In a public statement issued on February 24, 2021, Acting Securities and Exchange Commission ("SEC") Chair Allison Herren Lee announced that she is directing the staff of the SEC's Division of Corporation Finance (the "Staff") to increase its focus on climate-related disclosures by public companies. The statement directs the Staff to: (i) review the extent to which public companies address the topics in the SEC's 2010 Commission Guidance Regarding Disclosure Related to Climate Change (the "2010 Guidance") and otherwise comply with related disclosure obligations under federal securities laws, (ii) engage with registrants on climate disclosure issues (e.g., through the Staff's review of public filings), and (iii) make efforts to explore how public markets are managing risks relating to climate change. The insights from this review will then be used to update the 2010 Guidance.
The SEC also announced on March 4 the creation of a Climate and ESG Task Force (the "Task Force") in its Division of Enforcement. The Task Force will develop initiatives to identify environmental, social and governance ("ESG") related misconduct, including the use of "sophisticated data analysis" to assess information across publicly reporting companies in order to identify potential violations. The initial focus of the Task Force will be on identifying "any material gaps or misstatements in issuers' disclosure of climate risks under existing rules." In addition, the Task Force will pursue tips, referrals, and whistleblower complaints on ESG-related issues, and the press release announcing the Task Force provides a link for such complaints. The work of the Task Force is meant to complement other SEC initiatives in this area, including the recent appointment of a Senior Policy Advisor for Climate and ESG.
In addition to the SEC's heightened focus on public companies' ESG and climate-related disclosures and further highlighting the SEC's focus on these topics, the SEC's Division of Examinations' ("EXAMS") 2021 examination priorities, issued on March 3, reflect a similar focus with respect to the entities it regulates. EXAMS' enhanced climate-related focus will consider whether the business continuity plans of the investment advisors and brokers that it supervises, particularly those of "systemically important registrants," account for the increasing physical and other regulatory risks associated with climate change. EXAMS also plans to focus on the consistency, adequacy, and accuracy of the disclosure that registered investment advisors and funds provide to investors regarding their offered ESG products and strategies.
In a joint public statement issued on March 4, SEC Commissioners Elad Roisman and Hester Peirce (who has historically been critical of prescriptive ESG and climate disclosure requirements) emphasized that the three announcements "raise more questions than they answer" and do not create any new standards. Nonetheless, taken together, the recent announcements are a clear signal that the SEC will be intensifying its focus on climate-related disclosures in the coming year. This client alert provides background on the 2010 Guidance, the SEC's actions with respect to climate-related disclosures since then, and key issues with respect to such disclosures that public companies should consider going forward.
The SEC's 2010 Guidance was intended to respond to heightened public awareness of the risks of climate change and to investor calls for increased disclosure on the subject. The guidance did not create new affirmative disclosure requirements, but instead clarified that climate risks and related opportunities could be material to public companies in some circumstances and, as a result, could trigger the need for disclosure under Regulation S-K of existing materiality-based disclosure requirements. The 2010 Guidance identified four categories of climate risk: (i) impact of legislation and regulation, (ii) impact of international accords, (iii) indirect consequences of regulation or business trends, and (iv) physical impact of climate change. According to the 2010 Guidance, the disclosure of climate risks and opportunities could be appropriate pursuant to various items of Regulation S-K, including descriptions of business, legal proceedings, management's discussion and analysis of financial condition and results of operations ("MD&A"), and risk factors. The 2010 Guidance is described further in our 2010 client alert on the subject.
Since the publication of the 2010 Guidance, as a part of the SEC Staff's routine review of public filings, the Staff has issued a limited number of comment letters to select companies with respect to their climate disclosure. Comment letters are used by the Staff to promote compliance with disclosure requirements and may result in requests for supplemental information to help the Staff understand a company's disclosure, or in revised or additional disclosure. Various studies have found that Staff comment letters on climate disclosures trailed off quickly after the initial publication of the 2010 Guidance, with 38 letters in 2010, 11 letters in 2011, approximately 3 letters (on average) per year from 2012-2016, and approximately 1 letter (on average) per year thereafter.1 Recent commentary has also concluded that, while the quantity of climate-related disclosures has increased since publication of the 2010 Guidance, the quality of such disclosure remains varied and does not in all instances provide sufficiently tailored discussion of the specific impact of climate risks and opportunities on reporting companies' businesses and operations.2
Notwithstanding investor calls for improved climate disclosure, the SEC considered and rejected mandatory, standardized climate change disclosure requirements in recent pronouncements on the modernization of Regulation S-K. The SEC's 2016 concept release seeking public comment on modernizing Regulation S-K expressly asked for comment on the need for mandatory, line-item disclosure of sustainability matters (including climate change). However, neither the SEC's August 2020 final rules modernizing the Regulation S-K description of business, legal proceedings, and risk factor disclosure requirements, nor its November 2020 final rule modernizing MD&A disclosures, contained specific new requirements with respect to climate disclosure. The Federal Register notice accompanying the final rule in November 2020 explained that the SEC was not imposing any ESG or sustainability requirements under Item 303 "[i]n keeping with the [SEC's] principles-based approach to MD&A" and further stated that it continued to emphasize its existing 2010 Guidance. The SEC's decision not to include new climate-related disclosure requirements was criticized in January, August, and November public statements by then-Commissioner Lee, who has been a vocal proponent for such disclosure.
