Lee Reiners and Morgan Smith
On March 21, 2022, the Securities and Exchange Commission (“SEC” or “Commission”) released a proposed rule titled “The Enhancement and Standardization of Climate-Related Disclosures for Investors.” If finalized, the rule “would require registrants to provide certain climate-related information in their registration statements and annual reports.” The comment period for the 490-page proposing release was originally set to end on May 20, 2022 but was pushed to June 17, 2022 after the Commission received numerous requests for an extension.
It is not an exaggeration to suggest that this is the most anticipated, and contested, rulemaking in the history of the SEC. This is evidenced by the record-breaking number of comment letters submitted to the Commission and the public campaign being waged against the rule in the Wall Street Journal (here, here, and here) and other media outlets. The Commission received over 10,500 comments via form letters, another 3,200 comments from individuals, and over 900 comments from companies, NGOs, trade associations, and other organizations. By way of comparison, thirty-seven rules mandated by the Dodd-Frank Act and promulgated by the SEC before the end of 2014 received, on average, only ninety-two comments per rule.
The number of comments submitted for the latest proposed rule is double those received in June 2021 after then-SEC Acting Chair Allison Herren Lee released fifteen questions for consideration “with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change.” Lee Reiners and Mario Olczykowski reviewed a large sample of last year’s comments to “identify widespread points of agreement and specific issues where opinions varied based upon commenter type (NGO, multinational corporate, financial institution, etc.).” They found that most commenters supported mandatory climate-related disclosures, but that commenters differed on what exactly should be disclosed and the level of review by third-party auditors and legal liability these disclosures should be subject to.
Commission staff reviewed last year’s comments and incorporated many of their insights – the proposing release contains 1,068 citations – in the proposed rule. The result reflects a delicate compromise between the demands and interests of many environmental and progressive organizations and the need to promulgate a rule that is not prohibitively costly to comply with and that is capable of withstanding legal challenge. No issue reflects this compromise better than the proposed requirements around Scope 3 emissions. While the rule would require registrants to disclose Scope 3 if it is material or if the registrant has set an emissions target that includes Scope 3, it would also provide an exemption from Scope 3 disclosure for smaller companies as well as a safe harbor against shareholder lawsuits for Scope 3 disclosures. In addition, Scope 3 would be subject to a longer phase-in period.
To better understand the main points of contention in the proposed rule, we reviewed over 500 comment letters submitted by organizations and captured the main arguments of each in a master spreadsheet organized by commenter type. Our final sample includes comments from:
Our review revealed five key points of contention across commenter type. They are:
This article summarizes our key findings for each of these items and identifies points of disagreement across commenter type.
The SEC’s Legal Authority
Along with Democratic politicians and environmental NGOs, most asset managers, institutional investors, and other financial institutions recognize the SEC’s legal authority to mandate climate-related disclosures. For example, Amalgamated Financial Corp. "acknowledge[d] the Commission’s unique authority to address the issue of climate-related financial risk and its implications for investor protection and market efficiency” in its comment letter. Asset manager Ethical Partners Funds Management also recognized the proposed rule as within the SEC’s remit, observing that “[t]he absence of adequate information on climate risk and opportunities is already contributing to systemic financial stability risks and barriers to investment in low-emissions and climate resilient economic activity . . . which results in poor decision-making and the misallocation of capital.” Earthjustice, an environmental nonprofit, similarly noted that “[t]he disclosure requirements stay true to the Congressional directive to protect investors, requiring information necessary to address a substantial lapse in current disclosure practices and appropriate to properly inform investors of evolving climate-related risks.” Finally, the Attorneys General of California, Colorado, Connecticut and seventeen other states argued that “[t]he Proposed Rule’s mandatory disclosures address harmful informational imbalances to protect investors, markets, and the third parties that rely on market efficiency.” The Attorneys General also pointed out that the proposed rule does not implicate the major questions doctrine because it deals with disclosure obligations, which are central to the SEC’s mandate, and that the rule does not violate First Amendment prohibitions on compelled speech because it requires disclosure only of “factual and uncontroversial” information that is not “unjustified or unduly burdensome.”
The major questions doctrine has taken on added significance in light of the Supreme Court’s decision in West Virginia v. Environmental Protection Agency (EPA) at the end of June. Under that doctrine, “a clear statement is necessary for a court to conclude that Congress intended to delegate authority ‘of this breadth to regulate a fundamental sector of the economy.’” The Court found no such statement in the case of the EPA’s Clean Power Plan and many commenters to the SEC’s proposed climate disclosure rule emphasized that the rule touches on a similar “major question” that Congress has yet to weigh in on. Supporters of the proposed rule argued that the SEC is simply fulfilling its statutory mandate to provide investors with the information they need to make informed investment decisions.
