- US climate disclosure requirements are set to become stricter: the US Securities and Exchange Commission (SEC) is leading the charge, but the exact shape those changes take is unclear.
- Companies and investors need clear, consistent standards: US regulators should coordinate with foreign and domestic authorities to work toward a harmonised global reporting standard, and look to existing frameworks.
- The debate over materiality shouldn’t deter corporate reporting: regulators should incentivise climate risk disclosure through safe harbour provisions or similar approaches.
- Strict enforcement underscores the importance of early preparation: corporates and investors should be prepared – and get ahead with investment and research into reporting and monitoring methodologies.
The SEC has announced its intention to update its requirements on climate-related disclosures. Back in 2010, the SEC reinforced its risk disclosure requirements for public company filings. Its guidance laid out specific areas to consider, including the impacts on businesses from weather-related events, future climate change regulations that might impact energy production, and international treaty obligations.
Today, climate enthusiasts and some lawmakers are criticising this guidance as outdated and ineffective. Ceres, a non-profit organisation that oversees climate disclosures to the SEC, estimates that nearly half of large companies still don’t provide useful disclosures on climate-related risks, and that disclosures are often essentially meaningless.
The SEC has now solicited the industry for wide-ranging feedback on the direction of its guidance. The questions it is asking provides useful insight into the issues it’s grappling with. These include how to regulate climate change disclosures to provide more consistent, comparable and reliable information for investors; how to quantify and measure climate risks; whether to establish different reporting standards for different industries; whether to harmonize with existing global frameworks or create its own; and how to enforce standards. The answers to these questions will have enormous implications for US companies and investors.
Companies and investors need consistent standards
For reporting to be meaningful, it’s vital that companies aren’t required to navigate a morass of inconsistent global standards. It’s also beneficial for investors to be presented with consistent global standards when making investment decisions.
Unfortunately, however, there doesn’t seem to be a unified position within the industry or the SEC itself around any particular global standard, or even whether there should be one consistent global standard.
We believe the SEC should coordinate with foreign and domestic authorities to work toward a harmonised global reporting standard and look to existing frameworks, such as the Task Force on Climate-Related Financial Disclosures (TCFD), which is already used widely in Europe and espoused by top US officials.
The debate over materiality shouldn’t deter corporate reporting
It’s also critical to determine what information the SEC will mandate in its disclosures and whether it will call for disclosure of information beyond what is financially material.
One of the key differences between existing international climate-related frameworks and US securities law is the definition of “materiality.” In the US, materiality is defined as whether a “reasonable investor” would consider the information important in making an investment decision. However, the International Financial Reporting Services adopts an arguably broader definition.
Gary Gensler, the recently confirmed Chair of the SEC, has signalled support for the traditional US “reasonable investor” definition of materiality, although it’s still unclear what the SEC believes falls under this definition.
In order to encourage the disclosure of meaningful, robust climate-related information, including information that may fall outside the definition of materiality, we believe the SEC should consider enacting a multi-year safe harbour for the provision of such information outside a standard 10-K filing. This could include, for example, company reports on carbon emissions broken down into scopes 1 and 2. Providing a safe harbour would promote, without fear of penalty, the disclosure of robust climate information that would be useful to investors.
Strict enforcement underscores the importance of early preparation
Any new disclosure requirements look likely to be aggressively enforced. SEC Chair Gensler was previously a Chair of the Commodity Futures Trading Commission, responsible for writing, implementing and enforcing the Dodd-Frank rules that overhauled financial regulation in the US after the global financial crisis. He also pursued several enforcement actions against banks accused of manipulating LIBOR.
Experience tells us that Mr. Gensler will be active in reviewing, amending and drafting ESG-related rules and aggressive in enforcing them. What’s more, in March the SEC announced the creation of a Climate and ESG Task Force in its Division of Enforcement.
The SEC has warned that its initial focus will be on identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. Of course, this will change once the Commission’s climate disclosure guidance has been updated. In the meantime, issuers need to provide clear disclosures of material climate-related information that adequately detail their data assumptions, metrics and methodologies used. Stricter enforcement also underscores the importance of early preparation, which for corporates includes investment and research into reporting and monitoring methodologies.
More regulation to come
President Biden recently announced another sweeping executive order that calls for action by federal agencies to combat climate-related financial risks to the economy. The order has wide-ranging transparency, disclosure and investment implications for investors, companies, and regulators alike.
It also provides further impetus to the SEC and other agencies to deliver on the President’s sweeping climate agenda. We’re expecting the SEC to propose updated climate-related disclosure requirements soon given the clear importance the Biden Administration is placing on climate reform.
The importance of being prepared
It seems that the longstanding debate on whether and what to mandate in climate disclosures is coming to a head, although it’s still unclear exactly what the requirements will be for now. What is certain is that President Biden will be taking further action to promote the climate agenda – underscoring the importance of being prepared.