Although the SEC has declined to adopt climate disclosure requirements, subcommittees of its Investor Advisory Committee ("IAC") and Asset Management Advisory Committee ("AMAC") published reports (IAC report and AMAC discussion draft) in 2020 calling for the SEC to establish standards or a framework for the disclosure of material ESG information by issuers. In recommending that the SEC begin the process of developing a principles-based ESG disclosure framework, the IAC report notes that current ESG disclosure practice, which largely occurs outside of mandatory public filings and with reference to a patchwork of voluntary disclosure frameworks, has resulted in a lack of consistent, comparable, decisionuseful, material ESG information. The IAC report is described further in our June 2020 client alert.
Of the many existing voluntary sustainability disclosure frameworks, the framework developed by the FSB's Task Force on Climate-Related Financial Disclosures ("TCFD") has been the most widely endorsed. The TCFD framework for climate disclosure refers to climate-related risks as either "transition" risks (risks, including reputation risks, associated with policy, legal, technology, or market changes as the world transitions to a low-carbon economy) or physical risks (risks to assets from acute weather events or chronic, longer-term shifts in climate patterns that may cause sea level rise or chronic heat waves). The framework is general and meant to be applicable across all sectors, although the TCFD has published sector-specific guidance for a handful of industries. The framework includes 11 recommended climaterelated disclosures across four areas: (i) governance, (ii) strategy, (iii) risk management, and (iv) metrics and targets. Since the 2017 publication of the TCFD framework, over 1,300 public companies (including 219 U.S. companies)3 have expressed support for the TCFD recommendations. In addition, many of the world's largest asset managers, including BlackRock,4 Vanguard, and State Street Global Advisors, have asked their portfolio companies to report on how they are managing climate risk using the TCFD framework, or have otherwise expressed support for the framework.5 A number of foreign jurisdictions have also endorsed the TCFD framework, with the U.K. and New Zealand both indicating that they will mandate TCFD-aligned disclosure and the European Commission incorporating TCFD recommendations into its guidelines on reporting climate-related information.
The TCFD recommendations have also been integrated into a number of leading sustainability disclosure frameworks as part of a movement to align and harmonize the various frameworks. Acting Chair Lee has remarked publicly on several occasions that the SEC should "partner with and leverage" the work done by the TCFD and others (e.g., SASB, Global Reporting Initiative ("GRI")) to establish standardized ESG and climate disclosures, and has also publicly noted that the SEC has begun outreach to global organizations, such as the FSB and the International Organization of Securities Commissions, to collaborate on the development of a disclosure framework.6
It had been widely expected that the new Biden administration would take action on climate disclosure, given President Biden's campaign pledge to require such disclosure,7 and his "Climate Day" Executive Order,8 which emphasized that the "Federal Government must drive assessment, disclosure, and mitigation of climate pollution and climate-related risks in every sector of our economy." In his confirmation hearings on March 2, 2020, Gary Gensler, President Biden's nominee to lead the SEC, also expressed his view that the SEC would continue to focus on questions relating to climate risk disclosures, and that both investors and issuers would benefit from such disclosures. Viewed in the context of the new administration's focus on climate-related matters, the February 24 statement on assessing existing disclosure and updating the 2010 Guidance may signal further SEC action to come. The February 24 statement by Acting Chair Lee expressly notes the potential for such further action in its concluding sentence, which states that "[e]nsuring compliance with rules on the books and updating existing guidance are immediate steps the agency can take on the path to developing a more comprehensive framework that produces consistent, comparable, and reliable climate-related disclosures."9
In light of the enhanced focus of the SEC on climate-related disclosures (including the potential for increased Staff engagement and comment letters on the topic and the creation of the new Climate and ESG Task Force), public companies should consider:
- Reviewing climate-related disclosures in upcoming annual reports and other future public filings to ensure that they adequately disclose material climate change risks and opportunities identified in the 2010 Guidance.
- Becoming familiar with the TCFD framework and other sustainability frameworks that build on the TCFD recommendations, and begin the process of adopting the TCFD recommendations for their climate-related disclosures, given the potential that key elements of these frameworks could be incorporated into the updated climate disclosure guidance.
- Ensuring that adequate controls and procedures are used to verify the accuracy and consistency of all climate-related disclosure, regardless of whether such disclosure is in mandatory filings, voluntary sustainability reports, or on websites.
- Being ready to respond to Staff comment letters on climate-related disclosures even for industries not typically associated with climate risk as companies in industries that were largely overlooked after publication of the 2010 Guidance could experience increased scrutiny of the transition risks and physical risks of climate change to their businesses, investors, and the U.S. economy.
- Reviewing their strategy for addressing climate-related risks and opportunities to ensure that they adequately consider the physical and transition risks associated with climate change.
- Staying tuned for the publication of the SEC's updated guidance and potential future rulemaking on climate disclosures.