SEC Should Lead in Requiring Climate Disclosures

It is important for the Securities and Exchange Commission (SEC) to require climate disclosures that will provide investors with the information they need to make informed value-relevant investment decisions. We’ve said this in a recent letter to Chair Gensler in response to his agency’s request for public input on climate change disclosures. The following is a summary of our response.

We have two additional comments before we begin.

First, the bulk of the request for information is related to what you could call the “how” of establishing climate disclosure standards and not to the “what.”  As it relates to the “what” of climate disclosures, CFA Institute supports disclosure of Scope 1 and 2 emissions and, as is the case with all risks, a sensitivity analysis. We recognize, however, that sensitivity analysis for climate disclosures may be challenging given how little sensitivity analysis is provided in SEC filings currently relative to more established risks.

Second, as a participant at a recent roundtable noted, “ESG (environmental, social, and governance) is not a stable molecule,” meaning that ESG risks are evolving and the need for rulemaking will not likely be a one-time effort.

State of Play

Increasingly, investors are being called upon by their clients to manage climate-related portfolio risks and opportunities. We highlight in our comment letter survey results that show investors are seeking to incorporate climate risks into their asset selection.  To be able to incorporate climate change into their financial analysis and investment decision-making process—and to efficiently allocate capital—investors need accurate, timely, and comparable data on climate change from the issuer community. It is important for the SEC to require climate disclosures that will provide investors with the information they need to make informed investment decisions.

The SEC has an important role to play—that is, helping to establish the rules of the road of disclosure. Too stringent a carbon disclosure regime, and economic activity could be unnecessarily stifled, while too lax a standard would not achieve the greenhouse gas reduction goals needed to avoid the more catastrophic impacts of climate change. Fortunately, the SEC can leverage work already underway by entities such as the Sustainability Accounting Standards Board and the Task Force on Climate-Related Financial Disclosures as well as other complementary efforts.

It is important to recognize that investors are getting ESG and climate data and information from sources other than issuer disclosures, and such nontraditional data collection efforts will continue and only expand in the future. Data sources such as CDP, satellite data, government data, and data from numerous vendors are all used by investors and are not required disclosures of public companies. The SEC should not attempt to recreate the wheel and instead should let this market for non-issuer-released data thrive and even refer investors to such data, when appropriate.

What We Said

• Focus on Financially Material Data.  The SEC should focus only on financially value-relevant information, and not on information for all stakeholders. Information for other stakeholders can be provided in documents outside the SEC’s purview. The SEC should concentrate on material ESG and climate data that can be measured and managed by issuers. Such data will likely grow over time and more resources are dedicated to these efforts by issuers and investors.
• Speed (Evolution vs. Revolution). The SEC must recognize that their approach must be evolutionary rather than revolutionary. Issuers and investors must recognize that the nature of the disclosures will evolve as information becomes available and investors learn the more specific nature of the risks, as well as how to measure such risks and how to incorporate them more precisely into their investment decision-making.
• Global vs. Local. While we support global standards for accounting and sustainability standards, the reality is such that the establishment of a global standard setter, such as the International Financial Reporting Standards (IFRS) Sustainability Standards Board (SSB), the creation of global standards, and the ability of the SEC to utilize them is limited by many factors, even more so than for financial reporting standards under IFRS. The SEC does not accept IFRS except for foreign filers, and as such, accepting standards for IFRS sustainability standards for all registrants seems fraught with hurdles. Furthermore, the IFRS SSB disclosures will be linked to the IFRS conceptual framework and not to the US GAAP conceptual framework. 
• Proceed with Rulemaking. Practically speaking, the SEC must proceed with its own rulemaking—while staying engaged in the international effort to enhance comparability—and leverage existing standards, such as those developed by the Sustainability Accounting Standards Board, Task Force on Climate-Related Financial Disclosures, and Climate Disclosure Standards Board. We believe the SEC must undertake rulemaking akin to that for market risk disclosures to include such information in periodic filings of issuers in the United States. Over time, it may be appropriate to delegate such authority to a third-party standard setter.
• Meaningful Discussion and Analysis. Climate-related disclosures cut across the current requirements in Regulation S-K. There is, or should be, a meaningful discussion of these issues in the sections on Risks, Critical Estimates, Description of the Business, and Management Discussion and Analysis (MD&A), as well as in relevant proxy materials. We always support sensitivity analysis and scenario testing, but we know from existing disclosures that risk disclosures broadly are generic and boilerplate. They lack company specificity and, as in the case of Critical Estimates, quantification and sensitivity analysis. Meaningful discussion of climate risks requires a linkage between all these relevant sections of company filings.
• Create a New Section. It may be best to commence with a section similar to that of Market Risk Disclosures (an element of the MD&A disclosure) with a cross-reference to other sections and a central integrated discussion of climate disclosures in this single section Although we believe the market risk disclosures, particularly the “sensitivity analysis,” are too basic, the spirit of what is intended by those disclosures is the closest to the information investors need for climate disclosures to be meaningfully analyzed. Investors need a discussion of how the business creates or needs to address the risks, how they can measure and manage the risks, and how they are manifested in current and future operating results – a separate section that requires such synthesis seems to be the best solution.
• Increase Enforcement of Quality of All Risk Disclosures. For climate risk disclosures to be meaningful, the SEC likely needs to “up its game” on enforcement of existing requirements on Risks and Critical Estimates given that what investors are seeking on sensitivity analysis related to climate risk is not different than what they have sought on other material risks and uncertainties. For it too work for climate it needs to work for other risk disclosures. 
• Filed versus Furnished. ESG and climate disclosure should be filed rather than furnished. Without being filed, the quality of the information will not be sufficiently reliable for investors.
• Everyone Reports. If disclosures are financially material, they should be required by all companies irrespective of size, but we would support a phased approach to develop market consensus on practices.
• Minimum Standards. We do not support minimum standards as they quickly become the maximum disclosures. We would support an evolutionary process, but disclosures must be meaningful with a path toward more complete disclosures.
• Comply or Explain. We do not support a comply-or-explain approach as there is never  compliance nor explanation. This is a false choice.
• Enforcement. The SEC’s enforcement on climate disclosures should be no different than other information provided in the same venues.
• Public versus Private. Climate disclosures are value relevant to both private and public companies.
• Assurance. The level of “assurance” (as in audit assurance) depends on the location of the information. Investors differ on who they think should be responsible—not necessarily auditors—as they worry auditors may not have the necessary underlying functional expertise, and auditors are traditionally opposed to providing assurance on forward-looking information.  Our investor survey suggests greater support for verification from those with the underlying ESG expertise.
• Management Attestation. Management attestation (internal controls over financial reporting or disclosure controls and procedures) depends on location and may need to be evolutionary.
• Linking to Compensation. We support management accountability and linkage of risk management to compensation, but linkage to compensation may need to evolve based on the evolution in the disclosures.
• Industry Specific. Investors always prefer industry-specific guidance. Given the very different ways in which climate may affect companies, it seems preferable to develop industry-specific standards. We support disclosure of common metrics across industries complemented by industry-specific metrics.

Time for SEC to Act

Governments, companies, and investors increasingly are making commitments to a lower-carbon world, for example, with net-zero 2050 commitments. Such a transition to a lower-carbon economy will have a significant impact on the global economy, with the US economy being no exception. It is time for the SEC to take the lead.

Photo Credit @ Getty Images / Andriy Onufriyenko