Ahead of the imminent publication of updated climate disclosure rules, the SEC has published a sample comment letter providing companies with guidance as to the regulator’s current focus and expectations under the rules. The last official SEC guidance on climate-related guidance was published in 2010; however, the SEC, and individual top brass, have been vocal about the need for updated regulations. In that regard, in March 2021, the SEC published a statement requesting public input on climate change disclosures. It is expected that either a rule proposal or temporary final rules are forthcoming. For more information on differing views following the March 2021 request for public comment, including from regulators, industry groups and individual SEC Commissioners, see HERE.
In 2010 as today, companies were and are required to report material information that can impact financial conditions and operations (see most recent amendments to MD&A disclosures: HERE). In addition to MD&A, climate-change-related disclosures, including risks and opportunities, may be required in disclosures on a company’s description of business, legal proceedings, and risk factors. Although some environmental disclosures are prescriptively required by Regulation S-K or S-X, climate matters would be disclosable if it fell under the general materiality bucket of information. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or put another way, if the information would alter the total mix of available information. Disclosure may also be necessary under the anti-fraud rules which require a company to include such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.
Disclosure matters discussed in the 2010 guidance include: (i) the impact of pending or existing climate-change-related legislation, regulations, and international accords; (ii) the indirect consequences of regulation or business trends; and (iii) the physical impacts of climate change. I’ve included a recap of the March 2021 request for public comment and 2010 guidance at the end of this blog.
Sample SEC Comment Letter
The SEC sample comment letter is broken down by disclosure topic.
As I’ve discussed in previous blogs, some companies opt to publish an ESG report, often referred to as a social responsibility report (“CSR”), on their website but not include the report in their SEC reports. There are many reasons for this including the obvious, that information included in SEC reports is subject to Sarbanes-Oxley (SOX)-related requirements including that reports be generated as part of a system of internal controls over financial reporting (ICFR), that management assess such ICFR, and in the case of 10-Q’s and 10-K’s, file CEO and CFO certifications attesting to such assessment (see HERE). There is also the matter of auditor involvement in the preparation of reports, and responsibilities of the board of directors (see HERE).
At the same time as advocating for increased climate change disclosures, the SEC has been clear that it is focused on the veracity of such disclosures. There is a concern that some companies, including investment companies, are publishing ESG goals with no real underlying commitment or execution. Likewise, as there are no standard requirements related to third-party CSR reports, a company could obtain a positive report, regardless of underlying metrics.
With that backdrop in mind, the SEC sample comment letter includes the following general comment: “We note that you provided more expansive disclosure in your corporate social responsibility report (CSR report) than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your CSR report.” The SEC is clearly sending a warning that published CSR reports should be consistent with disclosure in an SEC report, and if not, the company needs to explain themselves.
Item 503 of Regulation S-K requires disclosure of the most significant factors that make an investment in the company or offering speculative or risky. Where appropriate, climate change risk factors would need to be included, such as existing or pending legislation or regulation. For more information on risk factor disclosure requirements, see HERE.
Despite the SEC’s consistent message that risk factors should not merely be generic disclosures that could apply to any public company, most companies, big and small, continue to copy and paste a list of boilerplate risks. The sample comment letter is focused on the degree to which companies are merely addressing climate risk in a generic and abstract sense or are adequately considering and disclosing particular material matters.
The two sample comments include: (i) [D]isclose the material effects of transition risks related to climate change that may affect your business, financial condition, and results of operations, such as policy and regulatory changes that could impose operational and compliance burdens, market trends that may alter business opportunities, credit risks, or technological changes; and (ii) [D]isclose any material litigation risks related to climate change and explain the potential impact to the company.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
It is in the area of MD&A that the SEC is pushing companies to really improve disclosures, with the underlying necessity that the issues be well vetted and thought through. The sample SEC comment letter includes 6 multi-part comments that, I believe, provide the most insight into what we can expect in the new disclosure rules.
