In remarks yesterday on a webinar, “Climate and Global Financial Markets,” from Principles for Responsible Investment, SEC Chair Gary Gensler offered us some clues about what to expect from the SEC’s anticipated climate disclosure requirements by analogizing to the Olympics: there are rules to measure performance and the “scoring system is both quantitative and qualitative,” which “brings comparability to evaluating” performance among athletes and over time. In addition, as with the components of public company reporting generally, the types of sports included in the Olympics change over time—there was no Olympic women’s surfing competition 100 years ago, but interests and demand have changed. So with disclosure requirements, which have gradually expanded to include disclosure about management, MD&A, compensation and risk factors, some hotly debated topics in their time. Now, investors are demanding disclosure about climate risk, and it’s time for the SEC to “take the baton.” To that end, Gensler has asked the SEC staff to “develop a mandatory climate risk disclosure rule proposal for the Commission’s consideration by the end of the year.” In his remarks, he outlines some of the concepts that are being considered for inclusion in that proposal.
Today, he observes, investors are asking for information about climate risks of the companies that they invest in—”consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs.” Of the 550 (unique) comment letters that have so far been submitted in response to the request for public comment announced by then-Acting SEC Chair Allison Herren Lee (see this PubCo post), three out of four responses, Gensler notes, supported mandatory climate disclosure rules.
Although some companies are already providing climate risk information—almost two-thirds of companies in the Russell 1000 Index, including 90% of the 500 largest companies in that index “published sustainability reports in 2019 using various third-party standards”—they are not necessarily as consistent, comparable or decision-useful as investors would like. After the SEC issued interpretive guidance on climate risk disclosure in 2010 (see this PubCo post), Gensler notes, a review conducted by Ceres of filings from companies in the S&P 500 found that filers “generally did not engage in ‘quantifying risks or past impacts’ with respect to climate. They also tended to use ‘boilerplate language of minimal utility to investors.’”
Gensler believes that both companies and investors “would benefit from clear rules of the road. I believe the SEC should step in when there’s this level of demand for information relevant to investors’ decisions.” With that in mind, he has asked the staff to develop a mandatory climate risk disclosure rule proposal that will “bring greater clarity to climate risk disclosures.”
First, the disclosures need to be “consistent and comparable” over time. Alluding again to the Olympics, he says, “it’s not like some sprinters run a 100-meter dash and others run 90 meters.” But voluntary disclosures can be quite inconsistent and, as a result, he believes the disclosures need to be mandatory. He has also asked the staff to consider whether these disclosures should be filed with the SEC as part of Form 10-K.
The location of information in particular documents submitted to the SEC often raises the issue of liability. Forms 10-K are considered “filed” with the SEC, but some forms or parts of forms are considered to be “furnished,” generally meaning that, while they continue to be subject to potential liability under Rule 10b-5, they are not subject to certain other liability provisions, such as Section 18 of the Exchange Act, and not incorporated by reference into other filings. For example, Form 8-K Item 7.01, relating to Reg FD disclosure, can be “furnished” to the SEC, as can compensation committee reports included in proxy statements. In a recent speech before the ESG Board Forum, Putting the Electric Cart before the Horse: Addressing Inevitable Costs of a New ESG Disclosure Regime, SEC Commissioner Elad Roisman advocated, in light of increased litigation risk in the event the SEC adopted mandatory ESG disclosure requirements, that the SEC categorize environmental and social disclosures as “furnished” to the SEC, not “filed,” comparable, he suggested, to the approach taken with disclosure of resource extraction payments. (See this PubCo post.) In his view, if the argument is that investors want the information and would benefit from the uniformity and comparability, “those benefits can be realized without imposing the level of liability that filing with the SEC presents.” In addition, to address litigation risk and avoid chilling the disclosure effort, he suggested that a safe harbor—much like the safe harbor in the PSLRA for forward-looking statements with accompanying cautionary statements—be adopted for good faith efforts to provide the required information. (See this PubCo post.) Even Commissioner Lee has advocated that the SEC might consider “deploy[ing] a safe harbor to help companies with compliance.” (See this PubCo post.)
To illustrate, Gensler identifies as potential qualitative disclosures information that “could answer key questions, such as how the company’s leadership manages climate-related risks and opportunities and how these factors feed into the company’s strategy.” Examples Gensler provides of potential quantitative disclosures include “metrics related to greenhouse gas emissions, financial impacts of climate change, and progress towards climate-related goals.”
