The SEC and Climate Risks

Eakinomics: The SEC and Climate Risks

From the moment President Biden announced that climate change would be his number one policy priority, it was easy to anticipate a small tsunami of regulatory activities in pursuit of this goal. And from the moment that Gary Gensler was confirmed as chair of the Securities and Exchange Commission (SEC), he openly advertised his intention to require publicly traded companies to reveal their exposure to climate-change risks. The SEC released the proposed rule on Monday, and AAF’s Thomas Wade lays out the issues in his new insight.

For the non-specialist, there are probably three big takeaways: the rule is sweeping, if not daunting, in its proposed disclosures; it could be extremely expensive and simultaneously not useful; and it may get tossed as being unconstitutional. Let’s consider these in turn.

The proposed rule would require public companies to disclose (per Wade):

• the oversight and governance of climate-related risks by the company’s board and management;
• how climate-related risks have or will impact a company’s strategy and outlook;
• the company’s processes for identifying, assessing, and managing climate-related risk;
• the ‘likely’ ‘material’ impacts to a business and its consolidated financial statements over any time frame;
• direct GHG emissions (Scope 1) and indirect GHG emissions (Scope 2) from purchased electricity and other forms of energy, in addition to indirect GHG emissions resulting from the business’ supply chain (Scope 3); and
• would require companies to publicly state not just any internal climate-related targets but also any progress towards these goals, including the use of carbon offsets or renewable energy certificates.

That’s a lot of disclosure! Just contemplating how to set up the internal reporting and monitoring systems is a challenge. Also, notice that Scope 3 (i.e. the supply chain) would require that even private companies – those outside of the jurisdiction of the SEC – would probably have to become willing partners of the public companies to satisfy this requirement. This is simply an enormous and potentially costly mandate.

And it may not be terribly useful, either. First, the rule does not make clear exactly what climate change scenarios against which the financial and other implications should be measured. Unless there is a standard set of such scenarios, information is not comparable across companies and the value to investors is nil. While the implication is that the SEC will be the one to set these disclosure reporting standards/templates, including potential scenario testing, this puts companies in the laughable position of having to take climate economic modeling instructions from the SEC, not currently famous for its environmental science and risk expertise. Moreover, investors who value climate change information can already require their companies to provide such disclosure – and SEC disclosure requirementsalready require firms to disclose all material financial risks anyway. In the extreme, all the rule accomplishes is to mandate that companies disclose, at considerable cost, information that investors do not value. Not exactly progress.

Finally, it may not ever happen. As Wade describes, “The SEC proposed rule raises significant concerns as to the constitutionality of such a sweeping new framework and expansion of its responsibilities. Requiring public companies to disclose non-material data (progress on climate-related goals, for instance) could violate those companies’ First Amendment rights, and by the government’s own standards the rule may not pass the strict scrutiny test demonstrating either a ‘compelling governmental interest’ or that the rule has been tailored as narrowly as possible to meet this interest.”

This is a proposed rule and will be open to revision in light of comments received from the public, so stay tuned for further developments.