The SEC is asking that companies consider the impact on their business of the significant developments in federal and state legislation and regulation and international accords regarding climate change. Companies should include a discussion of any material pending or existing climate-change-related regulatory or similar changes that may impact their business and describe the effect on the business, financial condition, and results of operations. This disclosure would necessarily include climate-related litigation, challenges to permits, and impacts on customers and suppliers.
Although it seems obvious that companies should have been including material climate-related capital expenditures in their reports, the sample comment letter includes a request to “Revise your disclosure to identify any material past and/or future capital expenditures for climate-related projects. If material, please quantify these expenditures.” Similarly, the SEC asks for disclosure of any material increased compliance costs related to climate change and challenges companies to quantify that increase. Making sure that a company provides rounded disclosure, the sample comment letter also asks for disclosure about a company’s purchase or sale of carbon credits or offsets.
The SEC clearly assumes that climate change has and will continue to alter the economy and supply chains. Indirect consequences of these changes should also be analyzed and discussed, including: (i) decreased demand for goods or services that produce significant greenhouse gas emissions or are related to carbon-based energy sources; (ii) increased demand for goods that result in lower emissions than competing products; (iii) increased competition to develop innovative new products that result in lower emissions; (iv) increased demand for generation and transmission of energy from alternative energy sources; and (v) any anticipated reputational risks resulting from operations or products that produce material greenhouse gas emissions.
Climate change is not just an esoteric discussion about the future of the planet but has a current real-world physical impact as well. In that regard, the SEC comment letter requests information on the physical impact to a company, including: (i) the severity of weather, such as floods, hurricanes, sea levels, arability of farmland, extreme fires, and water availability and quality; (ii) quantification of material weather-related damages to your property or operations; (iii) potential for indirect weather-related impacts that have affected or may affect your major customers or suppliers; (iv) decreased agricultural production capacity in areas affected by drought or other weather-related changes; and (v) any weather-related impacts on the cost or availability of insurance.
March 2021 Request for Comment
On March 15, 2021, the SEC issued a statement requesting public input on climate change disclosures. The request for public comment outlined specific questions for consideration, including:
- How can the SEC best regulate, monitor, review, and guide climate change disclosures in order to provide more consistent, comparable, and reliable information for investors while also providing greater clarity to registrants as to what is expected of them? Where and how should such disclosures be provided? Should any such disclosures be included in annual reports, other periodic filings, or otherwise be furnished?
- What information related to climate risks can be quantified and measured? How are markets currently using quantified information? Are there specific metrics on which all companies should report (such as greenhouse gas emissions)? What quantified and measured information or metrics should be disclosed because it may be material to an investment or voting decision? Should disclosures be tiered or scaled based on the size and/or type of registrant? Should disclosures be phased in over time? How are markets evaluating and pricing externalities of contributions to climate change? Do climate change related impacts affect the cost of capital, and if so, how and in what ways? How have registrants or investors analyzed risks and costs associated with climate change? What are registrants doing internally to evaluate or project climate scenarios, and what information from or about such internal evaluations should be disclosed to investors to inform investment and voting decisions? How does the absence or presence of robust carbon markets impact firms’ analysis of the risks and costs associated with climate change?
- What are the advantages and disadvantages of permitting investors, registrants, and other industry participants to develop disclosure standards mutually agreed by them? Should those standards satisfy minimum disclosure requirements established by the SEC? How should such a system work? What minimum disclosure requirements should the SEC establish if it were to allow industry-led disclosure standards? What level of granularity should be used to define industries (e.g., two-digit SIC, four-digit SIC, etc.)?
- What are the advantages and disadvantages of establishing different climate change reporting standards for different industries, such as the financial sector, oil and gas, transportation, etc.? How should any such industry-focused standards be developed and implemented?
- What are the advantages and disadvantages of rules that incorporate or draw on existing frameworks, such as, for example, those developed by the Task Force on Climate-Related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), and the Climate Disclosure Standards Board (CDSB)? Are there any specific frameworks that the SEC should consider? If so, which frameworks and why?