One specific question up for consideration is disclosure about Scope 1, 2 and 3 greenhouse gas emissions. While some companies provide information on a voluntary basis about Scope 1 and Scope 2 GHG emissions (which Gensler describes as “emissions from a company’s operations and use of electricity and similar resources),” many investors are also looking for Scope 3 information (which Gensler describes as GHG “emissions of other companies in an issuer’s value chain. ” Gensler has asked the staff to “make recommendations about how companies might disclose their Scope 1 and Scope 2 emissions, along with whether to disclose Scope 3 emissions—and if so, how and under what circumstances.”
According to the EPA, “Scope 1 emissions are direct greenhouse (GHG) emissions that occur from sources that are controlled or owned by an organization (e.g., emissions associated with fuel combustion in boilers, furnaces, vehicles). Scope 2 emissions are indirect GHG emissions associated with the purchase of electricity, steam, heat, or cooling. Although scope 2 emissions physically occur at the facility where they are generated, they are accounted for in an organization’s GHG inventory because they are a result of the organization’s energy use.” The EPA defines Scope 3 emissions as emissions that “are the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly impacts in its value chain. Scope 3 emissions include all sources not within an organization’s scope 1 and 2 boundary. The scope 3 emissions for one organization are the scope 1 and 2 emissions of another organization. Scope 3 emissions, also referred to as value chain emissions, often represent the majority of an organization’s total GHG emissions…. Scope 3 emission sources include emissions both upstream and downstream of the organization’s activities.”
In addition, Gensler is considering the inclusion of industry-specific metrics, such as for banking, insurance or transportation.
Also on the table are whether to require “scenario analyses” about how the company would adapt to physical risks and transition risks. Physical risk refers to risks resulting from changes in climate, while transition risks refer to the range of risks “associated with stated commitments by companies or requirements from jurisdictions.” Gensler observes that many companies have announced “net zero” commitments or other climate pledges, including 92% of companies in the S&P 100 that “plan to set emission reduction goals.” However, Gensler maintains, “companies could announce plans to be ‘net zero’ but not provide any information that stands behind that claim. For example, do they mean net zero with respect to Scope 1, Scope 2, or Scope 3 emissions?” Alternatively, companies may operate in jurisdictions that could impose regulatory changes to comply with their own commitments, such as the Paris Agreement. How would that affect the company? Gensler has asked the staff to consider “which data or metrics those companies might use to inform investors about how they are meeting those requirements.”
In May, the White House issued an Executive Order expressing its policy “to advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk… including both physical and transition risks.” The EO states that the “intensifying impacts of climate change present physical risk to assets, publicly traded securities, private investments, and companies—such as increased extreme weather risk leading to supply chain disruptions. In addition, the global shift away from carbon-intensive energy sources and industrial processes presents transition risk to many companies, communities, and workers. At the same time, this global shift presents generational opportunities to enhance U.S. competitiveness and economic growth, while also creating well-paying job opportunities for workers.” (See this PubCo post.)
In 2019, non-profit CDP (fka the Carbon Disclosure Project) released an analysis of the responses to its climate change questionnaire for 2018 from a large group of almost 7,000 respondents. Companies identified twice as many “transition risks” as “physical risks.” Transition risks identified were primarily related to policy and legal issues rather than market, reputation or technology risks. Over 2,700 companies (39%) reported at least one transition risk. The four transition risks most commonly reported were:
- “Policy and legal: Increased pricing of GHG [greenhouse gas] emissions (nearly half the companies—1123 companies);
- Policy and legal: Mandates on and regulation of existing products and services (792 companies);
- Policy and legal: Enhanced emissions-reporting obligations (645); and
- Market: Changing customer behavior (627).”
The most commonly identified physical risks were:
- “The increased severity of extreme weather risks;
- Changes to precipitation and weather patterns; and
- Rising mean temperatures.”
(See this PubCo post.)
Although many of the public comments received so far in response to the SEC’s request referred to external standard-setters, such as the TCFD, and Gensler has asked the staff to “learn from and be inspired by these external standard-setters,” Gensler appears to dismiss any inference that the SEC will be outsourcing its rulemaking; he makes clear that, in his view, the SEC should “write rules and establish the appropriate climate risk disclosure regime for our markets, as we have in prior generations for other disclosure regimes.”
On a related topic, Gensler also discussed so-called “green” funds, asking what “information stands behind those claims? The basic idea is truth in advertising.” He thinks that investors “should be able to drill down to see what’s under the hood of these funds,” and, accordingly, has directed staff to consider whether “fund managers should disclose the criteria and underlying data they use,” as well as whether the SEC needs to revisit the Names Rule, a rule designed to address concerns that certain fund names may mislead investors about a fund’s investments.