SEC Lays Its Cards on the Table

Despite high levels of investor support, proposed rules on climate-related disclosures have prompted questions of regulatory over-reach.

Earlier this month, the US Securities and Exchange Commission (SEC) extended the deadline for public comment on its draft proposal to improve and standardise issuers’ climate-related disclosures for investors. Commenters with “diverse views” asked for additional time to review the proposal, said the SEC. The comment period will now end on 17 June.

Mindy Lubber, CEO and President at Ceres, told a recent webinar that the proposal had created “a lot of engagement at the board level” and excited more comment than the investor network had previously seen over SEC rules.

While the regulator says the draft proposal merely formalises current practices, it has been met with strong opposition in some quarters. This explainer sets out the current state of play.

What is the SEC proposing on climate disclosure?

The SEC’s draft, which runs to nearly 500 pages, says the new rules would require registrants (i.e. listed companies) to provide “certain climate-related information” in their registration statements and annual reports. Also, information about a registrant’s climate-related risks that are “reasonably likely to have a material impact on its business, results of operations, or financial condition” will be required. The required information would include disclosure of a registrant’s greenhouse gas (GHG) emissions. In addition, certain climate-related financial metrics would be required in a registrant’s audited financial statements.

The SEC says disclosure of this would provide “consistent, comparable, and reliable” (and therefore decision-useful) information to enable investors to make informed judgments about the impact of climate-related risks on current and potential investments.

The SEC proposal is modelled in part on the recommendations of the Task Force on Climate-related Financial Disclosure-aligned (TCFD) and also draws on the GHG Protocol. Among the information registrants will be required to disclose are:

  • How any identified climate-related risks have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term;
  • How any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook;
  • The registrant’s processes for identifying, assessing, and managing climate-related risks and whether these are integrated into the registrant’s overall risk management system or processes;
  • The impact of climate-related events (severe weather events and other natural conditions as well as physical risks) and transition activities on the line items of a registrant’s consolidated financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities.

The rules will also require registrants to disclose Scope 1 and 2 GHG emissions and Scope 3 emissions and intensity “if material or if the registrant has set a GHG emissions reduction target or goal that includes Scope 3 emissions”. Registrants also will be required to disclose climate-related targets or goals, and transition plan, if any.

Why is the SEC proposing to mandate climate risk disclosures?

Speaking at a Ceres webinar, SEC Chair Gary Gensler said the proposed rule “builds on a long tradition of consistent, comparable and decision-useful information” for investors and will provide consistent and clear reporting obligations for issuers.

The importance of disclosure dates back to the 1930s, he said, when the principle that “investors get to decide which risk to take” emerged. As long as public companies provide full disclosure, and are truthful, the SEC does not need to step in. The SEC’s role, he said, was to bring standardisation to the dialogue between issuers and investors, particularly with regard to disclosures that are material to investors.

“Today, climate disclosures are already happening and investment and voting decisions are being made based on these,” said Gensler.

In its draft, the SEC observes that many investors are seeking information about climate-related risks and many companies have begun to provide it in recognition of the potential financial effects of climate-related risks on their businesses.

The proposal states that the SEC is “concerned that the existing disclosures of climate-related risks do not adequately protect investors”, requiring the regulator to step in to improve “consistency, comparability, and reliability”.

Climate-related disclosures are often provided in different formats and documents, meaning that the same information may not be available to investors across different companies. “This could result in increased costs to investors in obtaining useful climate-related information and impair the ability to make investment or voting decisions in line with investors’ risk preferences.”

To the extent companies primarily provide this information separate from their financial reporting, it may be difficult for investors to determine consistency between financial and climate-related disclosures. In addition, the information provided outside of Commission filings is not subject to the liability and other investor protections that help elicit complete and accurate disclosure, says the SEC.

How has the market reacted?

“Every time the SEC steps out of financial matters and into other issues, there is controversy,” says Tim Mohin, Chief Sustainability Officer at climate technology company Persefoni. “Some argue that the move would be an expansion of the authority of the SEC and that controlling GHG emissions would be better done via environmental regulation.”

SEC Commissioner Hester Peirce issued a dissenting statement, arguing that the proposal “will not bring consistency, comparability, and reliability to company climate disclosures”. Rather, she stated, it would “undermine the existing regulatory framework” and could harm investors, the economy, and the SEC itself.

