US publicly listed companies face mandatory climate-related financial risk disclosures under SEC proposal
The US Securities and Exchange Commission (SEC) has proposed a rule change that could require publicly listed companies to include climate-related disclosures and GHG emissions in their annual SEC filings, with criminal penalties for knowingly misrepresenting climate-related financial risks. This proposal comes as other international bodies seek to develop a global framework of climate-related disclosures for capital markets; and, if implemented, will make the US one of the few regions alongside the EU, UK, and New Zealand to mandate corporate climate-risk reporting.
Fast Facts
The SEC’s proposed rule could require US public companies to make climate-related financial risk disclosures in line with the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas (GHG) Protocol’s Corporate Standard
If approved by the Commission, most companies will need to re-evaluate their existing climate risk assessment processes, disclosures, and risk mitigation strategies to ensure SEC filings are compliant
In line with other SEC rules, a company that knowingly misstates information related to climate-related risk in its registration documents or financial statements could be subject to criminal penalties
The move to a more uniform, mandatory reporting framework signals the changing tide of climate-related risk disclosure expectations, with material impacts on capital markets in the US, and a likely ripple effect for companies with US dealings or seeking to raise capital with US investors
Public comment for the proposal closed on 17 June 2022 showing both strong support and pushback for the proposed rule; a final ruling is expected from the SEC later this year, with implementation possible as early as 2024 (for 2023 fiscal year reporting)
Our Insights
Material implications for capital markets
At its highest level, the proposed rule requires companies to provide “decision-useful” information to investors and stakeholders so that they can make informed judgments regarding climate-related risks that could have a material impact on a given company. More specifically, registrants will need to disclose information about:
| Topic | Disclosures |
|---|---|
| Risk management | 1. Oversight and governance of climate-related risks by the registrant’s board and management; |
| 2. How identified risks have had, or are likely to have, a material impact on the business and financial statements over the short, medium, and long-term; | |
| 3. How identified climate-related risks have affected, or are likely to affect, the strategy, business model and outlook; | |
| 4. Processes for identifying, assessing, and managing climate risk, and whether these are integrated into the overall risk management system or processes; | |
| Financial impacts | 5. The financial impact, associated mitigation expenditure, and impact on financial estimates and assumptions of climate-related events (physical risks) and transition activities; |
| Emissions | 6. Scope 1 and 2 emissions metrics, separately and comprehensively disclosed |
| 7. Scope 3 emissions if material, or if the company has a target that covers Scope 3 | |
| 8. Climate-related targets or goals and transition plan (if any) |
These disclosure items have been modelled on the TCFD and GHG Protocol. The Commission noted this decision was made to avoid adding to the fragmentation of reporting standards caused by the recent flurry of third-party frameworks. For many registrants then, these disclosures will be familiar and may already be part of a company’s voluntary reporting on its website or annual sustainability reports. However, for those unfamiliar with the TCFD and GHG Protocol, or those yet to align to any given climate-related risk disclosure framework, the threat of criminal penalties for knowingly misstating material risks will provide real impetus to take meaningful action to accurately measure and report on physical and transition risks. In practice, this change will also likely require full alignment of assumptions and disclosures provided in registrants’ sustainability reports and on company websites.
Notably, audit firms will be among the biggest benefactors of this proposed rule change. Auditor assurance frameworks designed to check SEC reporting rules have been met will need to be expanded, generating additional revenue as companies rely on these firms to dot the i’s and cross the t’s on all new climate-related risk metrics to be included in their financial statements. However, this does raise a question of purview for the Public Company Accounting Oversight Board (PCAOB). Namely, that the PCAOB will be required to oversee auditors’ review of climate-related risks, which may materially expand and even conflate its general mandate to oversee public company financial statement audits. Depending on how PCAOB oversight will be dealt with if the rule is implemented, auditors may also face penalties from the PCAOB or the Commission for misrepresentations in their audits.
Mandatory reporting under threat of criminal penalties is likely to have a material ripple effect throughout capital markets closely tied to the US. A direct comparison will be possible between public companies in each sector, providing markets, investors, regulators and others with like-for-like information about the climate risk exposures of their peers – which may also be to the advantage of private companies not forced to make such disclosures. And yet, those that move fast to embrace the change can likely expect improved access to lower cost capital. Meanwhile, companies abroad seeking to trade with, or access capital from the US under the proposed ruling, may need to demonstrate alignment to the TCFD and GHG Protocol as part of the new cost of doing business with the US.
Changing tide for climate-related disclosures
The Commission first addressed climate-related disclosures in the 1970s, with its recommendation that registrants disclose the financial impact of environmental law compliance in their filings. Following almost a decade of extensive litigation and public hearings, the Commission moved to mandate broad disclosures of the effects of climate change where they posed a material risk to a company. By 2010, many companies were voluntarily reporting climate-related information outside of their SEC filings in response to investor demand for greater detail. The SEC’s 2010 Guidance noted that these voluntary disclosures could in fact be required in a company’s Description of Business, Risk Factors, Legal Proceedings, and Management Discussions and Analysis of Financial Condition and Results of Operations – depending on the circumstances. As such, the Commission has been careful to highlight that its latest rule change would ‘augment and supplement’ the disclosures already required in company filings, whilst also acknowledging the time has come for a clear, mandatory framework to produce ‘consistent, comparable, and reliable information’ for investors who might otherwise have difficulty obtaining such information.