Republican elected officials as well as oil and gas companies, both private and public, argued in their comment letters that the SEC does not have the legal authority to adopt the proposed rule. Nineteen U.S. Senators asserted that the rule “is not within the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation” and that it falls short of the current materiality qualifier by requiring the disclosure of information that is immaterial to a reasonable investor. They also argued that the rule compels speech in violation of the First Amendment. A letter from 131 members of the House of Representatives made a similar case: “The proposed rules exceed the SEC’s statutory authority and fundamentally misappropriate the SEC's rulemaking authority,” as “Congress did not establish the SEC to set climate policy nor to be the final arbiter of businesses’ strategies to combat climate change.”
Oil and gas companies similarly emphasized the SEC’s lack of statutory authority while also acknowledging what they view as the prohibitive cost of complying with the rule. Atlas Sand Company LLC, a private oil and gas company, warned that “[t]o avoid rendering any final rule arbitrary and capricious and contrary to law, the Commission must revise its cost benefit analysis to evaluate the indirect costs.” Additionally, National Fuel Corporation, a publicly traded oil and gas company, argued that the “SEC lacks the authority to promulgate this rule, which would elevate climate change over material financial considerations,” and that “[w]ithout Congress passing climate change legislation that codifies such policies, SEC [sic] cannot be used as a substitute to do so.” Another publicly traded oil and gas company, Liberty Energy Inc., asserted that the proposed rule is an attempt to regulate climate change in violation of the major questions doctrine.
Many trade associations, no doubt reflecting the views of their members, also emphasized the Commission’s lack of legal authority. The National Association of Convenience Stores noted that unlike the EPA, “the securities laws do not give the SEC authority to require individual companies to report on their share of such worldwide issues without reference to materiality” and questioned the material connection between a company’s emissions contributing to climate change and its financial performance. The National Association of Home Builders expressed another collective worry that the rule exceeds the SEC’s jurisdiction and will “impose the regulatory burden of SEC regulations on small businesses that are not regulated by SEC and are not familiar with SEC requirements” by requiring Scope 3 emissions disclosures, which we touch on further below.
Non-environmental NGOs are more evenly split, with their opinions of the SEC’s legal authority influenced by their mission and ideological underpinnings. Conservative nonprofits, like the Heritage Foundation and the Texas Public Policy Foundation, deny the SEC’s legal authority, while others, including the U.S. Impact Investing Alliance and the Rockefeller Brothers Fund, maintain that the proposed rule is in line with the Commission’s mandate. Specifically, the Working Group on Securities Disclosure Authority explained that “the SEC has clear statutory authority to mandate additional climate-related disclosures for publicly traded companies,” as the Commission has long mandated public-company disclosure of environmental-related matters. Therefore, the Commission can mandate additional climate-related disclosures because the climate-related information that issuers currently provide is not uniform, of low quality, and not universally required.
Prominent law firms argued that the SEC does not have the legal authority to mandate climate-related disclosures. Jones Day warned that: “[t]he Proposal will likely be challenged on the bases of the Commission exceeding its regulatory authority and unconstitutionally compelling speech under the First Amendment of the U.S. Constitution.” Davis Polk & Wardwell argued: “[T]he Commission does not have authority to impose costly and complex disclosure burdens on public companies that are untethered from the concept of meaningfulness to investors, or what is embodied in the basic principle of materiality.” Davis Polk added that Congress has already delegated authority for protecting the environment to the EPA, and that investor demand for climate-related disclosures is irrelevant, as that is not the standard for mandating disclosures. On the other hand, consulting firms Deloitte & Touche and Ernst & Young generally supported the proposed rule, recognizing the SEC’S authority without going into much detail.
Scope 3 Emissions Disclosure
The most contentious issue within the rule itself is Scope 3 emissions disclosure, defined as:
"All other indirect emissions not accounted for in Scope 2 emissions. These emissions are a consequence of the company’s activities but are generated from sources that are neither owned nor controlled by the company. These might include emissions associated with the production and transportation of goods a registrant purchases from third parties, employee commuting or business travel, and the processing or use of the registrant’s products by third parties."
