Bringing in the Big Dogs: Benefits of SEC’s Proposed Climate Risk Disclosure Rule
BY: Jaclyn Rothenberg, RBFL Student Editor
On April 11, 2022, the SEC proposed a new rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors. This rule adds a new subpart to Regulation S-K, which includes three types of emissions disclosures. Scope 1 disclosure requires a company to disclose information about its direct greenhouse gas (GHG) emissions, and Scope 2 disclosure requires indirect emissions from purchased electricity or other forms of energy. Finally, Scope 3 disclosure requires a company to disclose GHG emissions from upstream and downstream activities in its value chain if material or if the company has set a GHG emissions target or goal that includes Scope 3 emissions. A company would be required to disclose all climate-related risks that are “reasonably likely to have material impacts on its business or consolidated financial statements.”
The SEC emphasizes that there are significant benefits to this rule. First, the information about climate-related risks would be more comparable because investors will receive consistent, standardized content from different sized companies, and regardless of industry. Second, investors can better rely on these disclosures because it will be filed with the SEC, which increases potential liability to the firm. If companies fear liability, then companies will carefully consider the content of such disclosures and avoid filing misleading statements (e.g., greenwashing). Thus, investors can be more confident in the accuracy and completeness of the filing.
Third, there are benefits to the market. Because the rule would be mandatory and there is standardized content, investors will be able to better assess these climate risks and the impact on companies’ financial conditions and operations, such as products and services, supply and value chain, adaptation and mitigation activities, investment in research and development, types of operations and location of facilities, acquisitions or divestments, and access to capital. And thus, when investors can make better-informed investment decisions and are better protected, investors will not need to discount the prices of stock. Also, when investors process information more effectively, this improves their estimation of a firm’s future cash flows, leading to more accurate firm valuation. The market will be healthier because of improved liquidity, lower costs of capital, and higher firm valuations. Lastly, the rule reduces agency problems. The concern is that management might act in their own self-interest at the expense of shareholders by disclosing only certain climate-related information at their discretion. With the new rule, shareholders are better able to monitor a company’s climate-related decisions, especially surrounding the potential conflicts between short term and long-term climate risk horizons.
While many lawyers and scholars believed that the SEC would publish the official rule before the end of 2022, as of early January, we have yet to see any rule issued. Is this indicative of significant change between the proposal and the final rule? It’s hard to say. Regardless of the rule adopted, one thing remains clear: transparency, especially around climate-related transition risks, is at the forefront of investor demands. If it’s too early for the big dogs, investors will find other ways.
Key Sources:
Release No. 33-11042, The Enhancement and Standardization of Climate-Related Disclosures for Investors, 87 Fed. Reg. 21334, 21334 (proposed Apr. 11, 2022) (to be codified at 17 C.F.R. pt. 210, 229, 232, 239, and 249).
Section 2(b) of the Securities Act, 15 U.S.C. 77b (b), and Section 3(f) of the Exchange Act, 17 U.S.C. 78c(f), require the Commission, when engaging in rulemaking where it is required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. Further, Section 23(a)(2) of the Exchange Act, 17 U.S.C. 78w(a)(2), requires the Commission, when making rules under the Exchange Act, to consider the impact that the rules would have on competition, and prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the Exchange Act.
Financial Stability Oversight Council (“FSOC”), Report on Climate-Related Financial Risk 2021 (Oct. 2021) (“2021 FSOC Report”), available at https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf (detailing the various ways that climate-related risks pose financial threats both at the firm level and financial system level).