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US SEC seeks comment on revising approach to climate risk reporting

16 March 2021 Amena Saiyid

The US Securities and Exchange Commission (SEC) is asking for comment on how it can obtain reliable and consistent reporting on risks posed by climate and environmental impacts, as it embarks on an effort to set up a comprehensive reporting regime for these risks.

The risks posed by climate as well as environmental, social and governance (ESG) factors that companies have been reporting have not been up to par, according to SEC Acting Chairwoman Allison Herren Lee, who discussed the request during a 15 March discussion on "Meeting Investor Demand for ESG Information," convened by the Center for American Progress.

Investors need climate risk reports that are consistent, comparable, and reliable so they can use them to price risk and allocate capital, Lee said.

Lawyers and analysts tracking the SEC developments say the agency is not waiting for the incoming nominee for chairman, Gary Gensler, to be confirmed before proceeding with President Joe Biden's government-wide approach to tackling the climate crisis. They also agree that the agency's request for comment won't cause companies to take any further action other than being vigilant.

"Not a week seems to go by without another major announcement," IHS Markit Head of Americas Regulatory Affairs Salman Banaei said 15 March. He added that the SEC actions indicate the importance the Biden administration has placed on "improving climate risk and ESG factor disclosure."

Ronald Mueller, partner with the Washington office of Gibson, Dunn & Crutcher, who advises public companies on a broad range of SEC disclosure and regulatory matters, said the agency's direct announcement will not require companies to take any action.

Rather, "it adds to the drum beat of SEC statements that should already have companies evaluating what they are saying in climate disclosures," said Mueller, who is a member of the company's ESG practice.

'Jump-starting' the rulemaking

Investor demand for greater corporate disclosure about "climate change risks, impacts, and opportunities has grown dramatically over the past decade," Lee said. The SEC first identified climate impacts as a material risk affecting a company's investments in 2010 guidance, but at that time it did not establish any metrics or standards for reporting risk.

The SEC said it would accept comments for 90 days, or by 13 June, 2021, on its request that contains more than half a dozen questions that try to tease out the approaches the agency could take to improve disclosures.

Mueller characterized the SEC's action as "jumpstarting" the rulemaking process. "This is the type of questioning the SEC will often put out in advance of a rulemaking," Mueller told IHS Markit in a 15 March interview.

These include questions about the metrics that companies currently use to report Scope 1, or direct, greenhouse gas emissions from the source; Scope 2, or indirect, emissions generated as a result of transporting that product; and Scope 3 emissions, or the emissions resulting from the use of the end product.

IHS Markit's Banaei highlighted the following questions in a 15 March note to clients: "What quantified and measured information or metrics should be disclosed because it may be material to an investment or voting decision? Should disclosures be tiered or scaled based on the size and/or type of registrant? If so, how? Should disclosures be phased in over time? If so, how?"

Responses that the SEC receives on its request will inform Gensler and his staff's thinking on what to propose in terms of new rules, Banaei said.

Lee's announcement is the latest example of the Biden administration's more rigorous approach to corporate risk disclosure. It follows on the heels of a 10 March announcement by the US Department of Labor that it will not enforce two rules written under the Trump administration that would have discouraged investment advisors from using corporate ESG factors as part of their risk assessments.

SEC and climate risk

While the SEC first tackled this issue with the guidance in 2010, the lack of metrics on the agency's part gave rise to a variety of voluntary frameworks and standards that have since resulted in a patchwork of climate risk reporting regimes as well as what Lee termed "incomplete and inadequate" disclosures from companies.

A decade ago, the SEC was more focused on the nation's recovery from the subprime mortgage financial crisis, according to Mueller. At the time, there were fewer companies reporting climate risks, and there was less awareness about the science behind climate impacts.

At the time, the SEC said it would revisit the guidance with feedback from companies and stakeholders, and that seems to be happening in earnest now under the Biden administration. Lee said the SEC is responding to investors' demand for transparency.

"It's time to move from the question of 'if' to the more difficult question of 'how' we obtain disclosure on climate," Lee said, noting that the current voluntary framework is resulting in gaps in critical information.

She said the SEC needs to hear from investors, shareholders, and all interested parties about what data and metrics would be most useful to companies across industries, and to what extent should there be an industry-specific approach. She also asked what the SEC could learn from the existing voluntary frameworks to devise a climate disclosure regime that is sufficiently flexible to respond to market and scientific developments.