This tightening of disclosure requirements and push for uniformity sees the SEC join a growing list of regulators and standard setters calling for a single baseline of climate-related risks and GHG emissions disclosures. Current efforts to consolidate reporting frameworks are being led by the International Sustainability Standards Board (ISSB) established under the IFRS Foundation at COP26 in November 2021. The ISSB was tasked with the development of a comprehensive global baseline of sustainability disclosures to meet the needs of investors in various capital markets. It launched a consultation on its first two proposed standards on 31 March 2022, which cover general sustainability-related disclosure requirements and climate-related disclosure requirements. Other frameworks attempting a similar global baseline include the Global Reporting Initiative, the Carbon Disclosure Project, and the Climate Disclosure Standards Board and Value Reporting Foundation (both now a part of the IFRS foundation).
Asset managers on board, but concerns remain
ESG-related assets now account for one in three dollars managed globally according to Bloomberg, and are set to reach $41 trillion before the year is out. As sustainability fund inflow continues to grow year-on-year – with the US now leading the charge – it comes as no surprise that eight of the top ten US asset managers took up the SEC’s invitation to respond to its proposed rule change. Yet, despite broad consensus on the need for consistent and reliable disclosures on climate-related financial risks to inform investment decisions, two key issues were raised regarding risk ‘materiality’, and coverage of Scope 3 emissions.
On ‘materiality’, the new ruling proposes public companies disclose “whether any climate-related risk is reasonably likely to have a material impact on a registrant, including its business or consolidated financial statements, which may manifest over the short, medium, and long term”. The SEC has stated ‘materiality’ will be defined consistently with Supreme Court precedent, being a matter with “a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote”. Respondents have nevertheless cautioned the Commission against undermining the protections provided by the traditional materiality standard expressed by the Supreme Court by the SEC’s repeat references to the term ‘decision-useful’ information. The Investment Company Institute, which represents more than US$30 trillion in assets, discouraged the Commission against use of the ‘decision useful’ terminology, which detracts from established case law and could lead to over or under-inclusive reporting, exposing companies to unnecessary risk of litigation as a result.
On emissions, Scope 1 and Scope 2 are proposed to be covered by the ruling, with Scope 3 to be covered if material or included under a company’s emissions reduction target. Most asset managers that responded to the proposed ruling have expressed strong concerns over the latter, noting the lack of a widely adopted methodology to measure Scope 3 emissions reliably. Unlike Scope 1 and 2, Scope 3 emissions have proven difficult to monitor and control, with many businesses choosing not to attempt to abate them at risk of diverting too many resources or having those emissions be double counted by others in the supply chain. Similar pushback has been seen in other jurisdictions like Australia, the United Kingdom (unless derived from business-related travel for large companies), and the European Union (now under review) where Scope 3 emissions reporting remain voluntary by and large. As such, many asset managers have implored the Commission to instead promote the development of Scope 3 reporting practices and assessment methodologies before mandating disclosure of Scope 3 emissions. This approach would reduce the potential risk of litigation for companies unless and until a consistent, comparable, and reliable method of verifying Scope 3 emissions is achieved.
The Commission is yet to comment on the outcomes of the consultation. However, given both issues raised in response to the proposed ruling echo similar concerns expressed under alternative climate-related disclosure frameworks, it is likely that these concerns will be taken seriously and addressed in the SEC’s final determination.
Conclusion
After decades of iteration on federal filing requirements, mounting pressure from investors with growing ESG assets, and concentrated efforts to develop a globally adopted reporting framework, voluntary disclosures on climate-related risks may soon become a thing of the past for publicly listed companies in the US. If implemented, the SEC’s proposed mandatory disclosures will obligate US companies to measure and disclose the short, medium, and long-term transition and physical climate risks to their business. For Australian businesses not listed in the US, but with US dealings, or those seeking to raise capital from US investors, this could spell the end of turning a blind eye to climate-related risks, particularly if Australian regulators impose similar mandatory reporting obligations to keep pace with the likes of the US, UK, and New Zealand. Such companies will need to seriously consider aligning their strategy and company reports to well recognised frameworks such as the TCFD and GHG Protocol in order to remain competitive, and importantly, resilient to climate-related transition risks as the world converges on a pathway to net-zero emissions by 2050. And yet, one pressing question remains: what obligations, if any, are to be imposed on companies to measure the impact of their actions on the environment, and not just on the financial bottom line?
For more information, please contact Rhiannon Galletti at rgalletti@renniepartners.com.au