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SEC Climate-Related Disclosures Introduction: Part 2
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This post is the third in a series to do with the proposed rule from the United States Securities and Exchange Commission (SEC) to do with climate change disclosure. The first two posts are:
SEC Climate-Related Disclosures for Investors.
This is an analysis of the press release that accompanied the release of the proposed rule.
SEC Climate-Related Disclosures Introduction: Part 1
A review of the first 23 pages of the Introduction to the proposed rule.
We continue the review of the Introduction to the proposed rule in this post.
The rule is 460 pages long, so it is not realistic to reproduce its contents in their entirety in this blog series. Therefore, we show sections of the rule followed by a discussion as to their meaning and impact. The page numbers provided match those in the SEC’s document, located at https://www.sec.gov/rules/proposed/2022/33-11042.pdf. We start this post at page 24 of the proposed rule. We quote sections of the proposed rule followed by a commentary or analysis.
Analysis of the Proposed Rule
As the Commission recognized in 2010 and earlier, there has been significant investor
demand for information about how climate conditions may impact their investments. That demand has been increasing in recent years. Several major institutional investors, which collectively have trillions of dollars in investments under management, have demanded climate-related information from the companies in which they invest because of their assessment of climate change as a risk to their portfolios, and to investments generally, and also to satisfy investor interest in investments that are considered “sustainable.”
The SEC justifies the need for this rule by citing the concerns of major investors.
The word sustainable is rightly put inside quotation marks. It is a word that means different things to different people. It is also a word that seems to defy the Second Law of Thermodynamics.
The UN Principles for Responsible Investment (“PRI”) has acquired over 4,000
signatories who, as of July 13, 2021, have, in the aggregate, assets under management exceeding $120 trillion as of July 13, 2021.
The material on this page of the proposed rule emphasizes the need for consistency of reporting.
The PRI is the world’s leading proponent of responsible investment. It works:
to understand the investment implications of environmental, social and governance (ESG) factors;
to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions.
The PRI acts in the long-term interests:
of its signatories;
of the financial markets and economies in which they operate;
and ultimately of the environment and society as a whole.
The PRI is truly independent. It encourages investors to use responsible investment to enhance returns and better manage risks, but does not operate for its own profit; it engages with global policymakers but is not associated with any government; it is supported by, but not part of, the United Nations.
The Net Zero Asset Managers Initiative, which was formed by an international group of asset managers, has 128 signatories that collectively manage $43 trillion in assets as of July 2021;
The Climate Action 100+, an investor-led initiative, now comprises 617 global investors that together have more than $60 trillion in assets under management; and
The Glasgow Financial Alliance for Net Zero (“GFANZ”), a coalition of over 450
financial firms from 45 countries, responsible for assets of over $130 trillion, that are committed to achieving net-zero emissions by 2050, reaching 2030 interim targets, covering all emission scopes and providing transparent climate-related reporting.
Each of these investor initiatives has emphasized the need for improved disclosure by
companies regarding climate-related impacts. Each of these initiatives has advocated for mandatory climate risk disclosure requirements aligned with the recommendations of the Task Force on Climate-Related Financial Disclosures (“TCFD”) so that disclosures are consistent, comparable, and reliable.
There are many initiatives to do with financial reporting and climate change. The TCFD provides an important framework that will be discussed in future posts.
These initiatives demonstrate that investors are using information about climate risks now as part of their investment selection process and are seeking more informative disclosures about those risks.
Despite increasing investor demand for information about climate-related risks and
strategies, many investors maintain that they cannot obtain the consistent, comparable, and material information that they need to properly inform their investment or voting decisions . . . the fragmentation of information that has resulted from a rise in third-party data providers that have emerged to try to meet the informational demands of investors.
Consistency of reporting is crucial. Yet climate-related information comes from a wide variety of sources. Obtaining consistency on a timely basis is a massive challenge.
