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UPDATE: Publicly traded companies in US could face climate-risk disclosures from SEC
All publicly traded companies in the US would be required for the first time to disclose climate-related risk in their annual reports starting as early as FY 2023 under a US Securities and Exchange Commission (SEC) proposal approved 21 March.
Update: The proposed rule was formally published in the Federal Register on 11 April. A public comment period is open through 20 May.
Over several years, the "Enhancement of and Standardization of Climate-Related Disclosures" would phase in disclosure requirements for GHG emissions, starting with large banks and corporations, similar to the approaches pursued by Singapore, Switzerland, and the UK.
The SEC's commissioners voted 3-1 to support the regulation at their open meeting, with Republican appointee Hester Peirce dissenting. Peirce leveled a number of criticisms of the plan, highlighting several times that she believes the commission overstepped its regulatory authority by mandating GHG disclosure.
The commissioners who support the regulation said that their mandate is to protect investors, and the comments they received showed that this is an area in which investors are demanding greater transparency. "The science is clear and alarming … and the link to capital markets is clear," said Commissioner Allison Herren Lee, adding that the regulation "skillfully leverages widely accepted, market-developed solutions..."
Lee compared the climate crisis to the global COVID-19 pandemic, observing "the pandemic showed how a crisis outside finance markets can send shockwaves through markets." While that public health crisis came up unexpectedly, Lee said society has advance notice about climate change's impacts and the risks it creates to companies' operations, insurability, supply chains, operations—in short, their financial performance.
SEC Chairman Gary Gensler noted in his statement that weather-fueled climate impacts are affecting all parts of the US, manifesting in billions of dollars in direct costs of losses to homes, businesses, and vital infrastructure, and indirect costs such as increased insurance premiums. US companies also are facing "transitional risks" from switches to clean energy, another key point of disclosure, he added.
But Peirce said the commission departed from its standard of requiring companies to disclose what is "material" to their financial futures, given the "inherently unreliable" estimates of GHG emissions now and in the future. Materiality is a foundational principle of US securities law that public companies are obliged to disclose to prospective investors and shareholders information that is significant, or "material," to making informed investment and proxy voting decisions.
The new policies would enable "speculation" to intrude on what is supposed to be a "factual" report on a company's financial expectations, Peirce said.
Of the many elements in the climate rule, disclosure of GHG emissions is one aspect that will draw a great deal of attention during the comment period (see related article here for additional early reaction to the rule).
Companies will be required to disclose Scope 1 emissions, or direct GHG releases as a result of operations, and Scope 2 emissions from purchasing power and heat from a third party. These emissions will have to be audited by a third party and disclosed annually.
The Sierra Club, in a statement, noted the importance of disclosure of Scope 1 and 2 emissions, but it criticized "generous carve-outs for companies to avoid disclosing their Scope 3 emissions," which are other emissions up and down a company's value chain.
For Scope 3 emissions, Gensler explained the Commission is taking a blended approach. Companies for which Scope 3 emissions are "material" or if they have made a statement about Scope 3 emissions goals in their own sustainability reports will have to disclose those emissions. "These may be necessary to present investors with a complete picture of climate risk, particularly transition risk," he said.
Those Scope 3 rules would phase in, and they are limited to larger filers. And all disclosures about future Scope 3 emissions will be protected by a "safe harbor" provision related to the uncertainty of predictions, Gensler said, as is common in other parts of a company's forward-looking financial statement.
For the oil and gas industry, Scope 3 emissions are the critical component, as they represent 70% or more of total GHG emissions, but are fundamental to the actual use (burning) of their products.
The American Petroleum Institute (API), which represents oil and gas producers, said its members support sustainability reporting, and the SEC's goals of achieving greater comparability and transparency. But API said it's "concerned that the Commission's sweeping proposal could require non-material disclosures and create confusion for investors and capital markets."
If the SEC's rules are finalized as written, companies will begin by complying with a "limited assurance" standard for those Scope 1 and 2 emissions claims for two or three years (depending on company size). Limited assurance is basically a negative statement, explained Lee: that a company's management is "unaware" of any material issues related to Scope 1 and 2 emissions on future earnings. But after that period, the "reasonable assurance" standard would apply, and this is a more affirmative statement that a "reasonable investor" would not find the emissions to be material.
