In a July 28, 2021 speech, Securities and Exchange Commission (SEC) Chair Gary Gensler forecast that the SEC would consider adopting proposed regulations for mandatory climate risk disclosures for public companies before the end of 2021. Although the timing is uncertain for final regulations, it is reasonable to expect that these disclosures will be required at some point during 2022 for fiscal-year companies and by the 2022 year-end for calendar-year companies.
Much like the famous John F. Kennedy quote from his inaugural, “Ask not what your country can do for you — ask what you can do for your country,” the SEC continues to ponder the extent to which disclosures should be required, including (1) What actions can a company take to combat climate change? and (2) How will climate change affect a company’s business and how can a company address its impact? Gensler has raised those issues for the SEC staff to consider as it formulates recommendations for the regulatory proposal.
While Gensler wants climate change disclosures to be mandatory, his statement did not go so far as to say those disclosures must be in annual Form 10-Ks, suggesting the SEC might accept them disclosed elsewhere, like in a company sustainability report. If disclosure is required in Forms 10-K and 10-Q, these disclosures would be considered as “filed,” bringing with them a higher level of scrutiny from SEC staff and the potential for plaintiffs to sue if those disclosures were inaccurate or misleading to shareholders.
Gensler believes that mandatory disclosures will permit investors to benefit from disclosures that are consistent and comparable. He also wants those disclosures to be “decision-useful,” with sufficient detail so investors can gain helpful information — not just simply generic text.
Gensler suggested that the climate risk disclosures could fall into different buckets, including both qualitative and quantitative information about climate risk that investors can rely on or that would help them make investment decisions going forward.
As Gensler stated in his speech, "Qualitative disclosures could answer key questions, such as how the company’s leadership manages climate-related risks and opportunities and how these factors feed into the company’s strategy" — suggesting these are in the category of managing climate change business risks.
Gensler said that quantitative disclosures could include metrics related to greenhouse gas emissions, financial impacts of climate change and progress toward climate-related goals. For greenhouse gas emissions, Gensler noted there already exists a disclosure framework for emissions from a company’s operations (Scope 1) and use of electricity and similar resources (Scope 2). He suggested investors may also value a Scope 3 disclosure, which measures the greenhouse gas emissions of other companies in an issuer’s value chain.
Gensler gave credit to companies that already announced plans to be “net zero” —noting, however, that it is not often made clear whether a company intends to meet that standard for Scope 1, 2 or 3 emissions. He also wants the staff to consider which data or metrics a company would disclose to inform investors how it is meeting commitments in local jurisdictions, like those made under the Paris Agreement.
Gensler has also asked staff to consider whether "there should be certain metrics for specific industries, such as banking, insurance, or transportation.” We would speculate there may be other industries that would have their own metrics outside of this group, if the SEC were to move in that direction.
Gensler also pondered whether companies should be required to provide scenario analyses on how a business might adapt to the range of possible physical, legal, market and economic changes that it might contend with in the future. These could include forecasts of the physical risks associated with climate change and/or transition risks associated with stated commitments by companies or requirements from jurisdictions.
Gensler noted there are many existing frameworks and standards for climate-related disclosures and cited favorably the Task Force on Climate-related Financial Disclosures (TCFD) framework, which was recently endorsed by the Group of Seven. The group is made up of representatives of Britain, Canada, France, Germany, Italy, Japan and the U.S. He believes however, the SEC should move forward to write rules and establish the appropriate climate risk disclosure regime for our markets. Gensler did not suggest the TCFD framework wouldn’t help inspire the SEC’s proposal, so it is possible there may be commonalities between that framework and the one developed for U.S. markets.
Separate from the company disclosure issue, Gensler is concerned that no specific naming convention exists that accurately guides investors on fund goals, nor do funds have guidance on how to describe the criteria for deciding which companies are included in their portfolios. He noted that while some funds screen out certain industries, others focus on greenhouse gas emissions or water sustainability of their underlying assets, use human judgment or track outside indices. He wants staff to consider recommendations about whether fund managers should disclose the criteria and underlying data they use. He also wants staff to consider what naming convention these funds can or can’t use depending on their focus.
Gensler’s speech indicates meaningful movement by the SEC toward required climate change and climate risk disclosures, with the only questions being “what” they must contain, “where” they will appear and “when” companies must comply. Regardless of the answers, companies now know they must budget time and resources toward meeting these SEC requirements. While there is hope that the SEC will provide lead time for companies to comply, the Biden administration’s focus on climate change makes it plausible that these disclosures will be made effective as soon as the regulations are finalized, perhaps as early as mid-2022.
