Yesterday, Allison Lee, Acting Chair of the SEC, directed the staff of Corp Fin to "enhance its focus on climate-related disclosure in public company filings." This action should come as no surprise. As I wrote just yesterday, Lee has used almost every opportunity to emphasize the importance of the SEC's taking action to mandate climate risk disclosure. (See, for example, this NYT op-ed, her remarks at PLI entitled Playing the Long Game: The Intersection of Climate Change Risk and Financial Regulation and this statement, " Modernizing" Regulation S-K: Ignoring the Elephant in the Room.") "Now more than ever," Lee said in her statement, "investors are considering climate-related issues when making their investment decisions. It is our responsibility to ensure that they have access to material information when planning for their financial future." But what will this enhanced focus on climate entail?
According to her statement, the staff will review the extent to which public companies address the topics identified in the interpretive guidance the staff issued regarding climate change in 2010, "assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks. The staff will use insights from this work to begin updating the 2010 guidance to take into account developments in the last decade." Through the comment review process, the staff also "plays a critically important role in ensuring compliance with disclosure obligations, including those that implicate climate risk." Presumably, that means the staff will be looking hard at climate change disclosures as part of the disclosure review process. However, that is not the end of the story: "[e]nsuring compliance with the rules on the books and updating existing guidance are immediate steps the agency can take on the path to developing a more comprehensive framework that produces consistent, comparable, and reliable climate-related disclosures." So stay tuned for more!
This new report from the Institute for Policy Integrity at NYU and the Environmental Defense Fund suggests that the current regulatory regime has not been effective in eliciting appropriate climate disclosure. Two years after the issuance of the 2010 guidance, the SEC reported to Congress that it had not seen a noticeable change in disclosure as a result, a conclusion supported by "outside studies conducted in the first few years after publication of the guidance reached similar conclusions. One examination of disclosures made for fiscal years 2010 to 2013, for example, found that disclosures 'are very brief, provide little discussion of material issues, and do not quantify impacts or risk,' and that 41% of corporations did not include any climate-related disclosure in their annual report. Even now, some corporations continue to avoid climate risk disclosures whole cloth. Others provide only boilerplate disclosures that are neither corporation specific (or even industry-specific) nor decision-useful—that is, they do not help investors understand and assess the risk the corporation faces or how that risk compares to those faced by other corporations." And that state of affairs has generally continued, even in the face of the development of numerous voluntary frameworks and standards. What's more, the report says, Corp Fin has failed to use the review process to elicit more disclosure. In 2010, according to the report, Corp Fin sent 49 letters to companies that included comments regarding their climate risk disclosure, but sent only three in 2012 and none in 2013. Since 2016, the report could identify only six comment letters with comments on climate risk disclosure. (See this PubCo post.)
As a reminder, the 2010 guidance points to a number of climate-related topics that could have an impact on climate disclosure. For example, regulatory, legislative, business and market changes "could have a significant effect on operating and financial decisions, including those involving capital expenditures to reduce emissions and, for companies subject to 'cap and trade' laws, expenses related to purchasing allowances where reduction targets cannot be met. Companies that may not be directly affected by such developments could nonetheless be indirectly affected by changing prices for goods or services provided by companies that are directly affected and that seek to reflect some or all of their changes in costs of goods in the prices they charge." Likewise, the guidance highlights the potential physical effects of climate change that could have a material impact on a company's business and operations, including its "personnel, physical assets, supply chain and distribution chain." In addition, the impact of climate change can have an indirect financial impact through physical risks to entities other than the company.
The guidance observes that various provisions of existing rules have the potential to require climate-related disclosure, such as the Reg S-K requirements for business narrative, legal proceedings, risk factors and MD&A, and addresses in some detail how then-current disclosure obligations could apply to climate change.
In his statement on the MD&A proposal, then SEC Chair Jay Clayton, in arguing against the inclusion of prescriptive requirements for climate-related financial disclosure, reaffirmed the SEC's long-standing commitment to a materiality-based disclosure regime and pointed out that companies could continue to look to the SEC's 2010 interpretive release for guidance regarding the application of existing disclosure requirements to climate change issues (with regard to which the "staff has generally found robust efforts to comply"), as well as staff comments that are part of the disclosure review process. (See this PubCo post.) Likewise, in a speech in 2019, then Corp Fin Director William Hinman also adverted to the 2010 guidance, advising companies to look to the current disclosure obligations under existing laws and regulations for direction. (See this PubCo post.)