The SEC is seeking commenters' input on how to phase in the use of reasonable assurance for Scope 3 GHG emissions.
Reflecting government priorities
The commission's proposal reflects President Joe Biden's all-of-government approach to tackle the climate crisis, and especially its climate finance plan. It follows more than decade after the SEC first articulated its view that climate changes poses a material risk in a non-binding 2010 guidance, which did not establish any metrics or standards for reporting.
It takes advantage of voluntary programs that have developed in the last decade and have accelerated usage in the last couple of years as companies have sought to assure investors that they have set legitimate sustainability goals and are making progress towards meeting them. The Task Force on Climate-related Financial Disclosures (TCFD) is one prominent model that is cited in the rulemaking as a guide for how companies can disclose their risks. EU member nations, as well as Brazil, Singapore, New Zealand, and the UK are among the countries that are in the process of adopting the TCFD for corporate climate disclosures, Gensler said.
TCFD starts with generally applicable recommendations on reporting climate risk for all companies, which are supplemented by more sector-specific guidance.
But Commissioner Peirce said that basing a mandatory regulation on a program of voluntary guidelines is precisely one of the problems of the rule.
With this approach of using existing models, Peter Gardett, research and analysis director, for S&P Global Commodity Insights, said the rule is building on familiar ground, at least for some companies. He called the rule "a middle course between the expectations of activists who want to see companies tie full supply chain emissions directly to their balance sheet and corporate managers who are unsure how they'd even begin to quantify their climate risk exposure."
SEC Chief Economist Jessica Wachter noted in her part of the March 21 staff report that preceded the vote in favor of the rule that the SEC's own research indicates broad interest by investors on greater climate disclosure. A review of filings by 7,000 public companies in 2019 and 2020 found that one-third were already issuing some type of sustainability commitment, she said.
But lack of standardization "raises challenges for investors to compare and for companies to decide which [climate measures] to use," Wachter said. The new rule will improve "consistency and comparability" across time, across industries, and between companies, she said.
Emissions disclosure is a big move forward, said Steven Rothstein, Ceres Accelerator for Sustainable Capital Markets managing director. "Climate risk disclosure is fundamental for decarbonization, but it can only be managed if it is measured, and it cannot be measured without adequate GHG data about the emissions released all along the value chain," he told Net-Zero Business Daily.
Along with the GHG emissions disclosures, comments by SEC commissioners indicate that materiality is the other key issue in the new regulation.
One of the reasons that disclosure of climate risk has lacked clear consensus is this question of what is material to a company's bottom line or if materiality is even the right measurement for this type of risk disclosure, explained Margaret Peloso, who is Lead Sustainability Partner at Vinson & Elkins, in comments to Net-Zero Business Daily prior to the rule's issuance.
Commissioner Lee, who started the ball rolling last March on climate risk disclosure, made it clear in a speech last May that she believes public disclosure of any sort under federal securities law is triggered by an explicit duty, and therefore not limited to disclosure of a material fact, Peloso explained. Lee said at the time it's a "myth" to believe that materiality should be the basis for climate disclosure, as some large banks and groups have insisted.
The commission didn't go that far, as it retained the materiality standard for emissions disclosures. Thus it avoided "charting new ground legally" and possibly avoiding litigation on those grounds, Peloso said.
But Commissioner Peirce argued that the rule still went over the line. "The proposal turns the disclosure regime on its head," she said, shifting from what a company's management "sees through its own eyes … are material determinants of financial value" to what outsiders see, in this case activist investors who have a climate focus.
When it comes to climate matters, Peirce said that other federal agencies, such as the Environmental Protection Agency, have clear congressional mandate to regulate, and that's where the authority starts and ends.
Peirce called the SEC's plan "an array of noninvestment priorities, some of which are clearly theoretical," and she said it will force companies' reporting "to be seen through the eyes of a … set of stakeholders for whom climate reputation is more important than financial risk."
The US Chamber of Commerce, which represents corporations, expressed its concern about the materiality issue within an hour of the SEC's vote. "The Supreme Court has been clear that any required disclosures under securities laws must meet the test of materiality, and we will advocate against provisions of this proposal that deviate from that standard," said Chamber Executive Vice President Tom Quaadman in a statement on 21 March.
