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The SEC Climate-disclosure rule — Review of Commissioner Peirce's Comments: Part 2
Note: This post has been divided into two parts. This is Part 2 — Part 1 is here.
In March 2022 the U.S. Securities and Exchange Commission (SEC) issued its proposed Climate-disclosure rule. Many people and organizations oppose the need for this rule. One of those people is Commissioner Peirce. On March 21, 2022 she provided the following statement to justify her decision (some detail has been removed to reduce the length of this post).
At various points I have inserted my own comments in italics.
V. The Commission underestimates the costs of the proposal.
Even if it were within our statutory authority, the proposal is expensive. The Commission is sanguine about the costs of this endeavor because some companies are already making climate-related disclosures. I look forward to seeing whether commenters agree with the Commission’s cost assessments. Several aspects of the proposal could make implementation costlier than the Commission anticipates.
First, although the proposal is based in part on popular voluntary frameworks, those frameworks are neither universally used nor precisely followed. For example, the proposal looks extensively to the framework developed by the TCFD because its popularity “may facilitate achieving this balance between eliciting better disclosure and limiting compliance costs.”  Yet, a survey cited in the release suggests that U.S. companies pick and choose elements of the TCFD framework to follow and the majority do not adhere to key parts of the framework.  These results suggest that using the TCFD framework as a basis for this rulemaking will not reduce cost substantially. Moreover, for many companies the TCFD-based disclosures will be new. For these reasons, neither the data regarding predicted costs of complying with the TCFD as it was originally designed nor the data regarding costs to companies using bespoke versions of the TCFD are particularly instructive on the potential costs of complying with this proposal.
The Commission also ignores the distinction between voluntary disclosure in a sustainability report of selected items outlined in the TCFD and mandatory disclosure in SEC filings. The former disclosure is subject neither to mandatory assurance  nor to the level of liability  or scrutiny that attaches to SEC filings. I liken it to cooking. When I “follow” a recipe, I pick and choose which aspects to follow based on how much time I have, how ambitious I am feeling, and which ingredients I have on hand. If I were told that I had to prepare the same recipe in a Michelin-starred restaurant for a table of eminent food critics, my stress level would rise considerably, and I would have to outsource the job to a high-priced chef. A similar rude awakening is in store for companies that have been asking for disclosure mandates, perhaps thinking that these mandates would simply require a little more than what they are already doing voluntarily (and, as importantly, make their competitors do the same): Under these proposals, they are going to be playing an entirely different game, at far higher stakes. It is difficult to sympathize with the self-inflicted pain they are going to feel, but unfortunately, their shareholders, who, unlike corporate leadership, have not been clamoring for such disclosures, will foot the bill.
Second, as hard as it will be for a company to be confident in its own climate-related information, a company may not even be able to get the information it needs to calculate Scope 3 emissions. The company’s customers and suppliers may not track this information. Even if its suppliers disclose their emissions information, a reporting company may not feel sufficiently confident in the information to include it in its SEC filings. Many companies, therefore, will have to turn to third-party consultants to help them determine Scope 3 emissions. 
The proposal recognizes the unprecedented nature of the Scope 3 disclosure framework in a couple ways. First, it exempts smaller reporting companies.  Second, it provides a safe harbor for Scope 3 disclosures.  The efficacy of this safe harbor turns on its terms, which, in the spirit of the rest of the proposal, are nebulous. Specifically, the safe harbor covers Scope 3 statements unless they were “made or reaffirmed without a reasonable basis or [were] disclosed other than in good faith.”  “Reasonable basis” seems clear enough in most cases, but is it in this case? How is a company to determine which particular climate model or set of estimates constitutes a “reasonable basis” when different models and estimations lead to substantially different results? And what catapults a statement that was made with a reasonable basis into the category of “other than in good faith”? Is it bad faith if a company that gets wildly different numbers from two suppliers that appear to use similar processes for producing and transporting raw materials chooses to use the numbers that produce the lowest Scope 3 emissions? Third, the proposal also recognizes the unreliability of Scope 3 data by excluding those data from the assurance requirement. Realistically, nobody could credibly provide assurance for numbers that are inherently unreliable, and if nobody can credibly provide assurance, no investor is likely to find that these data provide a reasonable basis for making any investment decisions.
