“Highly anticipated” is surely an understatement for the hyperventilation that has accompanied the wait for the SEC’s new proposal on climate disclosure regulation. The proposed rulemaking has been a subject of conjecture for many months, and internal squabbles about where the proposal should land have leaked to the press. (See this PubCo post.) As one of those hyperventilators, I’ve been speculating for months about what it might include, what it might exclude. Would it require disclosure of Scope 3 GHG emissions? Would a particular framework be selected or endorsed? Would the framework sync up with international standards or, if not, how would they overlap or conflict?  Would the framework be industry-specific? Would scenario analyses be mandated? Would companies be required to obtain third-party attestation or other independent assurance? Would reporting be scaled? There were a lot of questions.  Now, we finally know at least some of the preliminary answers: yesterday, the SEC voted, three to one, to propose new rules requiring public companies to disclose information about the material impact of climate on their businesses, as well as information about companies’ governance, risk management and strategy related to climate risk. The disclosure, which would be included in registration statements and periodic reports, would draw, in part, on disclosures provided for under the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. Compliance would be phased in, with reporting for large accelerated filers due in 2024 (assuming an—optimistic—effective date at the end of this year). The proposal would also mandate disclosure of a company’s Scopes 1 and 2 greenhouse gas emissions, and, for larger companies, Scope 3 GHG emissions if material (or included in the company’s emissions reduction target), with a phased-in attestation requirement for Scopes 1 and 2 for large accelerated filers and accelerated filers. The proposal would also require disclosure of certain climate-related financial statement metrics in a note to the audited financial statements.  For some, a sigh of relief, for others, not so much.

According to SEC Chair Gary Gensler,

“[o]ur 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.”

The comment period will be 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.

As summarized in the fact sheet, domestic and foreign public companies would be required to disclose:

Here are the rule proposal—over 500 pages!—and the press release. I plan to publish an update to this post with more detail about the rule proposal at a later time.

Background

Of course, the topic is not exactly new to the SEC.  In 2010, the staff issued interpretive guidance regarding climate change disclosure, addressing in some detail how then-current disclosure obligations could apply to climate change, such as the Reg S-K requirements for business narrative, legal proceedings, risk factors and MD&A.  (See this PubCo post.)

Nevertheless, many have viewed the current regulatory regime as ineffective in eliciting appropriate climate disclosure. As described in this 2021 report from the Institute for Policy Integrity at NYU and the Environmental Defense Fund, two years after the issuance of the 2010 guidance, the SEC reported to Congress that it had not seen a noticeable change in disclosure as a result, a conclusion supported by

“outside studies conducted in the first few years after publication of the guidance reached similar conclusions. One examination of disclosures made for fiscal years 2010 to 2013, for example, found that disclosures ‘are very brief, provide little discussion of material issues, and do not quantify impacts or risk,’ and that 41% of corporations did not include any climate-related disclosure in their annual report. Even now, some corporations continue to avoid climate risk disclosures whole cloth. Others provide only boilerplate disclosures that are neither corporation-specific (or even industry-specific) nor decision-useful—that is, they do not help investors understand and assess the risk the corporation faces or how that risk compares to those faced by other corporations.”

And that state of affairs largely continued in periodic reporting, even in the face of the development of numerous voluntary frameworks and standards. What’s more, the report said, Corp Fin had failed, up to that point, to use the review process to elicit more disclosure. In 2010, according to the report, Corp Fin sent 49 letters to companies that included comments regarding their climate risk disclosure, but sent only three in 2012 and none in 2013. Since 2016, the report could identify only six comment letters with comments on climate risk disclosure.  (See this PubCo post.)

That began to change in February 2021, when then-Acting SEC Chair Allison Herren Lee directed the staff of Corp Fin, in connection with the disclosure review process, to “enhance its focus on climate-related disclosure in public company filings,” starting with the extent to which public companies addressed the topics identified in the 2010 interpretive guidance. The staff would also “assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.”  (See this PubCo post.) Lee also issued a statement in March 2021 requesting public input on climate disclosure, observing that, since the 2010 guidance, investor demand for climate disclosure has increased dramatically, and questions have arisen about “whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts, and opportunities, and whether greater consistency could be achieved.” According to Gensler, 600 unique comment letters were submitted in response and were beneficial in developing the proposal. In September last year, Corp Fin posted a sample letter to companies containing illustrative comments regarding climate change disclosures, presumably designed to help companies think about and craft their climate-related disclosure. (See this PubCo post.) And the staff then began to issue more climate-related comments as part of the disclosure review process, asking companies to justify—in some detail—why the disclosure in their corporate social responsibility reports wasn’t also in their SEC filings and drilling down on companies’ responses that they did not disclose certain climate information in their SEC filings because the information was not viewed to be material.  In many of those cases, the SEC indicated that they viewed the companies’ responses to be conclusory and pressed the companies to drill down in their responses by providing quantitative details or more detailed explanations to justify their conclusions. (See this PubCo post.)