In addition, a diverse group of third parties has developed climate-related reporting
frameworks seeking to meet investors’ informational demands. These include the Global Reporting Initiative (“GRI”), CDP (formerly the Carbon Disclosure Project), Climate Disclosure Standards Board (“CDSB”), Value Reporting Foundation (formed through a merger of the Sustainability Accounting Standards Board (“SASB”) and the International Integrated Reporting Council (“IIRC”)), and the TCFD.
However, because they are voluntary, companies that choose to disclose under these frameworks may provide partial disclosures or they may choose not to participate every year. In addition, the form and content of the disclosures may vary significantly from company to company, or from period to period for the same company. The situation resulting from these multiple voluntary frameworks has failed to produce the consistent, comparable, and reliable information that investors need. Instead, the proliferation of third-party reporting frameworks has contributed to reporting fragmentation, which can hinder investors’ ability to understand and compare
registrants’ climate-related disclosures.
Pulling all these initiatives together into one rule is a challenge.
The SEC justifies the need for a rule because voluntary actions have not produced consistency of reporting.
The staff has reviewed more than a dozen studies of climate-related disclosures
conducted by third parties, such as the CDP, KPMG, TCFD, and Ernst & Young, which assessed the adherence of the climate-related disclosures to various third-party frameworks, such as the TCFD. These studies have reinforced the staff’s observations from their review of filings that there is significant variation across companies and industries with regard to the content of current climate disclosures.
A Technical Experts’ Group of IOSCO worked with a Technical Readiness Working
Group of the IFRS Foundation to assess and fine-tune a prototype climate-related
financial disclosure standard (“Prototype”).
A standard format or “go-by” is needed.
In recent years, two significant developments have occurred that support and inform the Commission’s proposed climate-related reporting rules. The first involves the TCFD, which has developed a climate-related reporting framework that has become widely accepted by both registrants and investors. The second involves the Greenhouse Gas Protocol (“GHG Protocol”), which has become a leading accounting and reporting standard for greenhouse gas emissions. Both the TCFD and the GHG Protocol have developed concepts and a vocabulary that are commonly used by companies when providing climate-related disclosures in their sustainability or related reports. As discussed in greater detail below, the Commission’s proposed rules incorporate some of these concepts and vocabulary, which by now are familiar to many registrants and investors.
PAGEs 35, 37
The TCFD framework establishes eleven disclosure topics related to four core themes that provide a structure for the assessment, management, and disclosure of climate-related financial risks: governance, strategy, risk management, and metrics and targets . . .
. . . As a result, although the reporting landscape is crowded with voluntary standards that seek different information in different formats, the TCFD framework has been widely endorsed by U.S. companies and regulators and standard-setters around the world.
The GHG Protocol’s Corporate Accounting and Reporting Standard provides uniform
methods to measure and report the seven greenhouse gasses covered by the Kyoto Protocol – carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride, and nitrogen trifluoride.
In practice, measurement of the concentration of these gases, with the exception of carbon dioxide, is difficult and uncertain. The second most important greenhouse gas is methane. Yet there is considerable uncertainty as to how much of this gas is currently being released. Moreover, as surface and sea temperatures rise, methane emissions from natural clathrates will increase (in the limit this is known as the “clathrate gun”).
The reality is that there is much uncertainty to do with most greenhouse gases. Understanding the science behind these emissions must come before credible financial disclosures can be developed.
The GHG Protocol introduced the concept of “scopes” of emissions to help delineate those emissions that are directly attributable to the reporting entity and those that are indirectly attributable to the company’s activities.
The idea of Scopes is foundational to most climate-change reporting. Scope 3 is important but difficult to define and quantify.
Provides information to do with timing of reports to the SEC.
Many organizations are working on the development of climate-related financial reporting. However, these activities are voluntary. Hence, current reports tend to be inconsistent and they provide different levels of detail. The SEC rule pulls together many of these initiatives and creates a uniform approach that companies in the United States are required to follow.
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