Third, the assurance that companies do have to get likely will be expensive. Accelerated filers and large accelerated filers will be required to include an attestation report on their Scope 1 and 2 emissions signed by an independent GHG emissions attestation provider, which will be required to provide limited assurance for the second fiscal year after the Scopes 1 and 2 emissions disclosure compliance date, and reasonable assurance starting for the fourth fiscal year after the relevant compliance date.  Audit firms are likely to be the biggest winners, as they already have established assurance infrastructures and are familiar with SEC reporting and the proposed independence framework. The attestation mandate could be a new sinecure for the biggest audit firms, reminiscent of the one given them by Section 404(b) of the Sarbanes-Oxley Act. 
Companies also will incur audit costs in connection with a number of metrics proposed to be included in the notes to the financial statements. The mandated financial statement metrics “would consist of disaggregated climate-related impacts on existing financial statement line items.”  Requiring all companies  to include disaggregated, subject-specific metrics within the financial statements is unusual, fails to accommodate the diversity across companies, and reflects a disproportionate emphasis on climate. Embedding a risk-specific disclosure requirement in the financial statements erodes the important status of financial statements as objective, economically sound representations of a company’s financial situation. These numbers and the assumptions that underlie them will be invaluable for stakeholder groups looking to force companies to pour more money into climate-related expenditures, but their value to investors is unclear.
VI. The proposed rule would hurt investors, the economy, and this agency.
Many have called for today’s proposal out of a deep concern about a warming climate and its effects on the planet, people, and the financial system. It is important to remember, though, that noble intentions, once baked into complex regulatory plans, often have ignoble results. This risk is considerably heightened when the regulatory complexity is designed to push capital allocation toward politically and socially favored ends,  and when the regulators designing the framework have no expertise in capital allocation, political and social insight, or the science used to justify these favored ends. This proposal, developed under these circumstances, will hurt investors, the economy, and this agency.
The proposal, if adopted, will have substantive effects on companies’ activities. We are not only asking companies to tell us what they do, but suggesting how they might do it. The proposal uses disclosure mandates to direct board and managerial attention to climate issues.  Other parts of the proposal offer even more direct substantive suggestions to companies about how they should run their businesses. For example, the Commission suggests that a company could “mitigate the challenges of collecting the data required for Scope 3 disclosure” by “choosing to purchase from more GHG efficient producers,” or “producing products that are more energy efficient or involve less GHG emissions when consumers use them, or by contracting with distributors that use shorter transportation routes.”  And the proposal suggests options for companies pursuing climate-related opportunities as part of a transition plan, including low emission modes of transportation, renewable power, producing or using recycled products, setting goals to help reduce greenhouse gas emissions, and providing services related to the transition to a lower carbon economy.  Similarly, the proposal suggests ways companies can meet climate-related targets, including “a strategy to increase energy efficiency, transition to lower carbon products, purchase carbon offsets or [renewable energy credits], or engage in carbon removal and carbon storage.”  With all due respect to my colleagues, society is in big trouble if we are looking to SEC lawyers, accountants, and economists to dictate how companies should address climate change.
Executives, for their part, might not mind the new regime that elevates squishy climate metrics. After all, how wonderful it will be for an executive who has failed to produce solid financial returns to be able to counter critics with a glowing report on climate transition—“Dear Shareholders, we fell far short of our earnings target this year, but you will be pleased to know that all in all it was a fantastic year since we made great progress on our climate transition plan.” If the CEO’s compensation is tied to lower greenhouse gas emissions, she can forgo the focus on company financial value—so 20th century!—and spend her time following the proposal’s urging to convince suppliers to shift to electric transport fleets and customers to freeze their jeans instead of washing them. 
