On February 24, 2021, Allison Herren Lee, acting chair of the Securities and Exchange Commission (SEC or Commission), issued a statement titled Statement on the Review of Climate-Related Disclosure (Climate Disclosure Statement) that “direct[s] the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings.” This Climate Disclosure Statement expressly builds on the Commission’s interpretive guidance issued in 2010 regarding disclosure related to climate change (2010 Climate Guidance), which applied the Commission’s principles-based approach to climate change matters.
The Climate Disclosure Statement announces that, as part of the Commission’s “enhanced focus in this area,” SEC staff will take “immediate steps” to “review the extent to which public companies address the topics identified in the [2010 Climate Guidance], 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.” Using the insights gained from this work, the Commission will “work to begin updating the [2010 Climate Guidance] to take into account developments in the last decade.” Lastly, Acting Chair Lee indicates the Commission is “on [a] path to[wards] developing a more comprehensive framework that produces consistent, comparable, and reliable climate-related disclosures.”
Summary of the 2010 Climate Guidance
The 2010 Climate Guidance is an interpretive release issued in response to several petitions for interpretive guidance submitted by large institutional investors and other investor groups. Sticking to the Commission’s principles-based approach for assessing non-financial materiality with respect to disclosure under Regulation S-K, SEC staff identified four specific provisions of Form 10-K where climate risk could be relevant:
- Item 101: Description of Business. This item requires companies to disclose “the material effects that compliance with Federal, State and local provisions . . . may have upon the capital expenditures, earning and competitive position of the registrant and its subsidiaries.”
- Item 103: Legal Proceedings. This item requires corporations “to describe briefly any material pending legal proceedings, other than ordinary routine litigation . . . to which the registrant or any of its subsidiaries is a party or of which any of their property is subject.”
- Item 303: Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A). This item requires disclosure of “material events and uncertainties known to management that would cause reported financial information to not be necessarily indicative of future operating results or of future financial condition.” A “trend, demand, commitment, event or uncertainty” must be disclosed if the corporation cannot affirmatively determine that it is not reasonably likely to occur and not reasonably likely to have a material effect.
- Item 503(c): Risk Factors. This item focuses on risks that are unique or specific to a corporation’s business rather than general risks that are associated with the market as a whole and requires registrants to provide a “discussion of the most significant factors that make the offering speculative or risky.” (Note: this item has been moved to Item 105 with some changes, including replacing “most significant” with “material,” and eliminating the requirement to disclose “unique or specific” risks.)
The 2010 Climate Guidance also identified four topics registrants should consider when analyzing what may trigger climate-related disclosure:
- The impact of existing (and if material, pending) legislation and regulation in both the United States and globally.
- Where material, the impact of international accords relating to climate change.
- The indirect consequences of regulation or business trends, such as decreased demand for products or reputational damage.
- The actual or potential physical impacts of climate change, such as property damage or the disruptions in supply chains and operations of customers.
Shortcomings of the 2010 Climate Guidance
Although the 2010 Climate Guidance increased climate-related disclosure the following reporting year, with the number of S&P 500 companies who mentioned climate change in their annual reports increasing by 11 percent from the year prior, the positive impact of the 2010 Climate Guidance has since dissipated. The number of companies electing to make climate-related disclosures remained steady in the following years. Also, efforts by the SEC to promote compliance with materiality standards pertaining to climate risk using comment letters drastically declined. Between 2010 and 2013, the SEC sent comment letters to 23 public companies regarding the quality of (or lack of) their climate-related disclosures. Between 2014 and 2017, SEC staff sent comment letters to only 14 public companies. Since 2017, SEC staff has only sent comment letters to three public companies.
In 2016, the SEC issued a concept release regarding Regulation S-K, with some questions relating to sustainability reporting. Despite sustainability reporting being a very small portion of the release (4 of 92 pages), over two-thirds of the 276 non-form comment letters the SEC received addressed sustainability-related concerns. The SEC has not taken any action since this release with respect to climate-related disclosure. When the SEC did amend Regulation S-K in November 2020, it did so without addressing climate-related disclosure, drawing dissents from Commissioner Crenshaw and then-Commissioner Lee.
How the Market Is Currently Handling Climate-Related Risk
In the absence of government action relating to climate risk disclosures, the market has responded with the creation of many frameworks and standards relating to climate specifically, and more broadly sustainability. The most widely adopted frameworks and standards include those by the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), the Climate Disclosure Standards Board (CDSB), the CDP (formerly the Climate Disclosure Project), the Global Reporting Initiative (GRI”, and the International Integrated Reporting Council (IIRC). In the United States, the TCFD framework and the SASB standards have been the most widely adopted. The recommendations of the TCFD were also included as a backstop in the Climate Risk Disclosure Act of 2019, and the SASB standards were developed to be used in SEC filings and are based on the SEC’s materiality standard.
