More Bumps in the Road for US Climate Rule After SEC Glitch

Concerns over costs and legal challenges lie ahead, as deadline for new disclosure rule slips.

A recent technology failure at the US Securities and Exchange Commission (SEC) is far from the last hurdle facing its proposed climate risk disclosure rule, with legal challenges regarded as “inevitable”.

The much-anticipated rule, one in a series of sustainable investment regulations being introduced by the SEC, will now be delayed at least until Q1 2023, after the regulator was forced to reopen its consultation process to 1 November.

Future bumps in the road predicted by legal and regulatory experts include questions over compliance costs, liability for Scope 3 emissions, extension of requirements beyond listed firms, and legal challenges on grounds of regulatory overreach.

““There will be a variety of claims under constitutional and administrative law,” said Fredo Silva, Partner at law firm Morrison Foerster.

But growing demand for information on climate risks from domestic investors and the pace of international developments on sustainable investment frameworks mean that US firms should prepare for very similar climate risk reporting requirements to their peers globally.

“This is a really important baseline of data for investors,” said Greg Hershman, Head of US Policy at the Principles for Responsible Investment (PRI).

Having consulted the market in 2021, the SEC issued its draft climate disclosure framework in March. A 30-day comment period was extended to 17 June, but was reopened earlier this month after the proposals were found to be among 12 planned rules impacted by a technology glitch. With the SEC obliged to consider all new or resubmitted comments, the regulator will not be able to meet expectations to publish the final rule before the US mid-term elections in mid-November.

“This does push back the timeline,” said Hershman, suggesting the first quarter is “the earliest” period by which the rule could be finalised. Some have noted that Republican success in November could prompt initiatives in Congress to stop the rules or limit their impact.

Other recent SEC initiatives related to sustainable investment include rules on green fund labelling, and disclosures on executive pay and diversity, equity and inclusion.

“A huge delta”

Despite the mountain of feedback to the consultation already, reckoned at more than 14,000, experts believe that the ground laid by the SEC before publishing its proposal in March means there is now little scope for significant change.

“The Commission feels that the proposal was a good compromise. It broadly gets investors the information they’ve been asking for, and it doesn’t do it in a way that’s overburdensome to issuers. It takes into account some limitations in data availability, and that methodologies are still evolving, while staying closely within their jurisdiction,” said Hershman.

But that does not mean it’s plain sailing from here, with assessment of Scope 3 emissions one of the most contentious and complex areas due to the need to assess output along supply chains.

Although the SEC has adopted a flexible approach to Scope 3 emissions, requiring disclosures only where they are material, Morrison Foerster’s Silva says the compliance costs for smaller listed firms will be disproportionately high.

Estimates for larger firms stand at US$700,000 for the first year and US$500,000 annually thereafter. “That’s a huge delta from current compliance costs,” said Silva, adding that costs for smaller listed firms may not be that much less, even without Scope 3 reporting.

“They will still have to do the extra accounting, rely on third parties for attestation, and bring in consultants to advise on how to generate and interpret the data they’re going to be reporting,” he said.

Silva suggested extra compliance costs for smaller listed firms from climate disclosures could be US$400,000 in the first year and US$300,000 afterwards. “It’s not going to scale linearly and that’s going to make it very difficult for listed companies to continue to comply.”

On Scope 3, the SEC has said there will be a different standard of liability for issuer statements that are made with respect to Scope 3 emissions, compared to Scopes 1 and 2. Silver says this “subtle” distinction may not offer much comfort to firms, nor lighten their compliance burden.

“A slightly different standard of liability gives some protection, but they’re still going to have to do a whole lot of work to ensure the accuracy of those statements, so that they don’t end up in court or under investigation,” he said.

Scope 3 emissions are difficult for firms to provide, partly because they involved third parties but also because there are a number of sub-categories and a range of methodologies for calculating them. “But that does not minimise the need for good Scope 3 data,” said Hershman. “The direction of travel is that investors increasingly want Scope 3 data and there’s a lot of work being done to make that a reality.”

The PRI recently published a comparative analysis of the US climate disclosure proposal, the International Sustainability Standards Board’s draft standard for climate reporting and European Sustainability Reporting Standards, which found a close level of overall alignment.

Accusations of overreach

Legal challenges to the introduction of climate disclosure requirements have been anticipated since the SEC announced its intention to regulate.

“It’s almost inevitable these days that when a new rule comes out, regardless of what it is, you will have some sort of challenge. That’s the US process at this point,” said Hershman.

This expectation is one reason behind the painstaking efforts made by the regulator to deliver a balanced proposal, said Silva. “Their ultimate position is going to be that they will defend the proposals that they’ve made in court.”

In terms of overturning the regulation on grounds of overreach, there are a range of principles across statutory, administrative and constitutional law that offer a potential basis for a challenge, including compelled speech, and arbitrary and capricious regulatory implementation.

Past precedents include a challenge to SEC oversight of disclosures by issuers on mine safety, introduced in 2011 under the Dodd Frank Act. To supervise the disclosure requirements, the SEC needed the involvement of the Mine Safety and Health Administration, and its role was seen by some beyond its core field of competence. Critics of the SEC’s climate disclosure proposal have claimed that the Environmental Protection Agency should be the lead regulator rather than a financial markets watchdog.

In both cases, there is a potential argument that the practices being disclosed, mine safety or carbon emissions, are not sufficiently material to the economic interests of shareholders.

“It’s not the SEC’s job to require public companies to report on everything that people might care about, but rather on what is material to the economic return of shareholders. That is the same claim that is going to be made against these rules,” said Silva.

A court challenge could lead to certain provisions being ruled unenforceable, he added. “Until that happens, most firms are going to want to comply.”

The PRI’s Hershman suggested wider factors would need to be taken into consideration. “There’s broad demand for this information. And almost no matter what happens in the courts, this demand isn’t going away. The SEC is setting a baseline and investors are going to keep pushing that baseline,” he said.

Private markets implications

The SEC climate disclosure rules are expected to have an impact beyond the listed firms that fall directly under its supervision. This is seen as arising partly due to the SEC rules reinforcing or setting investor expectations of investee firms’ disclosures, but also due to pressures from international norms and regulatory requirements on investors, specifically fund managers.

The SEC’s incoming green labelling rules for funds and other financial products, which follow international developments such as the EU’s Sustainable Finance Disclosure Regulation, will impact private markets but are viewed as less onerous than for public market funds.

“They’re going to start demanding more information from the private companies they invest in,” says Silva. “The reporting rules applying to public funds will end up resulting in more reporting by the private companies. Since their investors have to do the reporting, they’re going to be forced to require the upward reporting from the companies in order to satisfy that.”

Currently, said Silva, most US venture capital and private equity funds aren’t requiring climate disclosures from investee firms, but will do so once the institutional investors among their liquidity partners require climate disclosures to meet their own obligations. “It’ll get there but it’ll take a while.”

Earlier this year, a survey from Bain & Company and environmental disclosure platform CDP found that 64% of public companies by global market capitalisation currently report on climate to the platform, compared with 1% of private companies.



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