We are at an inflection point. To date, especially in the United States, disclosures related to a company’s climate-related risks primarily have been voluntary.
In the past two months, however, multiple entities across state, federal and international jurisdictions have developed more formal paths to climate disclosures, all based in large part on the Task Force on Climate-Related Financial Disclosures (TCFD) Framework.
The Securities and Exchange Commission (SEC) released its long-anticipated proposed rule that, if finalized, will require public companies to disclose certain climate-related information in their registration statements and annual reports. The Federal Deposit Insurance Corporation (FDIC) issued its own climate disclosure proposed rule for FDIC-insured banks. The National Association of Insurance Commissioners adopted an industry survey, which 14 states and the District of Columbia have said they will require insurers to use. And regulators in the European Union proposed new climate-related disclosure obligations.
Although the majority of public companies do some level of TCFD disclosure today, the vast majority are reportedly only partially adhering to the framework, and in many—if not most—cases, the disclosures are relatively generic. In issuing its proposed rule, the SEC expressed concern that these voluntary disclosures do not adequately address investor demands and that greater consistency, comparability and reliability are needed.
Backlash against the SEC rule already is mounting, and litigation challenging the rule and the SEC’s authority to impose these requirements seems inevitable. SEC commissioner Hester Peirce dissented from the approval of the proposed rule, raising these statutory authority issues.
For brokerages, the new disclosure obligations may create some direct obligations and challenges. Publicly traded and bank-owned firms, for example, will have direct reporting obligations, which may create some disincentive for privately held firms to sell themselves to these firms. Even privately held firms are likely to get swept up into the SEC reporting regime over time, however, because they are enmeshed in supply chains in which others in the chain (publicly traded insurers and customers, for example) may demand it.
Peirce also noted repeatedly in her dissenting remarks that the big winners under the proposed rule are not the investors but the consulting cottage industry developing to help companies evaluate, disclose and manage climate-related risks.
Therein may lie great opportunity for us. First, companies that are subject to the expanded reporting obligations will need expanded directors and officers liability coverage. Some experts are predicting that the average SEC filing will expand by 40 to 50 pages to encompass all of the requisite disclosure, and each page presents new liability risks for misstatements. The proposed rule also includes a Sarbanes-Oxley styled certification requirement, which will further heighten those D&O concerns.
Second, the TCFD framework requires complying organizations to articulate the full range of their climate-related risks and exposures and to explain any existing risk mitigation plans. To me, that sounds like what brokers do every day—assist clients with identifying their risks; minimize those risks to the extent that they can; and insure what’s left. But here, the initial step of raising a client’s awareness of the potential risks will have been done for us by the mandatory disclosure regime with which many of our clients will need to comply one way or the other.
The new disclosure regimes will likely take many years to implement, in part because of the political and legal hurdles they will have to overcome and in part because reporting standards in this space will likely evolve over time. For today, though, here is a very brief overview of the SEC’s proposal, which is likely to be the disclosure touchstone in the United States.
Under the SEC’s proposed rule, all publicly traded companies (or “registrants”) are required to disclose the following information in a discussion document that will be included with their SEC submissions:
- How their board and management are overseeing climate-related risks
- How such risks have had or are likely to have a material impact on the company’s business and financial statements in the short, medium or long term
- The actual or likely material impact of identified climate-related risks on the registrant’s business model, strategy and outlook
- The registrant’s processes for identifying, assessing and managing climate-related risks; any transition plans adopted as part of a risk-management strategy; and the methodology used to assess the resilience of the business strategy in the face of these risks
- The impact of climate-related events and transition activities on the line items of a registrant’s consolidated financial statements, including estimates and assumptions used.
If a registrant has publicly set climate-related targets or goals, it must do the following also:
- Provide information regarding the scope of activities and emissions included in the target, time horizons, and any interim targets
- Describe how the company intends to meet these targets (and provide any pertinent progress updates)
- Disclose the specific amount of offsets or renewable energy certificates if the registrant’s climate plan includes pertinent targets.
Greenhouse Gas Emissions
In addition to the TCFD disclosures, which are largely reported in narrative form, the SEC’s proposed rule also requires a quantification of three buckets of greenhouse gas (GHG) emissions:
- Scope 1 emissions—direct GHG emissions produced by sources controlled by or owned by the registrant
- Scope 2 emissions—indirect GHG emissions generated by a registrant’s energy consumption, typically resulting from the purchase of electricity or other forms of energy
- Scope 3 emissions—all registrant-related emissions not included in Scope 1 or 2; this includes disclosure of emissions by other companies in the registrant’s “value chain” (essentially the entire supply chain) if those emissions are “material” or if the registrant has set a Scope 3 emissions target or related goal.
Scope 1, Scope 2 and (if required) Scope 3 emissions must be disclosed both in the aggregate and be disaggregated per constituent greenhouse gas. The Scope 3 emissions disclosures are the most controversial. The SEC attempted to blunt some of the criticism it knew it would receive over them by exempting smaller registrants and by creating a (limited) liability safe harbor for companies that make Scope 3 disclosures given the requisite reliance on third parties for data.
The SEC has targeted 2024 as the compliance date for some larger registrants; 2025 for the rest of the larger registrants; and 2026 for smaller companies. The inevitable litigation is, however, likely to at least delay those effective dates.
Much more to come on this, but, for us, it may be critical to think beyond our potential burdens under the rule and to evaluate how we can contribute to our clients’ compliance with these new requirements and management of the climate-related risks they may be required to confront and assess going forward.