Climate-related information is increasingly critical to investment decisions
For 50 years, the SEC has been clear that public companies must disclose their material environmental risks. In 2010, the commission provided guidance regarding its existing disclosure requirements as they apply to climate change matters. In the 14 years since, the planet has continued to warm, creating more devastating storms, catastrophic wildfires, supply chain disruptions, and other significant losses for companies and their investors. Nevertheless, companies have generally failed to disclose material climate-related risks—even after those risks have materialized into massive losses. And companies’ auditors have failed to flag those omissions.
Worse, the physical risks of climate change are accelerating. Over the most recent three years, more than 60 weather-related billion-dollar disasters have occurred in the United States, forcing millions from their homes and affecting businesses as well. The United Nations has stated that countries need to be more ambitious in reducing climate-harmful emissions to prevent the worst impacts of climate change, which include more frequent and severe droughts, heat waves, and rainfall. The urgency is palpable, and a global economic transition toward cleaner energy is taking place, including changed consumer behavior; altered supply chains; and new laws at the state, local, and international levels aimed at emissions reduction.
Investors in public companies, including institutional investors responsible for investing the savings of tens of millions of workers, need information about whether and how companies are managing for these physical and transition risks of climate change both for the near and longer term. Despite efforts by business, financial institutions, civil society, the accounting profession, and governments to establish voluntary standards for such disclosure, there remains a lack of reliability, consistency, and comparability in public company disclosures about the climate-related financial risks they face. Even when companies disclose some climate risk information, the information is difficult to find—often contained in separate documents—or not consistently reported from year to year or comparable with disclosures from other companies. And often, data on which the disclosures are based are drawn from proprietary or unreliable methodologies.
The SEC needs to step up to fulfill its mission. It must exercise its broad authority to protect investors by ensuring they have the reliable, consistent, and comparable information they need to make informed investment decisions.
The March 2022 proposal
According to press reports, the SEC is poised to join regulators from the European Union and the United Kingdom in requiring standardized climate-related disclosures.
While the SEC has not yet released the final rule, its March 2022 proposal, entitled “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” focused on ensuring that companies make financially material disclosures of climate risks in ways that are consistent with the globally recognized Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.
The March 2022 proposal would essentially require four types of disclosures:
- Financial impacts of actual and potential physical and transition risks reasonably likely to have a material impact on the business or its financial statements in the short, medium, or long term. This information is to be expressed numerically in the financial statement notes and in narrative form in a special section of its regular SEC filings entitled “Climate-related disclosure.”
- Expenditures the company makes to address those risks.
- Greenhouse gas emissions the company is responsible for, including emissions from its own fuel use (Scope 1), from the power plants that generate the electricity it uses (Scope 2), from the companies that make up its supply chain (upstream Scope 3), and from the use of its own products, such as the gasoline sold by an oil company (downstream Scope 3). The Scope 3 disclosures were proposed to apply only for larger companies—only if the disclosures are material or if the Scope 3 emissions constitute a significant portion of the company’s overall emissions—and with a special safe harbor to accommodate reasonable efforts by companies to estimate Scope 3 emissions.
- Integration of climate risk assessment and management into core business functions, including whether and, if so, how the company accomplishes this and covering governance; strategy, business model, and outlook; risk management; and targets and goals.
In addition, companies would have to disclose the impacts that the identified physical and transition risks have on the estimates and assumptions that the company uses to produce its consolidated financial statements.
Finally, the March 2022 proposal was clear that risks considered in the disclosures must be both “actual and potential” to ensure that a company is letting investors know how management is analyzing the possible risks it faces in the future, not just today. Forecasting future risk is an essential consideration for any business, as well as its investors, and speaks to the company’s resiliency and prospects.
Conclusion
The SEC will never tell companies to lower their greenhouse gas emissions or tell investors how to invest their money. The agency’s statutory mandate is to ensure that public companies disclose the information that investors need to make sound investment decisions and that those disclosures are reliable, consistent, and comparable across companies. This protects investors and the public interest by ensuring that capital markets are fair and efficient and by facilitating appropriate capital formation. Investors today urgently need reliable, consistent, and comparable climate-related information to make sound investment decisions.
In deciding what to keep in the final rule, the SEC, like many agencies, may be in the unenviable position of trying to anticipate the whims of increasingly capricious courts. But the SEC must create a clear, uniform climate disclosure standard that would apply to all companies operating in U.S. capital markets and provide investors the information they need. Whether the SEC chooses to provide clarity all at once or save some decisions for future rulemakings, there is no question about its need and statutory authority to act.