Who then might mind? Investors. And by investors, I mean real people who are saving for retirement and need to earn real financial—not psychic—returns on their money. When executives focus less on financial metrics and more on other things, the financial performance of companies is likely to suffer. Moreover, the proposal does not grapple with the potential that retail investors, who are essentially confined to the public markets, should expect to see lower returns over the long term. The logical result of using the financial system as a tool in combatting climate change is to drive down returns on green investments.  Companies that cannot get funding in the public markets will retreat to the private markets, where they will have to pay investors more for capital. Higher returns will be reserved for the wealthy, who the Commission has granted access to private markets. 
Investors will not be the only ones to suffer from the diversion of attention from financial to climate objectives. The whole economy, and all of the consumers and producers it sustains, could also be hurt. First, the proposal is likely counterproductive to the important concerns around climate change. Attempting to drive long-term capital flows to the right companies ex ante is a fool’s errand because we simply do not know what effective climate solutions will emerge or from where. Markets, if we let them work, are remarkably deft at solving problems of all sorts, even big problems like climate change,  but they do so in incremental and surprising ways that are driven by a combination of chance, opportunity, necessity, and human ingenuity. The climate-change mitigating invention which right now may be rattling around in the head of a young girl in Cleveland, Ohio—the intellectual descendant of great Cleveland inventors like Garrett Morgan and Rollin Henry White —is something of which we regulators cannot even dream. Our limited job as securities regulators is to make sure that enterprising young woman can get matched up with the funds necessary to bring her idea to life. We make that match less likely if we write rules that implicitly prefer the technology we have identified as promising today over the technology of the future germinating in our young inventor’s dreams. Second, the diversion of capital also will make the economy less effective at serving people’s other needs. Insufficient capital will go to solving other important problems. Third, contrary to the Commission’s reasoning,  driving more capital toward green investments as defined uniformly by financial regulators could fuel an asset bubble that could make the financial system more vulnerable rather than more resilient.
Finally, our meddling with the incentives for capital allocation will harm this agency, which plays such an important role in the capital markets. As discussed above, the proposal takes us outside of our statutory jurisdiction and expertise, which harms the agency’s integrity. In addition, filling SEC filings with information that is inherently unreliable undercuts the credibility of the rest of the information in these important filings.  Moreover, while the existence of anthropogenic climate change itself is not particularly contentious, how best to measure and solve the problem remains in dispute. The Commission, which is not expert in these matters, will be drawn into these disputes as it reviews, for example, the climate models and assumptions underlying companies’ metrics and disclosures about progress toward meeting climate targets. This proposal could inspire future more socially and politically contentious disclosures, which would undermine the SEC’s reputation as an independent regulator.  Meanwhile, we have other important work to do, and the climate initiative distracts us from it. 
We are here laying the cornerstone of a new disclosure framework that will eventually rival our existing securities disclosure framework in magnitude and cost and probably outpace it in complexity. The building project upon which we are embarking will consume our attention and enrich many, as any massive building project does. The placard at the door of this hulking green structure will trumpet our revised mission: “protection of stakeholders, facilitating the growth of the climate-industrial complex, and fostering unfair, disorderly, and inefficient markets.” This new edifice will cast a long shadow on investors, the economy, and this agency. Accordingly, I will vote no on laying the cornerstone.
If I were voting based on how hard the staff has worked to get this proposal out the door, however, I would support it. I appreciate the long hours, extensive thought, and intense work that staff from all over the Commission—the Division of Corporation Finance, the Division of Economic and Risk Analysis, the Office of General Counsel, and the Office of Chief Accountant, among others—poured into this rulemaking. I also am grateful to the many commenters who responded to Commissioner Lee’s request for comment and for the even greater number of comments I expect we will receive in response to this proposal. Your comments will inform my thinking about whether we should adopt climate disclosure rules and, if so, what they should look like. In particular, I am interested in hearing if there are types of universally material climate information that are not being disclosed under our existing rules.
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