Supporters of mandatory Scope 3 disclosure point to the fact that Scope 3 emissions account for sixty to ninety percent of most companies’ carbon emissions and are therefore critical information for investors to understand a given company’s transition risk (business-related risks that follow societal and economic shifts toward a low-carbon and more climate-friendly future). Detractors point to Scope 3’s data and methodological limitations and how these limitations increase the cost of Scope 3 disclosure.
Most environmental nonprofits support mandatory Scope 3 disclosure and are opposed to the accommodations around Scope 3, except the exemption for smaller reporting companies (“SRCs”) in the proposed rule. Specifically, they are worried that, if adopted in its current form, the proposed rule would cause public companies to avoid setting Scope 3 emissions commitments altogether. These commenters note that, by requiring Scope 3 disclosure for large issuers only if it is material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions, issuers will avoid making public emissions reductions commitments so as to avoid having to disclose Scope 3 emissions. This view is expressed in a letter from Americans for Financial Reform, Public Citizen, Ocean Conservancy, Sierra Club, Evergreen Action, and 72 additional signatories who noted that “[a]llowing registrants to self-determine whether Scope 3 emissions are material will lead to underreporting of those emissions and their associated risk.” Other environmental groups argued for mandatory Scope 3 disclosure for specific industries. The Environmental Investigation Agency recommended mandatory Scope 3 reporting for “companies producing HFCs [hydrofluorocarbons], and manufacturers of products containing HFCs, such as refrigeration and air conditioning systems.” Another letter signed by several environmental organizations, including Earthjustice and the Institute for Agriculture and Trade Policy, focused on the Scope 3 emissions from industrial agriculture firms:
“The ‘customs and practices of the [animal agriculture industry]’—which are responsible for 80% of all U.S. agricultural GHG emissions—entail significant Scope 3 emissions. Reports have shown that when the world’s top five largest meat and dairy companies’ Scope 3 emissions are accounted for (including, critically, the emissions from the animals themselves), these firms combine to emit more GHG than some of the most notoriously polluting oil and gas companies like Exxon-Mobil, Shell, and BP. And recent reports suggest that Scope 3 emissions may account for as much as 97% of some industrial livestock firms’ total GHG emissions. Accordingly, omitting the disclosures of these firms’ scope 3 emissions from reports on their total climate footprint will be grossly misleading.”
However, not every nonprofit and sustainability advocate that supports mandatory climate disclosures is in favor of Scope 3 disclosure. Amongst supporters of mandatory climate disclosure, the most articulate, and credible, case against mandating Scope 3 disclosure comes from a team of sustainable finance researchers at Stanford University. In their comment letter, they argued that Scope 3 is “not a carbon accounting system in the sense that GAAP is an accounting system” and that mandatory Scope 3 emissions disclosures will result in several unintended consequences, including: 1) diverting time and resources into compliance activities and “away from investments that result in real emissions reductions”; 2) double counting emissions across the financial system; and 3) “slow[ing] down efforts by companies to make public reduction commitments or join Net Zero coalitions out of fear of costly compliance or legal liability.” These researchers’ views were echoed by the Business Council for Sustainable Energy; they noted that Scope 3 requirements “should be carefully bounded given the current uncertainties of Scope 3 information” and that “registrants should be able to include this information as ‘furnished’ not ‘filed,’ which would further limit their exposure for including what may be less than fully accurate, but potentially helpful, information.”
Asset managers are broadly supportive of a mandatory climate disclosure rule but they too expressed reservations around mandating Scope 3 disclosure. Several asset managers called on the SEC to issue more detailed guidance on what constitutes “material” Scope 3 emissions. Others suggested in their comments that the SEC could look to the Science Based Targets Initiative (“SBTi”) and set a bright-line threshold to determine materiality, namely, that Scope 3 emissions are material if they constitute forty percent or more of a company’s total Scope 1, 2, and 3 emissions. However, a few ESG-focused asset managers argued that Scope 3 disclosure should be required for all companies.
The largest asset managers are wary of mandating Scope 3 disclosure due to the practical challenges in obtaining this data and what they consider to be its limited usefulness. State Street suggested Scope 3 disclosure should be voluntary, while BlackRock argued companies should only have to disclose “any of the fifteen Scope 3 categories that are material to them.” BlackRock was also concerned that the proposed Scope 3 requirements will “push publicly traded companies into the role of enforcing emission reduction targets outside of their control.” This concern was shared by many other public and private companies, who noted that by mandating Scope 3 under certain conditions, public companies will have no choice but to demand emissions data from their suppliers, many of whom are private companies that are not otherwise subject to SEC reporting requirements. The data provider Sustainable Fitch commented that: “the proposed inclusion of Scope 3 emissions will create pressure on private companies to monitor and report emissions data to the public companies they service, given the former’s increasing requirements to report on these.”
