On 21 March 2022, the U.S. Securities and Exchange Commission (S.E.C.) proposed rule changes which would require registered financial firms to make climate-related disclosures in their registration statements and periodic reports.
Listed firms will have to include information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and they must add climate-related financial metrics in a note to their audited financial statements.
This will have to include registered firms’ disclosure of their greenhouse gas emissions.
All of this may sound dry and dusty, but in fact it is momentous. The largest equity market in the world, worth in excess of $50 trillion, is getting behind the principles of the Task Force on Climate-related Financial Disclosures. It is accepting the logic that climate risk needs to be properly reflected in all financial decisions. It is coming into line with legislative trends across major markets, in the EU and elsewhere.
The Task Force on Climate-related Financial Disclosures (TCFD) has set out in this table what some of these climate risks are, dividing them into “transition” risks and “physical” risks -
SEC Chair Gary Gensler explained that the proposal -
...”would provide investors with consistent, comparable and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers...”
He went on -
“Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognise that climate risks can pose significant risks to companies, and investors need reliable information about climate risks to make informed investment decisions.”
Registered companies under these proposals will need to make disclosures concerning their governance of climate-related risks; how these risks are likely to have a material impact on the business in the short, medium and long term; how the risks will affect the registrant’s strategy and outlook; and the impact of climate-related events and transition activities on their financial statements.
Crucially, registrants will need to disclose information on –
Their own direct greenhouse gas (GHG) emissions (Scope 1);
Indirect emissions from purchased electricity or other forms of energy (Scope 2); and
GHG emission from upstream and downstream activities in their value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. The rule on Scope 3 emissions disclosures will address limits to resulting liability, and there will be exemptions for smaller companies.
The implications of these rules in bringing about really significant changes in, and beyond, U.S. companies has not gone unnoticed. For example, in a Reuters article by Mike Scott of 26 April 2022 ‘ESG Watch: “Writing is on the wall’ for U.S. companies with SEC’s tough new rules on reporting climate risk”.
This article underlines the significance of Scope 3 emissions being included, for companies with revenues over $75 million. It cites MSCI evidence that currently only 28% of companies analysed disclosed Scope 1 and 2 emissions, and just 15% disclosed any part of Scope 3 emissions.
Therefore it seems certain that both investors and companies will have to come to a much better understanding of the real impact of climate-related risks on most companies’ operations and financial statements. This will inevitably come to exert huge pressure on companies to begin to address climate change impacts more effectively: it will not be a viable strategy to ignore them.
The UK government recently enacted regulations placing similar requirements of climate-related financial disclosure on its largest public companies, but it has pulled back from making wider sustainability disclosures a legal requirement.
The S.E.C. rules are out for consultation, and the consultation period was just extended to June 2022. They may be subject to legal challenge, by states such as West Virginia. It is not unknown for the United States to elect governments, and Presidents, with a very different take on climate change policies. This happened before with the legislation and rules relating to U.S. pension schemes, known as E.R.I.S.A., where one President took action to make it harder for U.S. pension schemes to have to take climate into account, and his successor took an almost opposite view. But this feels a little bit different.
As the S.E.C. Chair says, investors representing tens of trillions of dollars now expect climate-related risks to be properly addressed in companies’ filings and financial statements. Not all such investors will be motivated solely by concern for the climate. They will also expect to have this information in order to be able properly to understand the true risk profile of their investments. Climate-related financial disclosures are becoming more mainstream and more standardised internationally, for example through the International Sustainability Standards Board’s ‘Sustainability Disclosure Standards’. Politics may change, but it is going to become increasingly hard to argue that this information is unnecessary and should not be generated or disclosed.
Many governments are responding to the short term pressures of the energy crisis, and the need to scale back dependence on Russian imports, by scrambling to secure more fossil fuels - more gas, more oil, more coal. They seem to have forgotten what they were saying at COP26 in Glasgow as recently as November 2021, and the fact that nearly all of them (195) endorsed the latest climate science in the IPCC’s Report of Working Group III on Mitigation just a few short weeks ago. The S.E.C.’s proposed new rules are a timely reminder that the financial markets consider climate science to be of essential relevance to all investments, and the energy transition to be well under way.