The SEC’s Climate Risk Reporting Proposal Is On Its Way

The Securities and Exchange Commission (SEC) will be voting on its proposal requiring public companies to disclose the risks that they face from climate change during an open meeting on March 21, and already a battle is brewing over what the proposal will entail. 

Last week, 75 institutional investors, with a combined $4.7 trillion in assets under management, sent a letter urging the SEC to include verified Scope 1-3 value chain emissions reporting in its upcoming proposal. 

Although focused primarily on the need for Scope 3 emissions reporting, a theme in the letter is that as the financial system moves to address climate risk the lack of adequate data is becoming increasingly clear.  

“As climate-related impacts reach historic and increasingly catastrophic levels, commensurate ambition and action is required. We have seen that voluntary guidance does not result in either quick or comprehensive action by markets,” the letter said. 

Investors and other advocates of mandatory physical and transition climate risk disclosures by public companies have been beating this drum for years. 

In the banking sector, for example, the lack of consistent, comparable climate risk data has hampered US banking regulators ability to issue formal industry-wide guidance on climate risk disclosures, despite the fact that US financial services industry regulators have identified climate change as a systemic risk.  

If the SEC requires public companies to report their physical and transition climate risk exposures, US banks would be better positioned to undertake a more complete portfolio-level analysis of their climate risk exposures. In turn, this could accelerate climate risk-related mitigation and adaptation efforts, while reducing the systemic financial threat that the climate crisis poses. 

As it stands now, the US is far behind Europe, the UK, and other countries on mandatory Task Force on Climate-related Financial Disclosures- (TCFD) aligned climate risk reporting, and it could fall even further behind if it doesn’t act soon. 

Last March, the SEC told companies that it planned to reevaluate its 2010 guidance on disclosures related to climate change. And since that time, market participants have been looking to SEC Chairman Gary Gensler’s speeches and tweets, the SEC’s sample letter to companies on climate change disclosures, and the SEC corporate finance division’s requests for information about public companies’ climate risk disclosures for clues about the SEC’s plans.  

The exact parameters of the SEC’s climate risk disclosure proposal will only be known when the proposal is released. But the expectations are that the SEC’s mandatory climate risk proposal will feature: 

• TCFD-aligned climate risk reporting. The TCFD’s framework, which defines climate risk as both a physical risk and a transition risk, is the most commonly used framework for addressing climate change. Unlike transition risk, which is relatively near-term and related to the shift to a low-carbon economy, physical climate risk exposure includes near-term acute shocks, long-term chronic stresses, and all points in between.
• Disclosure of material Scope 1 and Scope 2 emissions. Whereas Scope 1 emissions are GHG emissions that come directly from a company’s operations, Scope 2 emissions are indirect GHG emissions associated with a company’s purchase of electricity, steam, heat, or cooling. (There is less clarity around whether the SEC will require mandatory Scope 3 emissions reporting. Scope 3 emissions covers value chain emissions, essentially all emissions that a company is associated with but not directly responsible for. Scope 3 risk is considered a hot button issue for several reasons, notably its complexity, the volume of data it could entail, and the difficulties associated with getting data from third parties.)

What Comes Next? 

As surely as a public comment period will follow the SEC’s proposal’s release, legal efforts aimed at blocking the new disclosure rule are likely to emerge soon after the proposal drops. The pressure to put in place a more organized system for climate risk reporting in the US will remain, however. 

Financial services companies, for example, cannot fully meet their fiduciary responsibilities to stakeholders without a clear sense of their portfolios’ complete risk profile, which must include consistent data on companies’ physical and transition climate risk exposures. Also, multinationals will want global consistency to simplify implementation and ongoing climate risk reporting efforts.  

Along these lines, the International Sustainability Standards Board (ISSB), formed at COP26 in Glasgow in November, is developing a set of global sustainability disclosure standards that span ESG, starting with standards on climate-related risk disclosures. Like the International Accounting Standards Board (IASB), the ISSB is part of the International Financial Reporting Standards (IFRS) Foundation.  

Regulators do not have to adhere to the ISSB’s sustainability disclosure standards, but G20 leaders have welcomed the IFRS Foundation’s efforts, which are focused on providing a global baseline for sustainability disclosures. 

An aim of the ISSB’s effort is to develop standards that can be combined with jurisdiction-specific requirements and that are consistent with the approaches taken in the IASB’s financial accounting standards. In this way, the ISSB’s standards could accelerate the implementation of mandatory climate risk reporting globally. Also, the ISSB’s standards could increase climate risk data comparability globally, leaving no practical reason to reinvent the wheel. Essentially, if the SEC’s proposal says that US public companies must report material physical and transition risk exposures, the ISSB’s standards could show them a way to do that. 

These developments, though seemingly mundane, have become more important because, as the Intergovernmental Panel on Climate Change noted in its latest report, even today - at 1.1 degrees C of warming - weather extremes brought on by climate change are causing impacts that are hard to manage, and climate change risks rise with temperature gradient increases. 

The arrival of the SEC’s climate risk disclosure rule proposal will create a push for more comprehensive climate risk data and for climate risk analytics that can identify emerging climate risks early.