For example, developments in legislation and regulation (including potentially, international accords) regarding climate change could trigger disclosure obligations under Items 101, 103, 503(c) and 303 of Reg S-K.
"With respect to existing federal, state and local provisions which relate to greenhouse gas emissions, Item 101 requires disclosure of any material estimated capital expenditures for environmental control facilities for the remainder of a registrant's current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem material. Depending on a registrant's particular circumstances, Item 503(c) may require risk factor disclosure regarding existing or pending legislation or regulation that relates to climate change. Registrants should consider specific risks they face as a result of climate change legislation or regulation and avoid generic risk factor disclosure that could apply to any company. For example, registrants that are particularly sensitive to greenhouse gas legislation or regulation, such as registrants in the energy sector, may face significantly different risks from climate change legislation or regulation compared to registrants that currently are reliant on products that emit greenhouse gases, such as registrants in the transportation sector. Item 303 requires registrants to assess whether any enacted climate change legislation or regulation is reasonably likely to have a material effect on the registrant's financial condition or results of operation.... A registrant should not limit its evaluation of disclosure of a proposed law only to negative consequences. Changes in the law or in the business practices of some registrants in response to the law may provide new opportunities for registrants.... Examples of possible consequences of pending legislation and regulation related to climate change include:
- Costs to purchase, or profits from sales of, allowances or credits under a "cap and trade" system;
- Costs required to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a "cap and trade" regime; and
- Changes to profit or loss arising from increased or decreased demand for goods and services produced by the registrant arising directly from legislation or regulation, and indirectly from changes in costs of goods sold."
Similarly, the 2010 guidance suggests that companies could be affected by legal, technological, political and scientific developments regarding climate change through changes in demand for products or services. For example, the guidance points out that companies could face reputational risk or indirect consequences or opportunities such as
- "Decreased demand for goods that produce significant greenhouse gas emissions;
- Increased demand for goods that result in lower emissions than competing products;
- Increased competition to develop innovative new products;
- Increased demand for generation and transmission of energy from alternative energy sources; and
- Decreased demand for services related to carbon based energy sources, such as drilling services or equipment maintenance services.
These business trends or risks may be required to be disclosed as risk factors or in MD&A. In some cases, these developments could have a significant enough impact on a registrant's business that disclosure may be required in its business description under Item 101."
Clearly, severe weather resulting from climate change could have serious, even catastrophic, consequences. The 2010 guidance identified the following as examples:
- "For registrants with operations concentrated on coastlines, property damage and disruptions to operations, including manufacturing operations or the transport of manufactured products;
- Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods;
- Increased insurance claims and liabilities for insurance and reinsurance companies;
- Decreased agricultural production capacity in areas affected by drought or other weather-related changes; and
- Increased insurance premiums and deductibles, or a decrease in the availability of coverage, for registrants with plants or operations in areas subject to severe weather.
Registrants whose businesses may be vulnerable to severe weather or climate related events should consider disclosing material risks of, or consequences from, such events in their publicly filed disclosure documents."
According to Reuters, Acting Corp Fin Director John Coates remarked during a conference on climate finance that the SEC "'should help lead' the creation of a disclosure system for environmental, social and governance (ESG) issues for corporations." You might recall that Coates was a member of the SEC's Investor Advisory Committee that, in May 2020, submitted a recommendation to the SEC to "begin in earnest an effort to update the reporting requirements of Issuers to include material, decision-useful, ESG factors." Instead of materiality decisions being made by ESG providers, the committee contended that "the SEC is best-placed to set the framework for Issuers to disclose material information upon which investors can rely to make investment and voting decisions." While recognizing the difficulties, the committee contended that "well-constructed, principles-based reporting that enables each Issuer, regardless of industry or business line, to set out its risks, strategies and opportunities in relation to material ESG factors should be no different than current disclosure of business risk, strategy and opportunity. ESG matters are part and parcel of the business of every Issuer and are unique to every Issuer." (See this PubCo post.)
Originally Published by Cooley, February 2021
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