Many private non-oil and gas companies, specifically in the agricultural sector, expressed similar concerns regarding the increased cost burden they would face because of mandatory Scope 3 disclosure. In his comment letter, Donald Stehle of Stehle Cattle Company warned that mandating Scope 3 disclosures “will indirectly place a burden on every farmer or rancher whose goods are sent to publicly traded processing companies, restaurants, or retailers.” The seed company Beck’s Hybrids expanded on this concern in their comment letter: “This proposed rule will create a new burdensome reporting for family farms who sell into publicly traded supply chains and will force the disclosure of private information, and create multiple, new sources of substantial costs and liabilities,” including “reporting obligations, technical challenges, significant financial and operations disruption, and the risk of financially crippling legal liabilities for family farms, many of which only have a few employees.” Ann A. Jackson of Y Bar O Cattle Company explained that by mandating Scope 3 disclosure, the proposed rule “creates unavoidable legal risk for every cattle producer” due to the high potential for inaccuracy of data, a sentiment echoed by many other agricultural firms.
Oil and gas companies are similarly opposed to mandatory Scope 3 disclosures and have specific concerns about the feasibility of collecting Scope 3 data from their upstream suppliers and downstream users. This concern was best expressed by National Fuel Corporation: “Because any one company’s Scope 3 emissions permeate among potentially many hundreds or even thousands of companies and millions of consumers, they are nearly impossible to accurately measure, calculate, or otherwise estimate.” Western Midstream Partners added that it wants the Commission “to revise the scope of climate-related risks to exclude the entire value chains [sic] and consider whether it is reasonable to require registrants to attempt to assess risks that are far outside their control and operations.” Additionally, MRC Global described Scope 3 emissions as “ill-defined guesses,” and added that Scope 3 should include “only those emissions arising from activities for which the registrant pays,” and should exclude the cost of goods resold for distributors, retailers, and others that resell.
Cost of Compliance
A central component of the inevitable legal challenge to a final rule will likely be that the Commission failed to fulfill its obligations under the Administrative Procedure Act to perform a thorough cost-benefit analysis (“CBA”). While the SEC, as an independent agency, is exempt from past Executive Orders requiring CBA, the Commission has voluntarily included CBA in proposed rules dating back to the 1970s and the United States Court of Appeals for the DC Circuit has made clear that the SEC cannot reach a conclusion that is “unsupported by substantial evidence” or is otherwise “arbitrary [and] capricious.” For this reason, the Commission dedicates 127 pages in the proposed rule to what it calls “Economic Analysis,” which functions as a CBA.
The Commission was challenged by the lack of concrete data around the current costs associated with voluntary climate risk disclosure and how those costs may change under a mandatory reporting regime. For this reason, the Commission relied heavily upon a report prepared last December by Lee Reiners and Karen Torrent for the Climate Risk Disclosure Lab that surveyed three anonymous companies on their current climate disclosure practices, the associated costs, and how these costs may change under a mandatory climate disclosure regime. The SEC ultimately concluded:
“For non-SRC registrants, the costs in the first year of compliance are estimated to be $640,000 ($180,000 for internal costs and $460,000 for outside professional costs), while annual costs in subsequent years are estimated to be $530,000 ($150,000 for internal costs and $380,000 for outside professional costs). For SRC registrants, the costs in the first year of compliance are estimated to be $490,000 ($140,000 for internal costs and $350,000 for outside professional costs), while annual costs in subsequent years are estimated to be $420,000 ($120,000 for internal costs and $300,000 for outside professional costs).”
Very few commenters provided specific cost estimates that challenge the SEC’s numbers. In fact, one commenter, the sustainability consulting firm ERM, conducted its own survey of issuers and found that the “SEC’s estimated annual costs after the first year of compliance are generally comparable to corporate issuers’ current average spend as reflected by the ERM survey.” Opponents of the rule, like Utah Governor Spencer Cox, discussed costs in generic terms: “The SEC estimates costs between $490,000-$640,000 per registrant, but these underestimate the compliance cost, especially in consideration of unprecedented scope 3 emissions.”
