Early this spring, the SEC released its much-anticipated proposed rule on climate-related disclosures. And while the SEC’s initial iteration of the rule seeks to form a disclosure regime that investors could leverage to compare entities and make informed investment decisions, uncertainty and unease instead have lit up the corporate community.
Thousands of comment letters voicing concerns over the rule have been made public via the SEC’s website over the last few months. I’ve sifted through numerous corporate comment letters and teased out three of the biggest concerns on the proposed rule, broken down by sector.
Energy Sector Takes Issue with Financial Statement
If adopted, the SEC’s proposed rule would require the disclosure of climate-related risks outside of the established materiality definition set forth in the US Supreme Court’s 1976 decision, TSC Industries, Inc. v. Northway, Inc. Materiality occurs when there is a “substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote,” the court said.
The new rule would expand current disclosures and require registrants to detail climate-related risks totaling 1% or higher of a total line item in the financial statement for the relevant fiscal year.
While many affected companies commented on this requirement, several companies in the energy sector pushed back on the threshold, arguing that a disclosure of this nature would include irrelevant information and confuse investors, rather than help them to make informed decisions. I gleaned at least three proposed solutions from the many comments.
- Raise disclosure threshold. TotalEnergies SE suggested that if the SEC doesn’t utilize existing definitions of materiality, the commission should adopt a 10% threshold to limit the inclusion of irrelevant information.
- Apply materiality threshold. ConocoPhillips proposed utilizing the established materiality definition set forth in TSC Industries, arguing that deviation from that definition would lead to the disclosure of irrelevant information, unnecessary costs, and investor confusion in a manner that the current materiality definition does not. Liberty Energy took similar issue with the proposed rule, expressing concern that investors couldn’t make informed decisions under the proposed 1% threshold because a threshold that low would produce “an avalanche of trivial information”—precisely what TSC Industries warned against.
- Maintain current disclosure regime. MRC Global suggested that the proposed climate-related disclosures go beyond those that are necessary to inform energy sector investment decisions because existing and potential MRC Global investors rarely inquire into ESG or climate change issues. If investors did inquire, existing disclosures are sufficient to meet MRC Global investor demands.
Although general discontent with the threshold is apparent, the energy sector’s desired resolution of that discontent remains unclear while the final rule pends.
Financial Sector Urges Reporting Alignment
Prior to the release of the proposed rule, Nasdaq and the Society for Corporate Governance urged the SEC not to create additional disclosure requirements because companies would still need to disclose the same information (in different forms) under alternative frameworks. But the proposed rule did precisely that, and the financial sector took notice.
The SEC’s proposed rule would create a new disclosure framework loosely based on the Task Force on Climate-Related Financial Disclosures framework (“TCFD”), but with a more detailed disclosure regime than the TCFD has. The financial sector was particularly concerned with the SEC’s alignment with two frameworks.
- Alignment with TCFD. Several organizations opined that the SEC climate-related disclosure should be limited to those set forth in the TCFD. The Bank Policy Institute expressed concern that despite being modeled after the TCFD, the SEC’s climate-related disclosure framework far exceeds those set forth in the TCFD framework because of its narrower disclosure requirements, disaggregated financial reporting, and reporting timelines. And the institute and Nasdaq agreed that expansions beyond the TCFD wouldn’t be useful to investors, would be impossible to prepare, and would expel significant financial institution resources.
- Alignment with the TCFD and ISSB. The European Banking Federation and Japanese Bankers Association urged the SEC to more broadly align the proposed rule with not only the TCFD, but also the International Sustainability Standards Board proposals (“ISSB”) on International Financial Reporting Standards to prevent future patchwork climate-related disclosures.
Corporate actors—and especially financial institutions—are continuing to call for alignment on divergent climate-related disclosure regimes. And the SEC apparently didn’t heed that call.
Technology Sector Questions Implementation Timelines
The SEC’s proposed rule would require that companies adhere to the 10-K reporting schedule, including Q4 emissions data. Should more information become available, affected companies would be required to update the 10-K with any material changes.
The technology sector wasn’t satisfied with this detail, and asked the SEC to consider flexibility in the reporting timelines for new and historical climate-related data.
- Extension of Q4 Disclosures. Microsoft Corp. suggested that the SEC provide flexibility in the timing of Q4 disclosures to compensate for the three-to-six-month data lag in emissions data, recommending that the SEC consider a separate filing for these climate-related disclosures. Such an extension will provide investors with timely and accurate disclosure, according to Microsoft.
- Separate reporting timeline (outside of 10-K). Salesforce Inc. suggested that the climate-related disclosures not be included in the 10-K because delays, inaccuracies, or incomplete information in a 10-K may be detrimental to investors making informed decisions.
- Extended timelines for historical information. Dell Technologies Inc. recommended that the SEC phase in requests for historical information, arguing that the requirement to immediately produce historical climate-related data could take away from crucial resources needed to produce current and accurate disclosures.
While corporate actors may be feeling the pressure of the SEC’s looming proposed rule, the technology sector is taking issue with the 10-K Q4 disclosure timing and the inclusion of historical data, as both could produce inaccurate information to investors.
What Will the SEC Resolve
Among the thousands of comments received regarding the proposed disclosures, materiality, conflicting reporting requirements, and implementation timelines appeared to be the most urgent concerns.
But these detailed, sector-specific issues regarding the climate-related disclosures aren’t the only critiques of the proposed rule: Trade associations also weighed in.
The Business Roundtable pushed back on the proposed rule, expressing concern that filing climate-related disclosures in a 10-K would present liability risks. And the Business Council for Sustainable Energy argued that safe harbors in the rule should be expanded to include full protection from third-party litigation and SEC action. Based on the sometimes narrow and sometimes broad-scale focus of the comments submitted, we should anticipate substantial changes to or—if there are no changes or only modest ones— substantial SEC justification for that decision included in the final rule.
Either way, the SEC has to grapple with a lot. So how will these concerns play into what will likely be an equally lengthy final rule?
- Financial Statements. In order to form a clear and comprehensive disclosure regime, the SEC will likely broaden the explanation surrounding financial statements, including additional clarification on materiality, the 1% threshold, Scope 3 emissions, and applicability across industries/sectors.
- Reporting Alignment. It’s unlikely that the SEC will meet the financial sector’s demands for an aligned framework because the internationally reconcilable ESG frameworks don’t yet exist. But we should expect the international demand for an aligned climate-related disclosure regime to continue. Even if the demand goes unanswered.
- Implementation Timelines. The SEC will likely add guidance to the implementation timelines to account for historical, current, and projected future climate-related data, with specific considerations for data sources, data reliability, and data accessibility.
- Safe Harbor. Climate-related litigation fears will continue far beyond the finalized rule. However, we should expect additional clarification regarding the safe harbor provisions and how soon after the rule is implemented the agency will begin bringing enforcement actions.
As companies prepare to make disclosures under the new regime, the ball is in the SEC’s court to finalize the rule.
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