US regulator’s proposed climate disclosure rule is ‘watershed moment’

The US Securities and Exchange Commission’s (SEC) climate change disclosure proposals have been warmly welcomed by investors who are demanding more disclosure and management of climate-related risks.

While many US companies make these disclosures in their proxy statements, sustainability reports or on their websites, they can vary widely. This means investors have found it challenging to access accurate disclosures from companies on a consistent basis.

The SEC’s proposed disclosure framework is partly modelled on the Task Force for Climate-Related Financial Disclosures (TCFD) and draws upon the Greenhouse Gas Protocol.

Julie Gorte, senior vice president for sustainable investing at Impax Asset Management says: “The proposal is that companies should report Scope 1 and 2 emissions (under the Greenhouse Gas Protocol), large companies must also report Scope 3 emissions, and if firms have a goal to reduce emissions, they need to report on how they are going to get there.”

How will it impact companies?

Climate-related disclosure by US firms has been largely voluntary, and so there have been inconsistencies among companies where some have had high-quality disclosures and others have had none.

Sarah Wilson, CEO of Minerva Analytics says: “The SEC’s proposals designed to align the US with the rest of the world on the lines of TCFD are extremely welcome because these propel more companies to a minimum baseline of standardisation and creates an enforcement regime.”

The proposal is a watershed moment, says Greg Hershman, head of US Policy at the UN’s Principles for Responsible Investment (PRI), explaining that its signatories around the world need consistent disclosure from companies to continue implementing the PRI’s six principles.

“If we're asking investors to be responsible about the investments they make, then it makes sense that they need good underlying data about the companies that they're going to invest in,” he adds.

The more information investors have, the better they can price those risks. As Gorte says: “If we don't have information, then we're just setting ourselves up for a series of increasingly severe and unpleasant surprises.”

The consultation period was due to end on May 21 this year, but the SEC extended it to June 17 to give people more time to respond.

There is now uncertainty over whether the rules will come into place before the next election cycle because once the consultation concludes, it will likely take the SEC months to digest potentially many thousands of responses. The SEC wants to finalise the rule by the end of this year and the first disclosures are not likely to come into force until 2024-2025.

Political backdrop

There has been a huge amount of controversy and political debate over these proposed regulations – particularly over the cost to companies. This negative attitude towards climate disclosures stems back to when former President Donald Trump took the US out of the Paris Agreement in November 2020 after a three-year delay, resulting in the country’s detachment from addressing the realities of climate change.

Even though President Biden pulled the US back into the Paris Agreement in 2021, Gorte says the previous events caused the US to fall far behind the UK and Europe which have led the world on incentivising companies and the financial sector to take climate change risks into account.

She adds: “There is a lot of push-back from the conservatives saying, ‘this is going beyond the SEC's mission, this is mission creep’. Some are calling it ‘woke capital’.”

There are even rumours of groups planning to launch lawsuits against the regulator.

Hershman thinks there could be at least one or two lawsuits: “Knowing the litigious nature of the US, we are already hearing that there are groups which will sue the SEC over this to stop or pare back this rule, and that could slow down the implementation process.

“Where [lawsuits] get dragged out for a number of months or even years, I think it would be very unfortunate because investors do want this information.”

Despite the negative reaction from US companies, there is widespread opinion that the SEC has tried to limit the cost and regulatory burden on firms.

Gorte says the regulator has tried to make the proposed rule as harmonious and compatible as possible with other global disclosure regimes such as the International Accounting Standards Board’s new standard, the Sustainability Accounting Standards Board and the TCFD.

PRI’s Hershman believes the SEC has done a great job of creating a rule that would get investors the information they need in the right way, while making sure that they try to limit the costs on issuers.

He says: “There are several carve outs within the rule: Scope 3 emissions reporting is not mandatory for all companies, and there's an additional safe harbour from litigation for Scope 3 reporting. The SEC is phasing this in, giving issuers a number of years to comply with the rule, which we think is a pretty fair timeline.”

Power of shareholders

Looking forward, Wilson thinks that high levels of lobbying against the proposals could lead to an explosion of more shareholder resolutions on climate change at US companies.

“I expect a lot of negative lobbying, and this is where investors have a particularly important role to play with their fund managers and their service providers – irrespective of what the SEC finally comes out with in the end,” says Wilson.

Shareholders have a lot of power in the US but often companies ignore what shareholders say, she says. Meanwhile, in Europe including the UK, voting and engagement through soft regulation such as stewardship codes, have achieved a lot by changing conduct and understanding about climate change.

The SEC needs to hear from the providers of capital who are often forgotten in these debates, says Wilson: “The SEC desperately needs to hear from the asset owners who should not assume that trade associations will speak in the same way about these issues as the providers of capital with local accountabilities.”