"And," she asked, "how should we address the significant gap with respect to disclosure presented by the increasingly consequential private markets?"

Since the 2010 guidance, the SEC has acknowledged that companies face physical risks from the harmful effects of climate change that manifest themselves in the form of the direct economic costs of repairing facilities damaged by rising waters, hurricanes, and wildfires, and indirect impacts such as increased insurance premiums. The SEC also said companies face transitional risks such as changing clean energy technology; changes in international, national, and local climate policies; and related litigation, among others.

During 1 March remarks at a CERAWeek by IHS Markit 2021 conference, Lee said she believed the SEC should work with international partners to create a harmonized set of principles to measure those types of risks.

Global demand for addressing risk from climate impacts is something Lee said the SEC can no longer ignore. Investment fund managers, such as BlackRock, are pressing companies to be more transparent about their interests in fossil fuels, and to disclose climate and ESG risks.

In its request for input, the SEC asked 15 broad questions. One was whether it should develop "a dedicated standard setter for ESG" (similar to the voluntary reporting framework established by the Financial Accounting Standards Board).

"What are the advantages and disadvantages of developing a single set of global standards applicable to companies around the world, including registrants under the commission's rules, versus multiple standard setters and standards?" the SEC asked.

Enforcement of existing disclosures

Lee's remarks during the Center for American Progress webinar made it clear that she is determined to improve the transparency and accountability of climate risk going forward, while trying to move quickly to improve the quality and reliability of climate and ESG disclosures under existing voluntary programs.

On 4 March, the SEC set up an enforcement task force that is charged with identifying "any material gaps or misstatements in issuers' disclosure of climate risks under existing rules."

For companies, that means they should double check and make sure they preserve information that supports their statements, according to Mueller, who doesn't see any of the SEC actions on climate risk disclosure as warnings.

In a 15 March letter to the SEC, the US Chamber of Commerce warned the SEC about its "enforcement-first approach" to ESG and climate change even though the agency has yet to complete its review and updates to the 2010 guidance, which it said many see as a predicate to further guidance and rulemaking.

Aside from the request for comment, Lee used the opportunity to address a public forum to float a number of ideas about how to improve disclosures, which included asking investors to comment on the potential need to bring in external auditors to attest current voluntary reports.

External auditing

She also asked whether the Public Company Accounting Oversight Board (PCAOB) should be asked to set better standards or guidance for how auditors are currently addressing climate- and ESG-related financial disclosures. The PCAOB is a private sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 to oversee the auditors of publicly traded companies and protect the interests of investors by ensuring that audits are performed in a fair and informative fashion.

Although acknowledging that the SEC does not regulate credit rating agencies, which say that they consider ESG in their assessments of companies' risks, Lee asked how the SEC could encourage "enhanced transparency" by those rating agencies.

Lee also said the SEC may revisit rules to make sure that smaller shareholders would get some consideration when voting on ESG and climate matters. "They have a right to know where their money is being invested," she said.

Lee acknowledged that the SEC's list is "by no means exhaustive," as the risks and opportunities related to climate and ESG cut across all manner of boundaries.

But, she added, the SEC must do its part in partnership with market participants and regulators around the globe to address these issues, otherwise "the lack of common benchmarks and standardized language will continue to inhibit to some degree competitive dynamics around managing climate and other ESG risks."

What is 'Materiality'

When Andres Vinelli, vice president for economic policy for the Center for American Progress, asked how the SEC plans to define "materiality" of climate risk, Lee said she would defer to the investors who are demanding this information.

The chamber, however, cautioned the SEC against using climate risk disclosures "as a means to achieve policy goals outside the scope of the federal securities laws."

While disclosures may be a part of an all-of-government, comprehensive policy to combat climate change, disclosures should be used to protect investors and be rooted in the well-established US Supreme Court definition of materiality, Tom Quaadman, vice president of the chamber's Center for Capital Markets Competitiveness, wrote in the 15 March missive.

"We believe all disclosures should provide decision-useful information to investors and be workable for companies of different sizes and industries," Quaadman added.

According to Mueller, Lee's speech has made it clear that the SEC has a variety of possible options and approaches it can take to improve climate disclosure. She indicated "what the SEC might do rather than what they will do. And what they do, it all remains to be seen," he said.

Posted 16 March 2021 by Amena Saiyid, Senior Climate & Energy Research Analyst, IHS Markit

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