Climate change matters and related calls for regulation are in headlines daily. On August 9, 2021, the UN's Intergovernmental Panel on Climate Change (IPCC) published the first major international assessment of climate-change research since 2013. The IPCC report will inform negotiations at the 2021 UN Climate Change Conference, also known as COP26, beginning on October 31, 2021 in Glasgow.
Chair Gary Gensler of the Securities and Exchange Commission (SEC) has made climate change headlines of his own in recent weeks. On July 16, 2021, Chair Gensler appointed Mika Morse to the newly created role of Climate Counsel on his policy staff, further demonstrating the importance of climate policy to the SEC's agenda. In addition, the Reg Flex Agenda includes “Climate Change Disclosure" – whether to “propose rule amendments to enhance registrant disclosures regarding issuers' climate-related risks and opportunities." (See our client alert on the Reg Flex Agenda here.) Chair Gensler has also been very active on Twitter. On July 28, 2021, he posted a video on his Twitter feed addressing the question: “What does the SEC have to do with climate?".
In prepared remarks at the Principles for Responsible Investment “Climate and Global Financial Markets" webinar later that same day, Chair Gensler shared that he has “asked SEC staff to develop a mandatory climate risk disclosure rule proposal for the Commission's consideration by the end of the year," and offered detailed insights into potential elements of that rulemaking. Chair Gensler's remarks began, like many conversations this summer, with a reference to the Olympics. Drawing a connection between the games and public company disclosure, he contended having clear rules to judge performance is critical in both forums. Taking the analogy further, Chair Gensler observed the events competed in at the Olympics, as well as who can compete in them, have evolved substantially since the first modern games in 1896. Likewise, he suggested, the categories of information investors require to make an informed investment decision also evolve over time and that the framework for public company disclosure must take appropriate steps to modernize.
Chair Gensler's recent actions and statements signal that mandating climate disclosure is one step the SEC will soon take to keep pace with what it perceives to be the needs of the modern day investor. He shared his view that investors increasingly want to understand the climate risks of the companies whose stock they own or might buy. And public companies have been listening. Chair Gensler noted that “nearly two-thirds of companies in the Russell 1000 Index, and 90 percent of the 500 largest companies in that index, published sustainability reports in 2019 using various third-party standards."
He suggested, however, these voluntary disclosures provide insufficient value to investors. Given the level of “demand for information relevant to investors' decisions," Chair Gensler believes the SEC should step in to provide companies and investors with clear rules of the road.
In his remarks, Chair Gensler advocated for clear prescriptive rules, noting such clarity would provide investors with more consistent information, and would enable them to better compare companies in which they may invest. When disclosures remain voluntary, he argued, investors are provided with a wide range of inconsistent disclosures that hinder comparability. Chair Gensler contends investors “are looking for consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs." He further explains, “decision-useful disclosure has sufficient detail so investors can gain helpful information — it's not simply generic text," and notes he believes “such prescribed disclosure strengthens comparability."
In preparing their climate risk disclosure rule proposal, Chair Gensler has asked the SEC staff to consider a variety of both qualitative and quantitative disclosures. He noted the quantitative elements may include: financial impacts of climate change, progress towards climate-related goals and metrics related to greenhouse gas emission metrics. With that in mind, Chair Gensler noted he has asked the SEC staff to “make recommendations about how companies might disclose their Scope 1 and Scope 2 emissions, along with whether to disclose Scope 3 emissions[1] — and if so, how and under what circumstances." Chair Gensler further observed that qualitative disclosures could answer key questions regarding how companies manage climate-related risks and opportunities and how those risks and opportunities are reflected in the company's strategy.
Chair Gensler also requested the SEC staff to consider whether the disclosure framework should include industry-specific metrics or one single standard. He has also asked the SEC staff to consider whether to require companies to provide “scenario analyses" disclosures detailing how their business might adapt to the range of potential climate risks they may encounter. Chair Gensler also noted many companies have announced plans to “reduce their greenhouse gas emissions" or made “net zero" commitments or similar climate pledges. He has asked the SEC staff to consider which data or metrics those companies might use to inform investors about how they are meeting those requirements.
Chair Gensler said that he has also asked SEC staff to consider whether climate disclosures should be filed in the Form 10-K alongside other information that investors use to make their investment decisions.
He also asked the SEC staff to learn and take inspiration from the work of existing climate standard-setting bodies, including the Task Force on Climate-related Financial Disclosures (TCFD) framework recently endorsed by the Group of Seven. The SEC, however, he concluded, should write its own rules and formulate its own disclosure requirements that are appropriate for U.S. investors. “When it comes to disclosure," Gensler observed, “investors have told us what they want. It's now time for the Commission to take the baton."
The SEC is under public pressure from various advocacy campaigns to deliver proposed rules as quickly as possible, including a statement coordinated by The Investor Agenda, and signed by 457 investors representing over USD $41 trillion in assets, calling on the SEC to implement “mandatory climate risk disclosure requirements aligned with the TCFD recommendations, ensuring comprehensive disclosures that are consistent, comparable, and decision-useful."[2] Both the Investment Company Institute[3] and the Council for Institutional Investors[4] submitted letters in June urging the SEC to, among other requests, develop rules requiring issuers to develop, implement and maintain internal controls and disclosure controls and procedures for climate disclosures comparable to the systems used by issuers for financial reporting.
We note the SEC's section of the Spring 2021 Unified Regulatory Agenda forecasts proposed rules for climate change disclosure by October 2021, which would provide a proposed rules framework leading up to COP26 and ahead of the year-end timeline shared by Chair Gensler in his July 28th remarks. Although the timing and ultimate outcome of the potential rulemaking remain to be seen, we believe companies should expect to see a proposal in the next few months, which will be subject to public comments before final adoption by the SEC.
Endnotes
[1] Greenhouse gas emissions are categorized into three categories, or “scopes", by the most widely-used international accounting tool, the Greenhouse Gas Protocol. Scope 1 covers direct emissions from sources owned or controlled by the company. Scope 2 covers indirect emissions from the generation of purchased electricity, steam, heating and cooling consumed by the company. Scope 3 is defined more broadly to include all other indirect emissions that occur both upstream and downstream of the company's operations, such as emissions from the company's supply chain, the company's non-energy inputs and the full life cycle of the company's products, including the electricity the company's customers may consume when using their products. Given this broad range, a company's Scope 3 emissions are often far larger than its Scope 1 and 2 emissions combined.
[2] The Investor Agenda is a partnership of investor groups, including Ceres, that advocate collectively for public policy to accelerate a transition to a “net zero" emissions economy.
[3] The Investment Company Institute is a trade association representing regulated funds globally, including mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts in the U.S., and similar funds offered to investors in jurisdictions worldwide.
[4] The Council of Institutional Investors (CII) is a trade association of U.S. public, corporate and union employee benefit funds, other employee benefit plans, state and local entities charged with investing public assets, and foundations and endowments. The CII promotes policies that enhance long-term value for U.S. institutional asset owners and their beneficiaries.
Thank you to Patrick Cowherd, Of Counsel in the Houston office, for his extensive contribution to this article.