More and more investors demand disclosures from private markets

The discussion about bringing private companies under public-market style reporting regimes is rather ubiquitous. Every now and again, every major economy revisits the conversation. 

On the one hand investors, advocacy groups and policymakers seem to agree that the merits warrant action. On the other hand, challenges surrounding regulatory scope and capacity are all too real.

The latest move comes from down under. The Investor Group on Climate Change (IGCC), a coalition of institutional investors from Australia and New Zealand has written to the Australian government calling for the country’s reporting regime to “ cover large unlisted companies from day one”. 

According to the IGCC, private companies account for 60% of the country’s emissions. It seems logical then, that investor demand for transparent, credible information on these companies is inextricably linked to investor confidence in the sustainable finance project.

What makes this recurring conversation so critical?

Benefits of a level playing field

Fierce debates followed the US Securities and Exchange Commission’s (SEC) push to increase oversight over large, private companies in 2022. The SEC made the case that the widening gap in disclosure requirements would increase the incentive for emitters to remain or become privately-held. 

As former SEC Commissioner Allison Herren Lee said, “we must evaluate the opacity of large and important segments of the economy and what that opacity means for investors and our public markets”. In other words, disclosure variation breeds opacity in private markets.

The opacity in turn, puts into motion the worrying notion of private markets becoming sanctuaries for companies with large carbon footprints. Yet, it is the incentive, as opposed to the reaction that needs redressal. 

As Tariq Fancy, Blackrock’s former chief investment officer put it, “When the rules of the game are drawn and enforced in such a way, how much at fault are the players for playing the game the way they do?”

This argument is echoed by the IGCC’s submission to the Australian government. IGCC’s director of policy Erwin Jackson said, “Investors stand ready to put capital to work funding Australia’s transition to net zero. 

To do that they need a reliable picture of climate impacts and opportunities, and they need to know which companies have strong plans. Australia’s private and public companies should be on a level playing field, working to the same rules, and making the same contribution to the overall picture”.

The Capacity Constraint

The IGCC seems to make a valid point. However, levelling the playing field is anything but straightforward. The disclosures need to be enforced, their quality needs to be monitored and feedback mechanisms with the investor community are immensely critical to its success. 

The IGCC submission outlines two factors that will determine the success of disclosure requirements in private markets: (i) regulatory capacity and (ii) international alignment

Regulatory capacity includes all the factors that affect the extent to which the regulator is able to collect, monitor and screen information as well as ensure compliance. As one might expect, this requires a complex web of abilities. 

In 2022, the Financial Stability Board, a global advisory body recommended that regulatory bodies should be “encouraged to undertake research, analysis and supervisory and regulatory policy actions in the near to medium term on the appropriate enhancements to their regulatory frameworks”.

The other bit of the puzzle is international alignment. Climate-related disclosures in private markets are very much a problem of the commons i.e. it affects investors in all jurisdictions almost equally. 

Solving any problem of the commons, as economists will tell us, requires coordination. In this context, it would mean focusing on a standardised approach.

The IGCC recommends using existing standards such as those that the international sustainability standards board (ISSB) has put forth “Where it is available and applicable, leveraging guidance by the ISSB will help to streamline efforts and promote international alignment”, the letter reads.

Slippery slope

Lastly, critics of the expanded oversight into private markets have argued that increasing this capacity is a slippery slope. The question being - if regulators can increase requirements this time, where does it end?

In the US, the conversation has often steered back to the age-old question of whether climate regulation can fall under the roles and responsibilities of the SEC. 

As some legal experts have noted, “the challenge for the SEC is that its mandate includes protecting investors and promoting market fairness, not using securities regulation to promote public welfare and social responsibility”.

On their part, some SEC Commissioners have argued that financial risk and climate change are tied at the hip. 

Yet, it speaks to a wider challenge: implementing disclosures in private markets through financial regulators requires a legal justification regarding whether the agency’s mandate can allow for it.

An alternative approach to this is the UK strategy: the British bid to become the first G-20 country to implement such reforms, came through Parliament in 2021. 

The proposal to have the country’s largest companies subjected to a disclosure requirement was put to vote and passed into law, as opposed to introduced by a financial regulator.

Demonstrating the scope of regulatory mandates and avoiding breaches of potential regulatory overreach are examples of some fundamental challenges to regulating private companies. 

If investor demand for climate-related disclosures from private companies is to be met, it would require a fundamental recalibration of the public-private dichotomy and the regulatory mechanisms that govern these markets.