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SEC Chairman Gensler draws on US Supreme Court precedent to defend climate disclosure proposal

13 April 2022 Amena Saiyid

US Securities and Exchange Commission (SEC) Chairman Gary Gensler invoked two US Supreme Court opinions and the agency's long-standing tradition of providing "material" information to investors to defend its climate disclosure proposal in a rebuttal of critics who argue the agency overstepped its authority.

In a 12 April webinar briefing organized by sustainable investor group Ceres, Gensler said he was guided by the concept of "materiality."

As the Supreme Court held in the 1988 Basic Inc. v. Levinson ruling that in turn cited a 1977 opinion, Gensler said "information is material if 'there is a substantial likelihood that a reasonable shareholder would consider it important' in making an investment or voting decision, or if it would have 'significantly altered the total mix of information made available.'"

In response to burgeoning demand from global investors and companies, the SEC released the climate disclosure proposal on 21 March, which for the first time would require publicly traded companies to disclose their strategy, governance, and risk management with respect to climate-related risks. It closely tracks the 2017 reporting framework developed by the Task Force on Climate-Related Disclosures (TCFD).

Overstepping authority

Since the proposal's release, the SEC has been barraged with criticism about overstepping its legal authority from mostly conservative business circles and Republican lawmakers critical of the Biden administration's all-of-government approach for tackling climate change.

In an April 5 letter, a group of Republican lawmakers observed it was "unclear" to them "where the SEC has derived this drastic change in authority," noting that the commission is not tasked with environmental regulation, "nor has Congress amended the SEC's regulatory authority to pursue the proposed climate disclosure."

The US Chamber of Commerce too voiced concerns, saying the rule goes beyond the SEC's mandate for requiring disclosure to investors of matters "material" to a company's performance.

During the Ceres webinar, Gensler attempted to counter those objections and place the need for disclosure in the context of the SEC's long-standing tradition.

"The core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures," he said.

In the proposal, SEC staff used the 1988 Supreme Court ruling to buttress that argument, saying that "the materiality determination with regard to potential future events requires an assessment of both the probability of the event occurring and its potential magnitude, or significance to the registrant [company]."

Gensler said the SEC has a role to play in bringing some uniformity to the exchange of information happening between the companies and the investors, "particularly when it comes to disclosures that are material to investors."

The SEC chief also attempted to respond to US Senator Joe Manchin, Democrat-West Virginia, who in a 4 April letter questioned the agency's need to duplicate GHG emissions data collection requests from the industry, especially the fossil fuel companies when the US Environmental Protection Agency (EPA) already is reporting on this data.

The EPA produces an annual inventory of the nation's GHG data from all sectors, but that information is year-old data. For instance, EPA's most recent inventory, released in the fall of 2021, described all sector emissions for 2020.

Like Manchin, West Virginia Attorney General Patrick Morrisey also sees Biden's decarbonization push as an attack on the fossil fuel industry, and on his state, which is heavily dependent on it for revenues.

In a 13 April statement to Net-Zero Business Daily by S&P Global Commodity Insights, Morrisey said the state would not shy away from filing comments on the proposal, which if finalized, "would provide for coordinated discrimination against areas of the country like West Virginia that depend most heavily on fossil fuels for energy."

Rest assured, Morrisey added, "West Virginia and other States will vigorously participate in the rulemaking process, and, if necessary, go to court to defend against any regulatory overreach by the SEC in the name of climate disclosures."

Standardized reporting in one place

Gensler emphasized that investors need to find the relevant information reported in a standardized format that they understand, and to find it in a single place.

"It is important that investors be able to find consistent, comparable, and decision-useful information in one place rather than having to piece together information from different locations that might, in turn, differ from one issuer to another," he said.

When assessing an investment, investors usually look for relevant information in filings like the 10-K, an annual financial performance report the SEC requires from each publicly traded company, he noted.

"That was true when I was on Wall Street. It's true of the [Management, Discussion & Analysis] sections; it's true of the risk factors; it's true of the environmental disclosures starting in the 1970s. It's true for other key disclosures today," Gensler added.

Need for disclosure

The SEC's proposed rule, which remains open for public comment through 20 May, is in line with TCFD recommendations. It requires companies to disclose Scope 1 GHG emissions from their direct operations as well as Scope 2 emissions from purchasing electricity for heating and cooling purposes. The commission stopped short of mandating Scope 3 emissions disclosures unless investors deem it "material" or companies themselves have listed Scope 3 reduction targets in their transition plans.

Gensler acknowledged the methodology is not fully developed to assess Scope 3 GHGs emitted across the value chain of a product or service offered by a company, offering safe harbor protection against liability for any disclosure pertaining to such emissions.

Speaking after Gensler on the same webinar, Isabel Munilla, US financial regulation director for Ceres' Accelerator for Sustainable Capital Markets, stressed the importance of why investors need GHG disclosures.

"They help investors understand the quality of a company's earnings in the face of climate change during the energy transition, and, both current and future GHG estimates can help investors understand a company's liquidity and capital allocation when faced with specific climate risks, and opportunities," Munilla added.

However, some investment firms are a bit uncertain about how far the SEC is going with its disclosure mandates for Scope 3 emissions.

"Will this make you hesitate to lean into establishing a Scope 3 [target] because you're going to now be required?" Cynthia Curtis of investment giant Jones Lang LaSalle, said during the webinar. "You just don't want that chilling effect."

Globally harmonized rule

Both Gensler and Munilla pointed out that the general and climate disclosure proposals that the International Sustainability Standards Board (ISSB) released 31 March, 10 days after the SEC proposal, also draw heavily on the TCFD recommendations.

The ISSB was created in November at the UN COP26 meeting in Glasgow, Scotland, as an offshoot of the International Financial Reporting Standards Foundation and charged with developing a comprehensive global baseline for sustainability disclosure in the financial markets.

A Ceres analysis of public comments that the SEC sought a year ago prior to crafting its 21 March proposal revealed that more than 70% of all investors called for an alignment with TCFD guidelines; which Munilla said the SEC proposal does.

Among the investment management firms backing the SEC proposal are Franklin Templeton, which is a steward of $1.3 trillion in pensions, investments, and other savings, as well as global cloud software firm SalesForce.

Tom Sanzillo, financial analysis director for the Institute of Energy Economics and Financial Analysis, is among the critics who would have liked the SEC to just use the ISSB proposal and tailor it with some tweaks to the US market.

"What we need are globally harmonized standards, such as the ISSB is proposing," Sanzillo told Net-Zero Business Daily. Alluding to the SEC proposal, he said, "this is just typical Washington behavior … of ineffectual power play and politics."

However, Munilla noted during the webinar that the SEC proposal, as does the TCFD, requires companies to disclose their GHG reduction targets across all scopes, if articulated on their websites, and related scenario analysis, transition plans, and carbon offset use for meeting those goals.

This is important because "these are key tools that companies use to manage climate risk," she added.

Investors will find it valuable to know if companies that have developed transition plans are using an internal carbon price, said Renee Jones, director of the SEC's Division of Corporate Compliance, who was present for the discussion.

Posted 13 April 2022 by Amena Saiyid, Senior Climate and Energy Research Analyst

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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