“The proposal… tells corporate managers how regulators, doing the bidding of an array of non-investor stakeholders, expect them to run their companies. It identifies a set of risks and opportunities—some perhaps real, others clearly theoretical—that managers should be considering and even suggests specific ways to mitigate those risks,” she said

“It forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial performance.”

Law firm Mayer Brown identifies four areas where the proposed rules may be challenged:

  • They exceed the SEC’s statutory rulemaking authority
  • They exceed the limits on regulation of major policy questions (an agency’s exercise of regulatory authority over a major policy question of great economic and political importance requires a clear delegation of authority by Congress);
  • Mandating environmental impact disclosures from publicly traded companies may be interpreted as “unconstitutional compelled speech”, which could be challenged under the First Amendment (freedom of speech);
  • The SEC “unreasonably concluded” that the rule will generate comparable, consistent, and reliable disclosures.

Another sticking point has been disclosure of Scope 3 GHG emissions. Some business groups have opposed the inclusion of Scope 3 emissions in the rules, arguing that in many cases they have no direct control over the carbon output of their suppliers and customers. Peirce says a reporting company’s long-term financial value is only “tenuously at best” connected to such third-party emissions.

Gensler said Scope 3 disclosures will be required “only if such emissions are material or if a company makes a commitment that references Scope 3 emissions”. The proposal phases in Scope 3 disclosure “a little later” than Scopes 1 and 2, he added.

Law firm Ropes Gray also foresees legal challenges. “It is a virtual certainty that there will be a court challenge to the final rules,” the firm says. However, says the firm, SEC rules “will not end the call for more climate-related and other environmental disclosures”. Investors will continue to seek climate-related and environmental disclosures that go beyond SEC disclosure requirements. “In addition, even before the SEC’s proposed rules phase in, some institutional investors will encourage registrants to voluntarily early adopt those standards in their SEC or voluntary sustainability disclosures.”

Costs of compliance also have been identified as a concern. Persefoni, Ceres and sustainability consultancy ERM estimated that corporate issuers are already spending US$533,000 annually on climate-related disclosure activities, while institutional investors are spending an average of US$1.333 million annually to acquire and analyse climate data to inform investment decisions.

However, the potential cost of non-compliance and misleading disclosures far exceeds the cost of compliance, says Persefoni. “In order to comply with the impending SEC rules, as well as those emerging in states such as California and jurisdictions such as the EU, companies must apply appropriate rigour to their carbon accounting.”

Investor groups have generally welcomed the proposals. Ceres describes the draft rules as “a historic moment”. It notes the growing momentum around mandated climate disclosure with Belgium, Canada, Chile, France, Japan, New Zealand, Sweden and the UK introducing such rules. Isabel Manilla, Director of US Financial Regulation at Ceres, describes the draft proposals as “thoughtful and carefully calibrated, and respond directly to specific concerns from investors and issuers”.

Persefoni’s Mohin notes that investors have become increasingly vocal about the lack of robust GHG emissions information from companies on which to base investment decisions. Currently, climate information is in sustainability reports, which are voluntary and contain “only what a company wants to report”. This makes it difficult for capital markets regulators and investors to identify risks and opportunities.

“However, now that it is common practice to report sustainability information – 92% of the S&P 500 companies do this – the SEC wants to make that practice more reliable by setting common rules and filing deadlines,” he says.

What are the next steps toward climate disclosure rules in the US?

During the Ceres webinar, SEC’s Gensler encouraged US companies and investors to comment on the draft proposals. “If you think we have something right, tell us, if there’s something you think we should adjust, tell us. The more detail – line by line – that we have will benefit everyone.”

Mohin says investor pressure for disclosure will continue. “Institutional investors – the big pension and sovereign wealth funds – all want more and better information on climate. They know it is a risk but could also be an opportunity. In the transition to a low-carbon economy, investors want this information and that is not going to stop.

“The idea that voluntary sustainability reports are sufficient needs to be debunked. The SEC will require carbon disclosures to be integrated into financial reports. This will take time and effort and cannot be done on spreadsheets.”

The public comment period on the proposed disclosure rules will now close on 17 June. The SEC says it recognises that many companies will require time to establish the necessary systems, controls, and procedures to comply with the proposed climate-related disclosure requirements. It is proposing a phased timetable for compliance, giving additional time for some smaller companies.

Large companies will be required to file all proposed disclosures, including GHG emissions metrics of Scope 1 and 2, and associated intensity metric, but excluding Scope 3, by for fiscal year 2023 (to be filed in 2024). The phase-in date for smaller reporting companies is fiscal year 2025, to be filed in 2026.

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