in the terms of the Green Pill. Professor Fisch also observed that the paper frames company behaviour as either green or brown when in reality characterizing that behaviour is more nuanced.  A company’s strategies must be assessed in relation to the impact of the company on society through the goods and services it provides, the people it employs, as well as the degree to which the company contributes to climate change, both in absolute terms and in relation to other market participants. Finally, Professor Fisch observed that individualised commitment devices, such as Green Pills, might increase incentives for corporations to provide more reliable input into the regulatory process.

 

Gabriel Acuna Csillag is an Advisor on Sustainable Finance at the Financial Markets Commission of Chile, and Founder and Former President of the Oxford Sustainable Finance Students’ Society.

Stepanyda Badovska is an Associate at Baker & McKenzie - CIS, Limited, and Founder and Former Vice President of the Oxford Sustainable Finance Students’ Society.

 

Part 2 of this post is available here. Part 3 of the post is available here

This post is part of the series ‘Business Law and the Transition to a Net Zero Carbon Economy’. This series consists mainly of posts summarizing papers presented and presentations made at the 5th Annual Oxford Business Law Blog conference on ‘Business Law and the Transition to a Net Zero Carbon Economy’ which took place online on 25 to 27 May 2021. The recordings are available here.