SEC considering mandatory climate risk disclosures

In a July 28, 2021 speech, Securities and Exchange Commission (SEC) Chair Gary Gensler announced 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, these disclosures may be required at some point during 2022 for fiscal-year companies and by year-end 2022 for calendar-year companies.

As part of efforts to formulate recommendations for the regulatory proposal, Gensler has asked the SEC staff to consider 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?

Below we outline the key components of Gensler’s speech:

• Disclosure locations. While Gensler favors mandatory climate change disclosures, he did not go so far as to say those disclosures must be in annual Form 10-Ks. This suggests that the SEC might accept them disclosed elsewhere, such as 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.
• Consistency and comparability. Gensler believes that mandatory climate risk disclosures would provide investors with consistent and comparable information. They should be “decision-useful,” with enough detail to provide helpful information instead of just generic text.
• Quantitative versus qualitative. Gensler suggested that the climate risk disclosures include both qualitative and quantitative information about climate risk. "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." Gensler pointed out that quantitative disclosures could include metrics related to greenhouse gas emissions, financial impacts of climate change and progress toward climate-related goals.
• Scope of quantitative disclosures. As an example of the scope of quantitative disclosures, Gensler noted that a disclosure framework already exists for greenhouse emissions from a company’s operations (referred to as Scope 1) and use of electricity and similar resources (Scope 2). While not endorsing those necessarily as metrics the SEC will require to be disclosed, Gensler suggested investors may also benefit from a disclosure that measures the greenhouse gas emissions of other companies in an issuer’s value chain (a potential Scope 3).
• While crediting those companies that have announced plans to become “net zero” by a certain date, Gensler noted that companies aren’t currently required to disclose which scope of emissions they plan to reduce.
• Gensler also directed the staff to consider which data or metrics a company would disclose to inform investors how it is meeting local jurisdiction commitments to reduce emissions, such as those made under the Paris Agreement, a legally binding international treaty on climate change.
• Industry-specific disclosures. Gensler asked staff to consider whether “there should be certain metrics for specific industries, such as banking, insurance, or transportation.” Other industries could also potentially have their own metrics.
• Scenario analyses. Gensler questioned whether companies should be required to provide scenario analyses on how a business might adapt to the range of possible future physical, legal, market and economic changes. These could include forecasts of the physical risks associated with climate change as well as transition risks associated with stated commitments by companies or requirements from jurisdictions.
• Existing standards/frameworks or a new disclosure regime. Gensler believes the SEC should establish a new climate risk disclosure regime appropriate for U.S. markets. However, he directed the staff to “learn from and be inspired” by existing frameworks and standards for climate-related disclosures, including the Task Force on Climate-related Financial Disclosures (TCFD) framework, which was recently endorsed by the Group of Seven (made up of representatives of Britain, Canada, France, Germany, Italy, Japan and the U.S.). This leaves open the possibility that the SEC’s proposal for U.S. markets may share common traits with the TCFD framework.
• More clarity on “green” or “sustainable” funds. 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.

Going forward

Companies should begin to budget time and resources toward complying with the anticipated mandatory climate change and climate risk disclosures, which may be finalized as early as mid-2022.

Authors

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Gary Chase

Director, Retirement and Executive Compensation

email Email phone +1 212 309 3802

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Steve Seelig

Senior Director, Executive Compensation

email Email phone +1 703 258 7623

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