How To Read The SEC’s Milestone Proposed Climate-Related Disclosure Framework

The US Securities and Exchange Commission (SEC) released a 534-page proposal yesterday that would require publicly traded companies to disclose climate-related risks that are likely reasonably likely to have a material impact on its business, operating results, and financial condition. The required disclosure would also include independently certified greenhouse gas emissions, as a proxy for climate-related risk. While this proposed disclosure represents a sea change, it stops short of international efforts, in part due to the substantial resistance of some US public officials and industry groups.

Content of the Proposed Disclosures. The SEC’s proposed climate-related disclosure framework is modeled in part on the Task Force for Climate-Related Financial Disclosure (TCFD)’s recommendations and also draws upon the Greenhouse Gas (GHG) Protocol. TCFD, led by Financial Stability Board Head Mark Carney, issued recommendations in June 2017 for disclosing clear, comparable and consistent information about the risks and opportunities presented by climate change. GHG Protocol, the world’s most widely used GHG accounting standards for companies, buckets emissions into those from operations (Scope 1), from the energy that they consume (Scope 2), and all other upstream and downstream emissions (Scope 3).

In particular, the proposed rules would require public companies to disclose information about:

· Board and management oversight and governance of climate-related risks

· How any climate-related risks have had or are likely to have a material impact on its business and financial statements over the short-, medium-, or long-term

· How any identified climate-related risks have affected or are likely to affect strategy, business model, and outlook

· Processes for identifying, assessing, and managing climate-related risks and whether such processes are integrated into the overall risk management system or processes

· The impact of climate-related events (severe weather events, other natural conditions, and

physical risks) and transition activities (including transition risks) on financial statement line items, and disclosure of financial estimates and assumptions impacted by climate-related events and transition activities

· Scopes 1 and 2 GHG emissions metrics, separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute and intensity terms

· Scope 3 GHG emissions and intensity, if material, or there is a GHG

emissions reduction target or goal that includes its Scope 3 emissions; and

· Any climate-related targets or goals, or transition plan

When responding to any of the proposed rules’ provisions concerning governance, strategy, and risk management, companies may also disclose information concerning any identified climate-related opportunities.

Presentation of the Proposed Disclosures. Public companies would be required to provide climate-related disclosure in registration statements and annual reports. Regulation S-K mandated climate-related disclosure should be provided in a separate, appropriately captioned section of registration statements or financial reports. Regulation S-X mandated climate-related financial statement metrics and related disclosure should be provided in a note to the audited financial statements. By way of background, Regulation S-K generally focuses on qualitative descriptions, while Regulation S-X focuses on financial statements. Both narrative and quantitative climate-related disclosures should be tagged in Inline XBRL, and climate-related disclosure should be furnished rather than filed.

Phase-In Periods and Accommodations. The proposed rules would be phased in over time, with an additional phase-in period for Scope 3 emissions disclosure. Companies would benefit from a safe harbor for Scope 3 emissions disclosure. Companies would also be permitted to use estimates for fourth quarter GHG emissions together with actual GHG emissions data for the first three quarters, as long as any material differences between the estimated and actual GHG emissions data for the fourth quarter is promptly disclosed in a filing.

Toward Universal Climate Accounting Standards

The SEC’s proposed climate-related disclosure framework follows the release of the International Sustainability Standards Board (ISSB)’s Climate-Related Disclosures Prototype last November. As Oxford Professor and BCG Senior Advisor Bob Eccles expects that the ISSB’s impact on sustainability reporting will be analogous to the International Accounting Standards Board (IASB)’s for financial reporting. Both “develop standards for companies to report on their performance to investors. Both will be under the IFRS Foundation.”

The SEC’s proposed climate-related disclosure framework stops short of the more detailed requirements in the ISSB’s Climate-Related Disclosures Prototype. Specifically, the ISSB’s proposed disclosure, which also heavily relies on TCFD, goes further than the SEC’s by calling for disclosure of:

· Capital deployment: the amount of capital expenditure, financing or investment deployed toward climate-related risks and opportunities, expressed in the reporting currency

· Internal carbon prices: the price for each metric ton of greenhouse gas emissions used internally by an entity, including how the entity is applying the carbon price in decision-making

· Remuneration: the proportion of executive management remuneration affected by climate-related considerations in the current period

Since IFRS governs financial reporting in more than 140 countries, the ISSB’s final disclosure requirements are likely to heavily influence the disclosure of US issuers that seek international capital flows. The next release of the ISSB’s proposed sustainability and climate-related disclosure, building on the prototype disclosure issued last November, should also inform the SEC’s final rulemaking. Because the US capital markets are the largest and deepest in the world, the SEC and ISSB would ideally collaborate closely. Just as we need universal financial accounting standards, we also need universal climate accounting standards.

Navigating the Partisan Divide in the US

The SEC’s proposed climate disclosure framework follows last month’s US Department of Labor’s Request for Information on protecting retirement savings and pensions from risks associated with changes in climate and the Financial Stability Oversight Council (FSOC)’s formal designation of climate change an emerging and growing risk to US financial stability last year. These are part of a pattern of administrative (i.e. Executive Branch) rulemaking in support of sustainable investing during Democratic administrations.

This sustainable investing momentum may be at risk. Trump Supreme Court appointees Neil Gorsuch and Brett Kavanaugh both oppose the Chevron
CVX
deference, the doctrine that requires judges to defer administrative agencies’ interpretations of federal law where the law is ambiguous and the agency’s position is reasonable. Their opposition to administrative agency rulemaking for sustainable investing could thwart a key driver of sustainable investing momentum.

Within the SEC, Commissioners voted along party lines 3-1 to issue the proposed rule: all three Democrats backed the proposed rule. Lone dissenter SEC Commissioner Hester Peirce said that the proposed rule would undermine the existing regulatory framework without generating comparable, consistent, and reliable disclosures.

Numerous Republican lawmakers and attorney generals and industry groups also oppose the proposed disclosure framework. These individuals and organizations view the SEC’s proposed climate disclosure as overstepping its authority. West Virginia Attorney General Patrick Morrisey led a group of 16 state attorney generals opposing the SEC’s efforts to develop climate disclosure as “delving into an inherently political morass for which it is ill-suited.” The US Chamber of Commerce and American Petroleum Institute in particular agree with Hester Peirce. The list goes on.

Anticipating this substantial pushback, the SEC’s proposed climate disclosure framework is the product of months of trying to balance calling for comprehensive disclosure of climate risk from public companies with developing rules that could withstand judicial review in increasingly conservative federal courts. The comment period is expected to be a heated one. Feedback from companies, investors, and other stakeholders will be critical in developing robust final rules. The comment period will be at least two months, and comments can be submitted here.