Despite all these initiatives striving to provide investors with the data they demand, investors still lack comparable and reliable climate-related disclosures. Without a mandated disclosure framework, issuers are able to choose from any of the above-mentioned frameworks, causing confusion for investors trying to compare data among issuers, and confusion for issuers trying to benchmark their performance against their peers. The investor community has also been critical of the quality of disclosure made by those actually disclosing climate-related risks. SASB finds that, although the prevalence of climate-related disclosure is increasing, the disclosures are often boilerplate and lack the relevant, decision-useful information that investors are demanding.
Possible Legislative and Unilateral SEC Actions
To achieve mandatory climate risk disclosure, Congress can enact new legislation that creates prescriptive requirements and directs the SEC to amend or promulgate new rules, or the SEC can take unilateral action by updating or issuing new guidance, or by amending or promulgating new rules under existing legislation. In Congress, the Climate Risk Disclosure Act was introduced in both chambers during the 116th Congress, and in the Senate during the 115th Congress. The bill died with both legislative sessions. However, the House Committee on Financial Service’s Subcommittee on Investor Protection, Entrepreneurship and Capital Markets held a hearing on February 25, 2021, where the 2021 iteration of the Climate Risk Disclosure Act was discussed. The bill would amend the Securities Exchange Act of 1934 (Exchange Act) to require issuers to disclose various climate-related risks in SEC filings and would require the SEC to adopt rules mandating other climate-related disclosures. At the February 25 hearing, there was also a discussion on the Paris Climate Agreement Disclosure Act, which would amend the Exchange Act to require disclosures related to the Paris Agreement, including whether the issuer has set targets in line with the goals of the Paris Agreement or if it plans to do so in the future, or if it has not and does not plan to, a statement as to why and whether it supports the Agreement’s temperature goals.
On March 2, 2021, the House Committee on Energy and Commerce proposed the Climate Leadership and Environmental Action for our Nation’s Future Act (CLEAN Future Act). The CLEAN Future Act would amend the Exchange Act to require that the SEC promulgate rules requiring public companies to disclose information relating to, among other things, direct and indirect greenhouse gas emissions of the issuer and its affiliates, fossil fuel-related assets owned or managed by the issuer, and climate-related risk disclosures by industry or sector.
Given the slim democratic majority in Congress and resistance to proposed climate risk disclosure bills in the past, new legislation mandating climate risk disclosure is an unlikely scenario; unilateral SEC action is more likely. Acting chair Lee has already indicated that the SEC intends to update the 2010 Climate Guidance. The SEC has also established a Climate and ESG Enforcement Task Force to identify material gaps or misstatements in disclosures under current rules. These are the quickest steps the SEC can take toward increased climate risk disclosure because they avoid the procedural hurdles of the rulemaking process, but guidance lacks the force of law and doesn’t fully satisfy the calls by investors for “relevant, standardized, comparable, and reliable disclosures.”
The SEC can take a more forceful approach by amending current regulations or promulgating new ones, but these approaches must comply with notice and comment rulemaking and would likely be delayed further by court challenges. After the reviews to determine the current state of climate risk disclosure, the SEC will likely begin to work on a new disclosure framework rule (or an amendment to a current one). Acting chair Lee has called for a “global” disclosure framework, and John Coates, the Division of Corporation Finance’s acting director, has stated that the SEC “should help lead the creation of an effective disclosure system.” The ultimate question, though, is whether the SEC will create its own climate risk disclosure framework, or whether it will model its framework after an existing voluntary, global standard. Another option is to require issuers to disclose using voluntary metrics created by any of the above-mentioned standard setters.
The SEC asked similar questions on March 15, 2021, when it requested public input on climate change disclosures. The statement includes 15 questions for commenter consideration ranging from the best approach for requiring climate-related disclosures (e.g., within Regulation S-K or S-X, or under a new regulation devoted to climate risks and opportunities) to who should develop, update, and oversee standards.
Lee has also stated that the SEC has already engaged with the FSB and the International Organization of Securities Commissions (IOSCO). On the one hand, working with the FSB is a strong indication that the work done by the TCFD may be leveraged in creating a new disclosure framework. On the other hand, IOSCO has stated it is committed to advancing sustainability priorities with the International Financial Reporting Standards (IFRS) Foundation, which has begun work toward the establishment of a Sustainability Standards Board that would build on the work of the TCFD and the other above-mentioned standard setters. However, the SEC does not permit the use of IFRS (except by foreign issuers); the SEC requires the use of Generally Accepted Accounting Principles issued by the Financial Accounting Standards Board and the SEC has been hesitant to adopt IFRS or converge the two. Because of this difference, it will be interesting to see if the SEC endorses and/or mandates the use of standards developed by a body of the IFRS.
Only time will tell the manner in which climate change disclosures are mandated. However, given the broad support for the TCFD framework and the SASB standards in the United States, it is likely that the SEC will draw heavily on them (or require their use) when developing a disclosure framework. The SASB standards were also cited in the potential recommendations by the ESG Subcommittee of the Asset Management Advisory Committee as meeting the criteria for industry specific materiality standards. Until the 2010 Climate Guidance is updated, and the SEC has provided a clearer picture of what mandatory climate-related disclosures will look like, lawyers should review the 2010 Climate Guidance as it stands, become familiar with the various voluntary reporting frameworks and standards, and monitor regulatory developments.