Republican politicians, trade associations, and oil and gas companies focused on how the rule will increase costs for private companies in specific industries and the American people. One group that was singled out for bearing a disproportionate burden of the costs was farmers and ranchers; the logic being that they will be forced to track their emissions by the public companies they sell to and the financial institutions that extend them credit. As noted by the National Aquaculture Association, “[w]hile farmers and ranchers would not be required to report directly to the SEC, they provide almost every raw product that goes into the supply chain.” Accordingly, farmers are worried that the rule, if finalized, could lead to additional consolidation in the agriculture industry. In a one-page comment letter, cattle rancher Samantha Vincent urged the Commission “to limit the proposed rule to only scope one (direct) and scope two energy/electrical) emissions while omitting scope 3” due to “the immense cost and disruption this rule will pose to ranchers like me, who already invest in conservation practices and lack the resources to comply with this highly technical rule.”
The banking industry also expressed concern over their cost of compliance. The Independent Community Bankers of America commented that community banks “do not have a trove of climate-data readily at their disposal to collect, examine, or disclose” and their “finite resources and inexperience with the onerous disclosure framework” may result in substantial compliance costs. The Wisconsin Bankers Association noted that several of their members are worried the rule will result in industry consolidation because “the costs are simply not scalable and too exhaustive to remain competitive with non-filing institutions.”
Not surprisingly, the oil and gas industry, and their trade associations, argued that the rule would drive up energy prices, an argument that was sure to carry more weight amidst record high gasoline prices. The American Public Gas Association noted that their members, not-for-profit gas distribution systems owned by municipalities and other local government entities, conduct business with SEC-regulated companies and will therefore incur costs that “will ultimately be borne by American families and business-owners in the form of higher energy costs.” Sounding a similar alarm, Domestic Energy Producers’ Alliance, a trade association, asserted that "[t]he actual cost burden on society is undoubtedly much larger, as SEC [sic] has only assessed the costs of direct data collection and reporting and ignored the broader impacts as the rule makes American energy scarcer and more expensive.”
In its comment letter, the National Association of Convenience Stores combined concerns for small businesses with concerns for consumers in the form of higher gas prices, noting that their members “do not have the professional or financial wherewithal to determine their emissions as required by scope 3 of the proposed rule.” Therefore:
“Many would lose their ability to contract with issuers of securities or absorb significant financial losses trying to comply with the rule to provide emissions information. These dislocations would not only hurt these small businesses, but would increase costs in the motor fuel supply chain and thereby significantly increase the retail prices of gasoline and diesel fuel. This financial hardship, therefore, would be felt not only by the small businesses in the convenience industry but also by the 165 million American consumers that they serve every day. Unfortunately, none of this analysis appears in the proposed rule.”
Asset managers were more split when it comes to the cost impact of the proposed rule. Impax Asset Management echoed the views of several asset managers when it noted that “compliance may involve up-front costs to create systems for gathering and verifying data” that will decrease over time as companies get more familiar with the process. However, some other asset managers and financial institutions are concerned about the rule’s costs having unintended consequences. Dimensional Fund Advisors said that the cost of compliance “will be borne by each company’s investors, who may be harmed by a decrease in the company’s stock price, and by the company’s customers, who may have to pay higher prices for the company’s goods and services.” And Dan Romito from Pickering Energy Partners added that, “[r]egulatory mandates of this nature will act as a deterrent for future companies to go public and/or remain publicly traded, thereby negatively impacting technological innovation.” This concern was echoed by Harris Simmons, chairman of Zions Bancorp, who said that the “reporting burdens arising from this proposal will create a material disincentive for firms to access capital in the public markets and to list their securities on public exchanges.” Several law firms expressed similar concerns in their letters, including Davis Polk & Wardwell, who noted that the rule would “discourage new entrants from accessing the U.S. public capital markets because of the significant increase in regulatory compliance costs, and will cause some currently public companies, for the same reasons, to withdraw from these markets entirely.”
Several multinational corporations and asset managers expressed concerns about the potential costs of complying with multiple mandatory and voluntary climate disclosure frameworks. BlackRock said:
“If the Commission’s rulemaking were to require companies to disclose significantly more information than what is currently called for under the TCFD framework or TCFD-aligned international standards, particularly information that is not material, we are concerned that the resulting disclosure would obscure what information is material, have limited value to investors, heighten compliance costs and reduce the ability to compare across companies and regions.”