On the other hand, those investors that the Gensler, Lee, and fellow Commissioner Caroline Crenshaw said are clamoring for more consistent and greater transparency, seem pleased with the regulation as proposed. "The enhanced disclosure that the proposal calls for will provide investors with comparable, consistent, qualitative, and quantitative information," said the Investment Company Institute.
If finalized, the rule will require reporting of GHG emissions and climate risks in registration documents for stock sales and also on annual reports to the SEC, such as 10-K reports.
In addition to GHG emissions, the Commission would be requiring information about the following, among numerous disclosures:
- How any climate-related risks identified by the company have had or are likely to have a material impact on its business over the short, medium, or long term
- How the company's strategy and business model might be affected
- A company's processes for identifying, assessing, and managing climate-related risks
- If a company has a "transition plan" for physical or corporate risks - and if so, a detailed listing of the metrics and targets in that plan
- If it uses an internal carbon price, and if so, information about the price and how it is set
- The impact of climate-related severe weather events and other natural conditions on a company's finances
As Crenshaw explained, the SEC's goal is to have companies "separate out and disclose physical risk, transition risks, and other co-identified risks on the bottom line." Using the example of a hurricane, she said a company could be expected to disclose which facilities it owns or operates are vulnerable to storms, and what the company is doing to mitigate the risk.
Companies that are using carbon offsets to help reach decarbonization goals also will be required to provide detailed information on the amount of offsets and source(s) of those offsets, Crenshaw said. On that one issue, at least, there appeared to be a consensus, as Peirce said in her comments that she too is concerned about "greenwashing" by companies that make environmental promises that are hard to verify.
How quickly the rule could influence US corporate behavior is hard to predict, though the SEC is seeking to finalize it by 31 December 2022 and phase it in beginning in FY 2023.
But observers say that the rule will be litigated, and resolving litigation may take at least three or four years.
In June, attorneys general (AGs) from 16 states, all Republicans, sent a comment letter to the SEC on the proposed rule that said they believe it potentially violates the First Amendment by compelling speech.
The letter was coordinated by West Virginia AG Patrick Morrisey, who led the challenge to the EPA's rules on coal-fired power plants that recently was heard by the Supreme Court. In relation to the SEC's rule, Morrisey stated that the SEC is engaging in "mission creep" because securities law allows for disclosing risk only if it is "material" to protecting investors against fraudulent practices, that is, to "insure fair dealing in the security."
However the battle over the rule ends, Peloso said investors' demands for more transparency is clear. She is advising companies to be more clear in stating GHG reduction or net-zero commitments and pathways to achieving them, based on the SEC's statement in 2021 that it would be watching more closely for compliance with the 2010 guidance about climate risk disclosure. "You need to discuss in your filings how your allocated capital meets [your] commitment," Peloso said.
It's a global phenomenon, said others. "Investors are pouring $40 trillion per year and have no transparency whatsoever," said Richard Cohen, chair of the Global Steering Group for Impact Investment, on 21 March at the 7th annual Sustainability Week, sponsored by Economist Impact. "Without transparency, we're just fiddling on the edge of dealing with our issues…. Transparency on the impact [of emissions] is the fulcrum on which climate finance can shift …"
But others said that the new SEC policy might actually reduce transparency in the short term and even beyond.
This could be due to the uncertainty about how it will look in final form or the unintended consequences of any major new regulation, said S&P Global's Gardett. He noted that standardizing disclosure requirements could eliminate the "green premium" on their stock price or through a lower cost of capital that some companies enjoy by getting ahead of their peers on climate reporting. Without that marketplace benefit, they might pull back on their reporting, and then less information might make investors wary about placing their money in green and sustainable financing. "In Europe, the rollout of the sustainable investment taxonomy has had the contradictory effect of chilling activity in one of the most vibrant areas of European finance," he said.
The SEC certainly doesn't anticipate that scenario, said Wachter, who spoke about how investors are "clamoring for" more transparency, which will help to "end … information asymmetry … improve functioning of capital markets … [and enable] more effective monitoring and management …"
The companies themselves will benefit, too, with consistent measurements for emissions and reliable assurance of the accuracy of those measurements, she said.
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.
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