A relatively minor provision tucked in the SEC’s proposed climate disclosure rule is drawing criticism from securities lawyers who say it is unnecessarily making an analytical tool into a compliance step.
The proposed language would require companies to disclose to the Securities and Exchange Commission any analyses they use to measure the resilience of their business strategies to climate risks. The SEC said in the preamble to its proposed rule that scenario analysis information “could help investors evaluate the resilience of the registrant’s business strategy in the face of various climate scenarios.”
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Scenario analyses are “dress rehearsals” that companies use to test how potential, hypothetical future scenarios could affect their business.
But the provision would put companies in the position of having to share highly speculative forecasts that may end up being disconnected from reality, according to Cynthia Mabry, a partner at Akin Gump Strauss Hauer & Feld LLP.
“If you had a crystal ball, what would the world look like—how is that helpful to investors?” Mabry asked. “I really struggle with this one. On a Tuesday you could be thinking you see a market opportunity and it’s great, and on Wednesday the war on Ukraine breaks out and you’re not going to do business in Poland.”
Some standard principles to consider when developing scenarios have already been established, such as the evaluation of physical and transition impacts and mid-course corrections based on unanticipated events, said Hilary Tompkins, former solicitor at the Department of the Interior who is now a partner at Hogan Lovells US LLP.
In some cases, companies use scenario analyses as internal brainstorming exercises, helping them envision different futures ranging from essentially unchanging to catastrophic, Mabry said.
“Isn’t the SEC making an analytical tool now a compliance function?” she said.
Alexandra Farmer, a partner at Kirkland & Ellis LLP, said the proposal “may yet create a chilling effect on companies who wish to internally test out scenario analysis first and would not have the benefit of time to refine and get it right.”
Many companies already using scenario analyses have found it “particularly challenging to address, due to the inherent complexities,” said Paul Barker, a partner at Kirkland & Ellis LLP.
Safe Harbors Suggested
Commenters to the SEC’s docket have raised similar concerns. Some called for safe harbors for companies submitting scenario analyses, or a provision that lets companies deliver their analyses in separate reports that wouldn’t be scrutinized as closely as other filings.
The SEC acknowledged in the preamble that it “may be costly or difficult for some registrants to conduct such scenario analysis.” The proposal doesn’t require companies to prepare scenario analyses if they aren’t already using them.
The agency has also “signaled that a good faith, reasonable effort” to use a method similar to the one endorsed by the Task Force on Climate-Related Financial Disclosures will pass muster, noted Elizabeth Dawson, a former trial attorney at the Justice Department’s environmental division and now counsel at Crowell & Moring LLP.
The task force drafts recommendations for corporate climate reporting.
Moreover, scenario analysis isn’t a new practice, although only 13% of 1,651 surveyed public companies used the method in 2020, according to the task force. In 2018 the total came to only 5%.
Standard principles have already been established to develop analyses, including the evaluation of physical and transition impacts, with provisions for “mid-course correction based on unanticipated events,” said Tompkins.
“The disclosure should be prepared with an eye towards showing the company has asked the hard questions and has a strategy to reduce climate risks and strengthen climate resiliency,” Tompkins said.
Companies that fail to share any scenario analyses they use run the risk of SEC enforcement actions, federal securities law claims, and the reputational harm and loss of investors, according to Heather Palmer, a partner at Sidley Austin LLP.
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