BNP Paribas encouraged SEC “alignment with the ISSB [International Sustainability Standards Board] framework” since “differing initiatives can only result in inconsistencies in approaches and timing, misallocation of scarce expert resources, and confusion for investors.” Furthermore, according to BNP, “conflicting climate disclosure frameworks will also generate implementation conflicts that would hinder – rather than accelerate – the desired transformation of business practices.” To minimize the reporting burden on public companies, the investor-focused nonprofit FCLTGlobal encouraged “[c]limate reporting that is streamlined and compatible with other global disclosure frameworks and standards and explicitly recognized as good faith estimates.”
The proposed rule’s most ardent supporters either ignored or downplayed the costs in their comment letters. Some, like the Center for American Progress, even argued that the rule would decrease costs for investors that utilize corporate climate risk disclosures by providing consistent, comparable, and reliable climate risk disclosures in one place as opposed to the current system which requires investors “to seek this information independently for each company—information that may exist in a variety of places, such as company literature, media reports, and third-party analyses, or may not exist at all.” The Illinois State Treasurer commented that the “availability of standardized and accessible climate-related data could potentially save the Illinois Treasury tens of thousands of dollars every year – if not more – in money that would otherwise be spent on specialty databases and service providers.”
Industry-specific Metrics and Global Alignment
In the original March 2021 request for information, Commissioner Lee asked commenters about the advantages and disadvantages of “establishing different climate change reporting standards for different industries” and incorporating “existing frameworks, such as, for example, those developed by the Task Force on Climate-Related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), and the Climate Disclosure Standards Board (CDSB).” While the proposed rule avoids industry-specific disclosures, it is explicitly modeled “in part on the TCFD disclosure framework.”
Commenters in favor of mandatory climate risk disclosure were generally supportive of leveraging the TCFD’s principles-based approach. However, many of these commenters argued that the SEC should have gone further and required industry-specific disclosures. Proponents of industry-specific disclosures tended to support the use of ISSB standards as opposed to the SEC developing their own industry-specific standards.
Many asset managers noted that industry-specific disclosures provide the most decision-useful information. For example, Longfellow Investment Management Co. explained that “[c]limate risk takes many forms, and it would not be useful for companies in different industries to report on the same topics.” Because asset managers tend to allocate capital around the world – and are therefore concerned about a potential lack of comparability across mandatory and voluntary climate disclosure frameworks – many argued for the SEC to adopt climate disclosure standards that are similar to existing voluntary frameworks. BlackRock advocated for a “global baseline of climate-related disclosure standards to enable investors to make more informed decisions,” while also urging “regulators to work with standard setters, like the ISSB, to continue developing industry-specific guidance.” Similarly, Nipun Capital, an investment adviser focused on Asian and emerging market equities, noted that “coherence with future ISSB standards will reduce the burden of compliance on issuers as many of the largest U.S. issuers are global companies and will likely fall under the disclosure requirements of a jurisdiction following ISSB standards” and that “globally coherent disclosure requirements will lead to better comparability of data for investors.”
Many environmental NGOs and other nonprofits also expressed the need for a global baseline and urged the SEC to adopt a final rule that is compatible with ISSB industry-specific standards. The nonprofit Sustainable Silicon Valley advocated for “standard reporting frameworks by industry” to “help investors compare climate risks and impacts for public companies in the same industries.” Janine Guillot, CEO of the Value Reporting Foundation, also “encourage[d] the SEC to consider the utility of the ISSB General Requirements Exposure Draft for both domestic and foreign issuers,” as investors have expressed a need for industry-based sustainability disclosure standards that address all significant sustainability issues. The World Benchmarking Alliance added that “[a]lignment with the global standard set forth by the ISSB is important across disclosure topics, but it is especially important concerning Scope 3 emissions, as all entities benefit from aligned disclosures for international value chains.”
Some trade associations and institutional investors similarly advocated for a global baseline through alignment with ISSB standards and multilateral coordination to increase efficiency and comparability. For example, the Institute of Internal Auditors recommended that the SEC “include provisions of the ISSB standards as much as possible” in the final rule, adding that voluntary reporting “has led to a lack of uniformity and consistency, preventing comparative assessments and accurate assurance.” It explained that “[a] single, uniform framework and/or an aligned set of frameworks on climate disclosures would provide an opportunity for comparability among corporations and investors and allow for more informed business decisions that consider ESG impacts.” Pamela Steer, President & CEO of the Chartered Professional Accountants of Canada, advocated for coordination between the ISSB and regulators in the U.S. and EU. She explained that “it is important that in finalizing its new disclosure requirements, the Commission considers the needs of both investors and issuers participating in markets on a global scale.” The Washington State Investment Board, an institutional investor, also “support[ed] the SEC’s efforts to align its proposal with the ISSB’s draft standard because of the importance to issuers and investors of aligned global disclosure expectations and the strength of the ISSB’s draft and their standards creation process.”
