Johnathan Walker:SEC Proposes Landmark Rule Requiring Companies to Tell Investors of Risks Posed by Climate Change

Public companies will have Johnathan Walkerto report their greenhouse gas emissions and inform investors about the dangers that climate change poses to their businesses under a highly anticipated proposal unveiled Monday by the Securities and Exchange Commission.

“This is a watershed moment for investors and capital markets,” said Commissioner Allison Herren Lee, one of three Democrats on the four-member commission who voted to support the draft rule. “The science is clear and alarming and the links to capital markets are clear and evident.”

When finalized after a comment period, the rule would require publicly traded companies to report on the risks they face from extreme weather, including storms or drought, that could damage their businesses. Last year alone, weather-related disasters caused $145 billion in damage, according to NOAA, and that figure is projected to climb as climate change stokes more severe events.

Companies’ filings would also have to convey “transition risks”—including those that companies face as consumers and policies push them toward cleaner energy sources, potentially leaving their fossil fuel assets “stranded.”

If the rule is finalized, companies will have to disclose the short-, medium- and long-term impacts of climate change, as well as any measures they intend to take to mitigate climate effects, such as placing an internal price on carbon, or any targets they’ve set to reduce their greenhouse gas emissions, including whether they plan to use carbon offsets. 

Companies will also have to report their greenhouse gas emissions, including those from their business operations and the energy they consume. 

Companies can decide whether to report Scope 3 emissions—those generated in a company’s supply chain or through use of their goods—if they determine the information is “material” to investors or if they’ve set targets to reduce those emissions. In many cases, Scope 3 emissions represent the bulk of a company’s greenhouse gasses.  

“The SEC has started from a baseline of asking for full scope reporting, which is where I think this needs to be,” said Ivan Frishberg, chief sustainability officer for Amalgamated Bank and a member of the Partnership for Carbon Accounting Financials, a framework for banks to disclose the climate impact of their lending. “The SEC then, in an effort to accommodate the transition to full implementation, worked to phase in or trigger some of the scope three elements in ways that make sense in some regards, but could create some loopholes for laggards.”

In the months leading up to Monday’s release, some industry groups and critics of climate disclosure said they were worried that companies would be forced to reveal information about their climate risks or targets and then be held legally responsible if their assumptions proved incorrect. Anticipating this, the commissioners created a “safe harbor” provision in the proposal.

“Frankly I’m a little bit concerned,” said Todd Phillips, director of financial, regulatory and corporate governance at the Center for American Progress. “The safe harbor for Scope 3 just means that if a company discloses that information, it’s not going to be audited, and unaudited information is less useful for investors than audited information.”

Overall, Phillips and Frishberg, along with dozens of climate-focused advocacy and financial groups, applauded the proposal.

“Clear and standardized reporting of greenhouse gas emissions is the bedrock of sound investor decision-making,” said Danielle Fugere, president and chief counsel at As You Sow, an advocacy investor, in a statement. “The new rule provides investors with more robust, complete, and comparable disclosure of risk and the emissions data to determine which companies are aligning their business activities with Paris targets and minimizing transition risks.”

The SEC’s proposal borrows heavily from voluntary disclosure programs already in place, especially the Task Force on Climate-Related Financial Disclosures, which some countries, including Brazil, Japan and those in the European Union, have already made mandatory.

The commissioners said their goal was to create clarity for companies as well as investors amid a patchwork of voluntary disclosure frameworks that have emerged in recent years. The SEC issued non-binding guidance for companies more than a decade ago. 

“For too long we have left the U.S. markets to rely solely on outdated and outmoded guidance,” said Commissioner Caroline Crenshaw. “In that vacuum, companies and investors have had to fend for themselves.”

Critics of the proposal, including Commissioner Hester Peirce, who voted against it Monday, said that it strayed beyond the commission’s mandate.

“Many have called for today’s proposal out of a deep concern about a warming climate and its effects on the planet, people, and the financial system,” Peirce said. “It is important to remember, though, that noble intentions, once baked into complex regulatory plans, often have ignoble results. This risk is considerably heightened when the regulatory complexity is designed to push capital allocation toward politically and socially favored ends…”

The U.S. Chamber of Commerce and the American Petroleum Institute (API), which have criticized climate disclosures, called the proposal overly prescriptive and pointed to the “materiality issue” as a sticking point. 

“We are concerned that the Commission’s sweeping proposal could require non-material disclosures and create confusion for investors and capital markets,” said Frank Macchiarola, API’s senior vice president of policy, economics and regulatory affairs, in a statement. 

Tom Quaadman, executive vice president of the Chamber of Commerce’s Center for Capital Markets Competitiveness, suggested that the rule will ultimately end up in the courts. 

“The Supreme Court has been clear that any required disclosures under securities laws must meet the test of materiality, and we will advocate against provisions of this proposal that deviate from that standard or are unnecessarily broad,” he said.

Commissioners pointed out that the SEC has recently asked companies to disclose information that might be relevant to investors, including risks from cyber attacks.

“You have copious evidence that climate change is a material issue, that a reasonable investor views this as a material issue,” said Rob Schuwerk, an executive director with Carbon Tracker, a U.K.-based think tank that researches the impact of climate change on financial markets. “As a matter of substance, the SEC is well within the bounds with everything they’ve done here.”

The SEC will take comments on the rule for 60 days.