Investors have also been clamoring for better and more comparable climate information.  As Gensler indicated in his statement, “investors with $130 trillion in assets under management have requested that companies disclose their climate risks.” In 2021, a group of 587 institutional investors managing over $46 trillion in assets signed a statement calling on governments to undertake five priority actions to accelerate climate investment, including ‘implementing mandatory climate risk disclosure requirements aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, ensuring comprehensive disclosures that are consistent, comparable, and decision-useful.” (See this PubCo post.)  Both State Street Global Advisors (see this PubCo post) and BlackRock (see this PubCo post) have been focused on the systemic risk posed by climate change and promoted disclosure in alignment with TCFD and/or SASB.  For example, in his 2021 letter to CEOs, BlackRock CEO Laurence Fink asked companies to disclose a “plan for how their business model will be compatible with a net zero economy” (see this PubCo post), and BlackRock Investment Stewardship has advocated that companies provide disclosure regarding how climate risks and risk mitigation affect their business, including sea level rise and extreme weather events, as well as national emissions goals, carbon taxes, regulations and investment in alternative energy. (See this PubCo post.)

The proposal

As described in the fact sheet, companies would be required to provide disclosure regarding:

The proposal would require companies to provide climate-related disclosure in registration statements and annual reports under a separate caption. As proposed, Reg S-X would also mandate certain climate-related financial statement metrics and related disclosures be included in a note to the consolidated financial statements. Accelerated and large accelerated filers would be required to obtain an attestation report from an independent attestation service provider covering, at a minimum, Scopes 1 and 2 emissions disclosure. Both the narrative and quantitative climate-related disclosures would be tagged in Inline XBRL.  

The proposal includes several phase-ins and other accommodations. The general compliance phase-in would be based on filer status, with additional phase-ins for disclosure of Scope 3 emissions as well as for the assurance requirement and the level of assurance. Smaller reporting companies would be exempt from the Scope 3 emissions disclosure requirement, but for those subject to it, there would be a safe harbor from liability for Scope 3 emissions disclosure. The forward-looking statement safe harbor under the PSLRA would also be available to the extent that proposed disclosures would include forward-looking statements.

Below is the SEC’s table showing the various phase-ins, assuming a December 2022 effective date (optimistic!!) and a December 31 FYE.

At the open meeting

Not surprisingly, in a very lengthy statement, Commissioner Hester Peirce dissented. In essence, she considered the proposal to be “[s]core one for the climate-industrial complex!” In her view, the proposal would “undermine the existing regulatory framework that for many decades has undergirded consistent, comparable, and reliable company disclosures.  We cannot make such fundamental changes to our disclosure regime without harming investors, the economy, and this agency.” She contends that the proposal would turn

“the disclosure regime on its head.  Current SEC disclosure mandates are intended to provide investors with an accurate picture of the company’s present and prospective performance through managers’ own eyes….The proposal, by contrast, 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.  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.”

And the length of the proposal notwithstanding, she believes it’s still missing some key elements, such as a credible rationale, a statutory basis and a materiality limitation. She contends that the existing rules, which require disclosure of material risks and other material information, are structured to elicit tailored climate-related information from companies. She contends that the recent spate of company responses to SEC staff comment letters underscores that climate is not material for many companies. (See this PubCo post.)  Peirce views “materiality” to mean only financial materiality, but the proposed disclosure requirements, she argues, are largely “governed by an expansive recasting of the materiality standard.” (As Gensler has said numerous times, in determining whether an issue is material, he looks to whether a reasonable investor would consider it important in making an investment or voting decision.) In addition, Peirce observed, some of the requirements “apply to all companies without a materiality qualifier,” pointing, as an example, to the requirement to disclose Scope 1 and 2 emissions, which do not have a materiality qualifier. In addition, she contends that much of the quantitative data required by the proposal is “highly unreliable,” leaving investors “worse off” and resulting in information that is not comparable, consistent or reliable.

She also believes that the proposal exceeds the SEC’s authority:  the “proposal steps outside our statutory limits by using the disclosure framework to achieve objectives that are not ours to pursue and by pursuing those objectives by means of disclosure mandates that may not comport with First Amendment limitations on compelled speech.” In this context, she cites a professor for the proposition that, to determine whether a compelled disclosure is “controversial” and therefore in violation of First Amendment protections, “one should look to the degree that the mandate is consistent with the language and objectives of the statute authorizing the mandate.” She considers the authorizing statute to be focused solely on protection of investors “in their pursuit of returns on their investments, not in other capacities.  For this reason, to qualify as uncontroversial and thereby stay within First Amendment bounds, our disclosure mandates must be limited to information that is material to the prospect of financial returns.”