Many public companies and the trade associations they belong to also advocated for industry-specific disclosures. Magna International, an automotive supplier, argued “that investors would benefit from a more nuanced, industry-specific approach, rather than the ‘one-size-fits-all’ approach reflected in the Proposed Rule.” Several companies noted that a disclosure standard premised on materiality would naturally lead to more industry-specific disclosures because the climate related risk firms in one industry face may be different than what firms in other industries face. Tyson Foods said the “[p]roposed rule is a one-size fits all approach that is prescriptive, inflexible, and unnecessarily granular and adds new requirements for disclosure” and urged the SEC to “provide companies with more flexibility around identification, management, and disclosure of climate related risks and require disclosures for those risks that are truly material to a company.” This view is shared by Nareit, a trade association for real estate investment trusts, and the Indiana & Greater North Dakota Chambers of Commerce, all of whom oppose the proposed rule. Nareit commented that “[t]he proposal’s departure from a principles-based disclosure approach grounded in materiality to a highly prescriptive ‘one size-fits all’ approach is not warranted.” Similarly, the Indiana and Greater North Dakota Chambers of Commerce – writing separately but using the same language – expressed that “[a] more streamlined, principles-based approach qualified by traditional principles of materiality will produce a better outcome for the registrants that must prepare these disclosures and the investors who will consume them.”
1% Disclosure Threshold
The proposed rule contains financial impact metric disclosure requirements that:
“[R]equire a registrant to disclose the financial impacts of severe weather events, other natural conditions, transition activities, and identified climate-related risks on the consolidated financial statements included in the relevant filing unless the aggregated impact of the severe weather events, other natural conditions, transition activities, and identified climate-related risks is less than one percent of the total line item for the relevant fiscal year.”
The Commission believes such disclosure will “promote comparability and consistency among a registrant’s filings over time and among different registrants compared to a principles-based approach.” However, this bright-line standard was poorly received by private-sector commenters and their trade associations, who believe the 1% threshold is unrealistic and unworkable and would prefer for financial disclosures to be based on a traditional materiality standard instead.
The Australian mining giant BHP commented that the “1% materiality threshold to individual financial statement line items will result in the disclosure of information that is not considered decision-useful by users of the financial statements” and will “result in registrants producing excessive information that creates confusion for investors and capital markets.” Many other commenters echoed BHP’s concerns about the potential cost to preparers of financial statements and noted that the 1% threshold was not in keeping with generally accepted accounting principles. Salesforce said that the “1% absolute value threshold for financial impact metrics creates a significant cost to the preparer and is inconsistent with the current definition of materiality used when preparing financial statements” and that it would be unable to “effectively implement the 1% absolute threshold requirement” by the SEC’s proposed deadline (fiscal year 2023 for large accelerated filers).
Large asset managers also opposed the 1% threshold, which is noteworthy considering they generally support climate risk disclosure and will be the principal consumers of such disclosures. State Street argued that introducing any percentage threshold for disclosing climate-related financial impacts “has no premise in TCFD,” “would be a huge operational burden given registrants have to monitor and perform the calculation on a quarterly basis,” and “would be a significant departure from the well-established U.S. GAAP accounting definition of materiality.” Blackrock noted that the 1% threshold requirement was unnecessary because Financial Accounting Standards Board (“FASB”) standards require issuers “to consider changes in their business and operating environment when those changes have a material direct or indirect effect on their financial statements and related notes.” Both asset managers commented that this information would be of little use to investors anyway, because, as State Street put it, it “would be far too granular to inform investment decisions.”
Other commenters reflected on the limited value of any climate-related information disclosed in financial statements, including companies that would be responsible for verifying and auditing these disclosures. Deloitte urged the Commission to “consider whether this level of detailed disclosure is useful to investors, or if it may risk confusion among investors who may equate the level of detail with a level of precision that is not consistent with the nature of these disclosures.” Similarly, KPMG warned that the 1% threshold for any line item in the financial statement could compel disclosure of immaterial information and that “events that are arguably more important to the company’s operations might not exceed the 1% threshold and therefore would not be disclosed.”
