Last March, the Securities and Exchange Commission (SEC) voted to approve a comprehensive package of rule changes that would require public companies to report detailed information on climate-related risks and greenhouse gas emissions. The SEC had hoped to finalize these rules by October and begin implementing them in early 2023. But the volume of public comment — along with a June 2022 Supreme Court ruling threatening the agency’s regulatory authority — have extended this timeline into the new year.
The SEC’s move was no surprise: in July 2021, chairman Gary Gensler said that “investors increasingly want to understand the climate risks of the companies whose stock they own or might buy,” and that “consistent, comparable, and decision-useful disclosures” could help. Defenders of the proposed changes argue that climate-related disclosures must be applied to public companies, given the existential risks associated with climate change. Critics counter with concerns about the costs of compliance and mission creep at the SEC—a Depression-era regulatory agency originally established to protect investors. The critics are correct.
Start with the agency’s origins. The SEC was founded to enforce the Securities Act of 1933 and the Securities Exchange Act of 1934, which Congress passed to protect investors from fraud and to create a uniform, national regulatory regime for the trading of securities. The SEC defines its mission as “protecting investors, facilitating capital formation, and maintaining fair, orderly and efficient markets.”
Since then, the SEC has enacted rules and promoted legislation to advance these objectives. These include regulations to address selective disclosure of nonpublic information; rules related to false statements, deceptive practices, and insider trading; and legislation to create a safe harbor for companies making forward-looking statements. The SEC exists to protect investors and demand corporate transparency.
Enter the proposed climate-related disclosures, which arrive at a time when the investment community is increasingly under pressure from environmental advocates, including institutional investors. Indeed, investment firms have recently begun placing environmental mandates on the private sector, such as in Larry Fink’s 2020 Letter to CEOs, in which he highlighted “how climate risk is compelling investors to reassess core assumptions about modern finance . . . [and] deepening our understanding of how climate risk will impact both our physical world and the global system that finances economic growth.” They’re examples of larger advocacy efforts to project environmental, social, and governance (ESG) principles on the way investors view public companies.
While more information tends to be a good thing, any mandatory disclosure requirements should be evaluated against three key considerations: the cost of providing such information, the expertise of the agency implementing the mandate, and the relevance of the information. In this case, the proposed benefits of climate disclosure could outweigh the cost, and the SEC would have no trouble securing expertise. But the information the SEC is seeking — the risk that climate change poses to a company, and the effect that company has on climate change — bears little relevance to its statutory mission.
Uniform disclosures about the impact of climate on companies sounds reasonable. Public company disclosure obligations were designed, after all, to assess material risks that may threaten a company’s performance. But the proposed rules fail to distinguish between macro and micro climate risks — and this is where things get tricky. For example, the SEC stated that the proposed changes would require firms to disclose “how any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term.” The same formulation could, in theory, mandate disclosure of the risks of future thermonuclear conflict, solar flares, or viral pandemics. Such information is so general and far-reaching as to be effectively meaningless for assessing the risks to a specific company.
Meanwhile, the proposed “Scope 1” and “Scope 2” rules—which relate to the effects a company has on the climate—would require SEC registrants to disclose their own greenhouse gas emissions and those of companies they do business with. The stated goal is “to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks” as companies shift to greener business practices.
But a lot of assumptions are at play here. The notion of an inevitable “energy transition,” for instance, may be championed by political leaders, but it’s hardly foreordained. When and whether an ultimate transition to renewable energy sources will happen is unknowable, which renders any SEC disclosure wholly speculative. The SEC has said that “the proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol”— but neither of these agencies (unlike the SEC) have the force of law.
Investors should obviously be concerned with any and all risks associated with companies they invest in. Yet lawful activities may affect the climate without affecting its performance. Which is why the specter of them being prohibited by future environmental regulations is a major uncertainty that investors and fiduciaries can’t bank on.
Legal and financial challenges to ESG-related concepts have gathered steam over the course of 2022, including a number of states divesting billions of assets under management from investment giants such as BlackRock, which has aggressively embraced ESG principles. The SEC’s proposed climate rules, in whatever form they ultimately take, will no doubt open up another front in the regulatory assault on markets. What is clear is that requiring public companies to make climate disclosures imposes new costs — while providing few benefits, particularly for investors.