The SEC points to significant investor demand for climate information, but she asks, “why are they asking?  If they are asking for information to help them assess the financial value of companies in which they are considering investing, this information may be material and is likely covered by existing disclosure rules.  But many calls for enhanced climate disclosure are motivated not by an interest in financial returns from an investment in a particular company, but by deep concerns about the climate or, sometimes, superficial concerns expressed to garner goodwill….We do not have a clear directive from Congress, and we ought not wade blithely into decisions of such vast economic and political significance as those touched on by today’s proposal.” Finally, she contends that the SEC has significantly underestimated the potential costs of the rule.  

In conclusion, she believes that the “building project upon which we are embarking will consume our attention and enrich many, as any massive building project does.  The placard at the door of this hulking green structure will trumpet our revised mission: ‘protection of stakeholders, facilitating the growth of the climate-industrial complex, and fostering unfair, disorderly, and inefficient markets.’  This new edifice will cast a long shadow on investors, the economy, and this agency.  Accordingly, I will vote no on laying the cornerstone.”

Commissioner Lee had quite a different perspective.  Viewing the proposal as a “watershed moment,” she argues that climate change risk is “one of the most momentous risks to face capital markets since the inception of this agency. The science is clear and alarming, and the links to capital markets are direct and evident.” The SEC, she said, has “broad authority to prescribe disclosure requirements as necessary or appropriate in the public interest or for the protection of investors. Importantly, with that authority comes responsibility. We have a responsibility to help ensure that investors have the information they need to accurately price risk and allocate capital as they see fit.” She alluded to the pandemic as an example of a similar “crisis with roots outside financial markets [that] can, and often will, send shock waves directly through our markets.” And we have “ample, well-documented warning” that climate change can impose “potentially vast and complex impacts to financial markets.”  Investors representing trillions of dollars have sought better climate disclosure, “and, while investors are the principal drivers of demand and the principal users of disclosure, the support for enhanced disclosure requirements is far broader.” 

She asks the commenting public to consider several questions: First, under the proposal, disclosures regarding GHG emissions are required under Reg S-K, but would they be better situated under Reg S-X and located in financial statement disclosures, where they would be subject to internal control over financial reporting (ICFR)? Alternatively, should an ICFR requirement be imposed even if they remain in Reg S-K? In addition, if left in Reg S-K, the required assurance may be provided by third-party verifiers that are not PCAOB-registered audit firms. Will that difference “substantially affect the quality of, or confidence in, the verification”? Another question was whether to retain, as she clearly favors, the proposed requirement “to subject GHG Scopes 1 and 2 to reasonable assurance attestation after an interim period of limited assurance”? She also wondered whether the release provided adequate specificity about how to determine the materiality of Scope 3 emissions and whether there should be a requirement for companies to explain the basis for their determinations? Should assurance be required for Scope 3 at some point? Should the safe harbor for Scope 3 disclosures be dependent on the use of specific methodologies, instead of just a reasonable basis?

Crenshaw also observed in her statement that the U.S. is behind on these issues: “other jurisdictions and independent bodies have made significant strides to provide investors and companies with a basic framework for climate-related disclosures,” but the U.S. markets have had to rely on outdated  guidance. As result, in

“that vacuum, companies and investors fend for themselves. Companies do not know which regime to follow, what information to disclose, and how best to disclose it. Investors try to figure out how to compare different regimes, how to use discordant information, and how to discern whether it’s even accurate. All the while, these data have become more important than ever to investors as they make their investment and voting decisions. The result has been frustration—with companies making disparate climate disclosures that vary in scope, specificity, location, and reliability; and investors who do not have accurate, reliable, and comparable information.”

One example identified by Crenshaw of how the proposal would enhance disclosure is in connection with net-zero pledges from companies. Without more specific reliable information, investors have noted, “it will be difficult to assess and measure the progress companies make toward achieving what they have pledged.” Likewise, the proposal would require disclosure about the use of carbon offsets—credits “for emissions reductions purchased from an outside project.” The purchased offsets can then be used “to count as a reduction of its emissions footprint, without changing the emissions [the company] produces from its operations and business.” Under the proposal, if “offsets have been used as part of a company’s target or goal, the company would be required to disclose the amount of carbon reduction represented by the offset and information about the source of the offset. Essentially, if companies claim they are reducing overall carbon emissions by other means, they need to tell investors and how they are doing that. Commenters have indicated problems with offset verification, accuracy, and quality, and that they need better insight into how companies count offsets toward their climate goals.”

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