The SEC’s Upcoming Climate Disclosure Rules

Sarah Solum, Valerie Ford Jacob, and Michael Levitt are partners at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Ms. Solum, Ms. Jacob, Mr. Levitt, Pamela Marcogliese, Elizabeth Bieber and Heather Kellam. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

In his remarks before the Principles for Responsible Investment “Climate and Global Financial Markets” webinar on July 28, 2021, SEC Chair Gary Gensler provided insights into what companies might expect from the SEC’s upcoming climate disclosure rules. Gensler’s remarks follow in the wake of other similar proposals for enhanced climate disclosure made by authorities in the European Union and various European countries.

“When it comes to disclosure, investors have told us what they want,” Gensler said in his speech. “More than 550 unique comment letters were submitted in response to my fellow Commissioner Allison Herren Lee’s statement on climate disclosures in March. Three out of every four of these responses support mandatory climate disclosure rules.” Gensler believes that “the SEC should step in when there’s this level of demand for [climate] information relevant to investors’ decisions.”

Gensler said that new climate change rules follow in the footsteps of historical changes the SEC has made to disclosure requirements, such as adding new requirements for risk factors in 1964, MD&A in 1980 and stock compensation in the 1990’s.

Gensler analogized this evolving public company disclosure to the expansion of the Olympics:

“If the organizers never made any changes, we’d only get to watch the events from the first modern Olympics back in 1896. No soccer, no basketball, no women’s sports. That wouldn’t exactly reflect where sports are today. Occasionally, fans raise their hands and say, “I want something a little bit different.”

Gensler has asked the SEC staff to develop a new climate risk disclosure rule proposal for the SEC’s consideration by the end of the year with the below guidance.

Companies should evaluate these potential new disclosure requirements in the context of developing their evolving environmental/climate strategy, reviewing the financial impact of climate change on their business, evaluating relevant disclosure controls and procedures and revisiting their advertised environmental claims in light of the potential upcoming changes.

1. Climate disclosures are likely to be mandatory

Gensler stated his belief that only mandatory rather than voluntary disclosures can result in companies’ climate disclosures being “consistent and comparable” both between companies and over time.

2. Companies may be required to file climate disclosures in Form 10-K

Gensler asked the SEC staff to consider whether the climate disclosures should be filed in the Form 10-K “living alongside other information that investors use to make their investment decisions.”

3. Companies may be required to make qualitative disclosures, such as descriptions of how climate-related risk feeds into the company’s strategy

Gensler asked the SEC staff to consider qualitative disclosures that answer key questions, such as:

  • how the company’s leadership manages climate-related risks and opportunities;
  • how these factors feed into the company’s strategy; and
  • how a business might adapt to the range of possible physical, legal, market, and economic changes that it might contend with in the future, such as the physical risks associated with climate change and the transition risks associated with stated commitments by companies (such as “net zero” greenhouse emission by a certain date) or requirements from jurisdictions (such as the Paris Agreement).

4. Companies may be required to make quantitative disclosures, such as metrics related to greenhouse gas emissions and financial impacts of climate change

Gensler also asked the SEC staff to consider quantitative disclosures such as metrics related to:

  • greenhouse gas emissions, specifically how companies should disclose their Scope 1 and Scope 2 greenhouse gas emissions (which measure the greenhouse gas emissions from a company’s operations and use of electricity and similar resources), and under what circumstances (if any) companies should be required to disclose their Scope 3 emissions (which measures the greenhouse gas emissions from other companies in an issuer’s value chain);
  • financial impacts of climate change; and
  • progress towards climate-related goals.

5. Industry-specific disclosure requirements may be adopted

Gensler asked the SEC staff to consider whether there should be certain metrics for specific industries, such as banking, insurance, or transportation.

6. Companies may be required to back up their advertised environmental claims (such as “net zero” commitments)

Gensler noted that while many companies have announced their intentions to reduce their greenhouse gas emissions by a certain date, making “net zero” commitments or other climate pledges, these companies can currently do so without providing information that backs up their claim. For example, he asked “do [these companies] mean net zero with respect to Scope 1, Scope 2, or Scope 3 emissions?” Gensler has asked the SEC staff to consider which data or metrics those companies might use to inform investors about how they are meeting their commitments.

7. Fund names (such as “green” or “low-carbon”) may be subject to new regulation

Gensler noted that a growing number of funds market themselves as “green,” “sustainable,” and “low-carbon.” Gensler has asked SEC staff to consider whether fund managers should disclose the criteria and underlying data they use and whether the SEC should take a holistic look at the Names Rule. The Names Rule prohibits materially deceptive or misleading fund names, by requiring funds to invest at least 80% of their assets in the investment type, industry and geographic location their names suggest.

8. The rules may be inspired by the Task Force on Climate-Related Financial Disclosures (TCFD) framework, which focuses on governance, strategy, risk management and metrics/targets

Gensler asked the SEC staff to “learn from and be inspired by” the Task Force on Climate-related Financial Disclosures (TCFD) framework, which was recently endorsed by the Group of Seven. This 74-page framework is structured around four key principles of financial disclosure:

  • Governance – The organization’s governance around climate-related risks and opportunities
  • Strategy – The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning
  • Risk Management – The processes used by the organization to identify, assess, and manage climate-related risks
  • Metrics and Targets – The metrics and targets used to assess and manage relevant climate-related risks and opportunities

The SEC’s anticipated proposals parallel similar developments ongoing in Europe. For example, in the UK, premium listed companies are already required to disclose under the TCFD framework (or explain why not) for reporting years starting from January 1, 2021, with similar rules coming into force for regulated financial firms throughout 2021. Proposals are also in process in the UK to mandate TCFD disclosure by all large companies from April 2022.

Elsewhere in Europe, the EU’s Corporate Sustainability Reporting Directive, published in April 2021 and still passing through the final steps of the legislative process, seeks to replace and expand existing environmental and social reporting obligations as part of a wider strategy to make sustainability reporting by companies more consistent (see here). This Directive would require companies to publish information on how ESG risks affect their business, companies’ ESG targets and their progress toward achieving such targets. It would also introduce a unified EU-wide reporting standard and implement a general EU-wide audit and assurance requirement for sustainability reporting. As proposed, the Directive would apply to all large companies governed by the law of an EU Member State (whether listed or not) and all companies listed on EU regulated markets (regardless of their size); subsidiaries of non-EU companies falling under this scope would also need to make the disclosures, and could choose to make the required disclosure in the annual report of their parent company (e.g., Form 10-K for US companies).

Supply chain due diligence legislation is also being implemented at a national level in the UK (with respect to deforestation) and more generally has been adopted across certain EU countries (Germany, Norway, the Netherlands, France), imposing – alongside due diligence obligations – sustainability/supply chain reporting obligations on companies established in those countries (and foreign companies in some cases). The EU has also proposed to introduce a new directive on supply chain due diligence which would impose due diligence obligations and reporting obligations regarding the company’s due diligence efforts with respect to the company’s supply chain (see here). The current pre-draft of the EU directive aims to include non-EU companies if they operate in the EU’s internal market by way of selling goods or providing services.

Finally, the EU’s Sustainability Finance Disclosure Regulation, partially in force from March 2021, imposes both substantive and disclosure-related requirements on financial products marketed as green, which must be aligned with the EU’s “taxonomy” (list of environmentally sustainable economic activities).

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