This article is based on the post SEC Climate-Related Disclosures for Investors.
The material provided at this site focuses on the application of technology to climate change challenges. The material provided does not offer legal or commercial advice.
A theme of this site is that Net Zero leadership will be provided by businesses and industry. Indeed, they are already doing so. They are leading not because they want to “do good” but because they want to be commercially successful. They also want to avoid their own ‘Kodak Moment’ — they do not want to be the next Sears Roebuck.
Moreover, those companies that address the climate crisis most effectively are more likely to attract investment funds than those that talk a good game, but that are merely “greenwashing”. Therefore investors need to know what companies are really doing in order to address climate change risks. Investors need accurate, complete and timely information. Enter the SEC.
The SEC (Securities and Exchange Commission)
The United States Securities and Exchange Commission (SEC) was created in 1934 to provide investors with financial statements that were accurate, consistent and comparable. The SEC is an independent federal regulatory agency that oversees the stock market and enforces federal securities laws. Prior to the SEC’s creation, oversight of the trade in stocks, bonds and other securities was virtually nonexistent, leading to widespread fraud, insider trading and other abuses.
The SEC believes that climate change creates a substantial financial risk for companies. Therefore, investors should be provided with the information that allows them to understand the nature and scope of that risk. Hence the SEC proposes to require “climate-related disclosures for investors”.
The SEC’s actions are restricted to information disclosure. The agency is not empowered to force companies to act on the information provided. It does not possess powers such as are invested in agencies such as the Environmental Protection Agency (EPA). However, it is likely that investors, once they are provided with credible information, will put pressure on the management of companies to take those actions that reduce their climate-related risks. The SEC’s influence on climate actions is indirect.
Proposed Climate-Related Disclosures Rule
In March 2022 the SEC issued a proposed entitled The Enhancement and Standardization of Climate-Related Disclosures for Investors. The proposed rule is lengthy (490 pages). In a series of posts at this site we will examine and discuss key elements in the proposed rule and provide explanations, particularly with regard to the use of technology to reduce risk. We will evaluate the impact of the rule in the real world of energy shortages, technology scale-up, engineering and project management.
The Press Release
In this first post in this series we will review the press release (dated March 21, 2022) that accompanied the release of the proposed rule. We also provide a few comments and thoughts (shown in blue) on the information provided in that release.
SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors
FOR IMMEDIATE RELEASE
Washington D.C., March 21, 2022 —
The Securities and Exchange Commission today proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.
The word “required” means that this proposal would have the force of law.
The word “material” is important, potentially confusing, and thus requires interpretation. It will be discussed further in subsequent posts.
Climate-related risks can take various forms. Some companies are impacted negatively by climate change. For example, companies located in the American southwest that use large amounts of water are likely to face financial problems caused by the current drought. On the other hand, other companies can benefit from their climate-related actions, say by making “greener” products. Climate-related risk can be either backward or forward-looking. It can also be associated either with a company’s internal operations, or with the climate impact of its products once they are in the hands of their customers. Analyses of these risks are complex and are liable to inconsistency between companies. None of this is easy.
"I am pleased to support today’s proposal because, if adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers," said SEC Chair Gary Gensler. "Our 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. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions. Today’s proposal would help issuers more efficiently and effectively disclose these risks and meet investor demand, as many issuers already seek to do. Companies and investors alike would benefit from the clear rules of the road proposed in this release. I believe the SEC has a role to play when there’s this level of demand for consistent and comparable information that may affect financial performance. Today’s proposal thus is driven by the needs of investors and issuers."
Mr. Gensler makes it clear that the SEC’s role is limited to the provision of accurate and timely information. The SEC is not a climate enforcement agency. The statement places the SEC’s climate actions in a financial context.
The proposed rule changes would require a registrant to disclose information about (1) the registrant’s governance of climate-related risks and relevant risk management processes; (2) how any climate-related risks identified by the registrant 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; (3) how any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook; and (4) the impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.
There is a lot to unpack in this paragraph.
What is meant by the word ‘material’ in this context?
What is meant by short-, medium-, and long-term?
Transition activities could be enormously important, as discussed below.
To what extent should a company be obliged to reveal its business model? Climate-related business decisions can provide an important competitive advantage, so a company may not wish to reveal them.
For registrants that already conduct scenario analysis, have developed transition plans, or publicly set climate-related targets or goals, the proposed amendments would require certain disclosures to enable investors to understand those aspects of the registrants’ climate risk management.
Those companies that have already developed climate-action plans may, ironically, be at a disadvantage since they will be forced to share those plans. Those companies that have, on the other hand, done nothing will not be obliged to share any risks that would be identified.
The term “transition plans” covers a lot of ground. For example, a company may decide to transition from fossil fuels to wind and solar energy. The engineering associated with that transition will call for a large expenditure of fossil fuel energy. Will this transition cost be included in the Scope 2 reporting? Will the climate impact of the transition be greater than the resulting savings? This is a very complex topic — one that is very difficult to analyze, and that could easily lead to actions that are ineffective or even counter-productive.
The proposed rules also would require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. These proposals for GHG emissions disclosures would provide investors with decision-useful information to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks. The proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.
The use of Scopes to categorize emissions will be discussed in future posts. Suffice to say at this point that Scope 3 emissions are a potential mare’s nest that could lead to large inconsistencies between the reports from different companies, and that could also lead to double or triple-accounting.
Reference to other frameworks shows that the SEC is not operating in isolation. Other nations and organizations are working in the same space. In addition to the organizations mentioned, the IPCC (the Intergovernmental Panel on Climate Change) reports will provide valuable input as to how the climate may change, and what the impacts of such changes may be.
Under the proposed rule changes, accelerated filers and large accelerated filers would be required to include an attestation report from an independent attestation service provider covering Scopes 1 and 2 emissions disclosures, with a phase-in over time, to promote the reliability of GHG emissions disclosures for investors.
The proposed rules would include a phase-in period for all registrants, with the compliance date dependent on the registrant’s filer status, and an additional phase-in period for Scope 3 emissions disclosure.
Timing requirements for different types of company vary. Overall, companies have very little time to meet the rule’s requirements.
The proposing release will be published on SEC.gov and in the Federal Register. The comment period will remain open for 30 days after publication in the Federal Register, or 60 days after the date of issuance and publication on sec.gov, whichever period is longer.
It is important to stress that the proposed rule is still a proposal. It is probable that it will be the subject of litigation. The comments may also generate important changes to the proposed rule.
Assuming that the rule does move forward in something close to its present form then it will have the following impacts.
Time is pressing. Depending on their size, and on the status of their current climate programs, companies have two or three years to respond to the rule’s requirements.
Consistent and uniform reporting will be very hard to achieve. In particular, Scope 3 reporting could be highly inconsistent from one company to another.
Risk is always difficult to define. But climate-related risk is particularly difficult to understand — not least because climate science is far from an exact science, and also because the climate is part of broader systems such as fossil fuel depletion and destruction of the biosphere.