Commission staff are now engaged in the arduous task of reviewing all comment letters and, where appropriate, incorporating their insights into a final rule. According to the Office of the Federal Register, if the comment file “contains persuasive new data or policy arguments, or poses difficult questions or criticisms, the agency may decide to terminate the rulemaking”, or “continue the rulemaking but change aspects of the rule to reflect these new issues.” Specifically, Commission staff will be reviewing the comments to determine if there is a way to provide consistent, comparable, and decision-useful climate-related disclosures at a cost lower than what is expected in the proposed rule.
One simple way to reduce the cost burden while still accomplishing the Commission’s policy goal would be to extend the compliance timeline. The proposed rule envisions final adoption in December 2022 with large accelerated filers then filing all required disclosures, excluding Scope 3, for fiscal year 2023 (filed in 2024) (Scope 3 must be disclosed starting fiscal year 2024). Non-accelerated filers and small reporting companies would start disclosing for fiscal year 2024 and 2025 respectively, with Scope 3 disclosures beginning one year later. Many commenters characterized the implementation timeline as “aggressive” and costly, and called on the SEC to push it back. These concerns are embodied in a comment submitted by the National Association of Manufacturers:
“The timing pressures on companies working to adjust to and then comply with the proposed rule—in combination with the uncertainty and difficulty associated with the underlying data collection and analysis, the proposed rule’s new attestation requirements, and the increased legal liability associated with including such information in an SEC filing—will make compliance with the proposed rule extremely difficult for issuers and could result in less-reliable information for investors.”
The National Association of Manufacturers recommend the SEC “delay the compliance dates for each of the rule’s provisions such that the earliest disclosure obligations for large accelerated filers would be associated with the third fiscal year following the promulgation of a final rule,” while also “allowing the rule’s requirements to phase in over a longer period of time for certain classes of issuers . . . and for the most complicated individual provisions.”
Any changes to the proposal’s substantive provisions would involve a complicated set of tradeoffs that may push back the finalization date (if the changes are substantial, the Commission may publish a supplemental proposed rule). For this reason alone, the final rule is unlikely to deviate far from the proposal. Chairman Gensler is facing pressure from many Democrats to finalize the climate disclosure rule before the end of the year. If the GOP takes back Congress after the November midterms, they plan on launching “an all-out assault against Gensler and his leadership at the SEC” according to Fox Business.
The Supreme Court’s decision in West Virginia v. EPA added an additional level of difficulty when it comes to finalizing a climate disclosure rule. Now, Commission staff must assess whether specific changes are necessary if the final rule is going to survive the inevitable legal challenge. However, considering that many of the rule’s opponents argue that the SEC lacks any authority to compel climate-related disclosures beyond what is already “material” – meaning this rule falls under the “major question doctrine” – changes to the final rule will not mollify the critics. Therefore, Commission staff may decide to focus on specific elements of the rule that raised concerns amongst commenters who are otherwise supportive of mandatory climate-related disclosure.
Our review of the comment file revealed the proposal’s requirements for Scope 3 emissions drew the most criticism from supporters and opponents alike. The charge made by many that Scope 3 disclosure will impose significant costs on private companies and citizens not subject to the rule – costs that are not addressed in the rule’s “economic analysis” – will likely carry weight with any judge assessing the rule under the Administrative Procedure Act’s arbitrary and capricious test.
Another issue that drew the ire of both registrants and investors is the 1% threshold for financial impact metric disclosure requirements. The fact that several asset managers and investors commented that this information would not be useful in making investment decisions will also carry weight with judges. After all, Chair Gensler has repeatedly said the purpose of the rule is to “provide investors with consistent, comparable, and decision-useful information for making their investment decisions.” If the comment file makes clear that a specific disclosure item is irrelevant for making investment decisions, the Commission should exclude it from the final rule.
Whatever the outcome of the final rule, climate-risk disclosure is here to stay. Investors are increasingly demanding this information and companies are motivated to disclose it, not only to satisfy their investors, but also to manage their own risks and understand where opportunities lie for engaging in more sustainable practices that benefit the bottom line. The emergence of voluntary frameworks like the TCFD and ISSB have helped develop a common language for understanding climate-related risks, but more work needs to be done to drive greater consistency and integrity in the information companies disclose. A mandatory climate disclosure rule would accelerate this process. But even without an SEC mandate, better data, enhanced models, and educated investors will combine to push companies toward disclosing consistent, comparable, and decision-useful information over time.
Lee Reiners is the Policy Director at the Duke Financial Economics Center (DFE) and directs DFE’s Climate Risk Disclosure Lab.
Morgan Smith is a J.D. student at Duke University School of Law and a research assistant at the Climate Risk Disclosure Lab.