- How should any disclosure requirements be updated, improved, augmented, or otherwise changed over time? Should the SEC itself carry out these tasks, or should it adopt or identify criteria for identifying other organization(s) to do so? If the latter, what organization(s) should be responsible for doing so, and what role should the SEC play in governance or funding? Should the SEC designate a climate or ESG disclosure standard setter? If so, what should the characteristics of such a standard setter be? Is there an existing climate disclosure standard setter that the SEC should consider?
- What is the best approach for requiring climate-related disclosures? For example, should any such disclosures be incorporated into existing rules such as Regulation S-K or Regulation S-X, or should a new regulation devoted entirely to climate risks, opportunities, and impacts be promulgated? Should any such disclosures be filed with or furnished to the SEC?
- How, if at all, should registrants disclose their internal governance and oversight of climate-related issues? For example, what are the advantages and disadvantages of requiring disclosure concerning the connection between executive or employee compensation and climate change risks and impacts?
- What are the advantages and disadvantages of developing a single set of global standards applicable to companies around the world, including registrants under the SEC’s rules, versus multiple standard setters and standards? If there were to be a single standard setter and set of standards, which one should it be? What are the advantages and disadvantages of establishing a minimum global set of standards as a baseline that individual jurisdictions could build on versus a comprehensive set of standards? If there are multiple standard setters, how can standards be aligned to enhance comparability and reliability? What should be the interaction between any global standard and SEC requirements? If the SEC were to endorse or incorporate a global standard, what are the advantages and disadvantages of having mandatory compliance?
- How should disclosures under any such standards be enforced or assessed? For example, what are the advantages and disadvantages of making disclosures subject to audit or another form of assurance? If there is an audit or assurance process or requirement, what organization(s) should perform such tasks? What relationship should the SEC or other existing bodies have to such tasks? What assurance framework should the SEC consider requiring or permitting?
- Should the SEC consider other measures to ensure the reliability of climate-related disclosures? Should the SEC, for example, consider whether management’s annual report on internal control over financial reporting and related requirements should be updated to ensure sufficient analysis of controls around climate reporting? Should the SEC consider requiring a certification by the CEO, CFO, or other corporate officer relating to climate disclosures?
- What are the advantages and disadvantages of a “comply or explain” framework for climate change that would permit registrants to either comply with, or if they do not comply, explain why they have not complied with the disclosure rules? How should this work? Should “comply or explain” apply to all climate change disclosures or just select ones, and why?
- How should the SEC craft rules that elicit meaningful discussion of the registrant’s views on its climate-related risks and opportunities? What are the advantages and disadvantages of requiring disclosed metrics to be accompanied with a sustainability disclosure and analysis section similar to the current Management’s Discussion and Analysis of Financial Condition and Results of Operations?
- What climate-related information is available with respect to private companies, and how should the SEC’s rules address private companies’ climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?
- In addition to climate-related disclosure, the staff is evaluating a range of disclosure issues under the heading of environmental, social, and governance, or ESG, matters. Should climate-related requirements be one component of a broader ESG disclosure framework? How should the SEC craft climate-related disclosure requirements that would complement a broader ESG disclosure standard? How do climate-related disclosure issues relate to the broader spectrum of ESG disclosure issues?
2010 Climate Disclosure Guidance
In 2010 the SEC issued a 29-page document providing guidance on climate change disclosures delineating areas that could require such disclosure, including:
Description of Business
Item 101 of Regulation S-K requires a description of the general development of the business, both historically and intended. Then and now, Item 101 requires disclosures related to the costs and effects of compliance with environmental laws. Although the specific section and language in Item 101 has changed since 2010, the general requirement that disclosures be provided related to the costs of compliance and effect of compliance with environmental regulations, including capital expenditure requirements, remains the same.
With respect to existing federal, state and local provisions which relate to greenhouse gas emissions, Item 101 requires disclosure of any material estimated capital expenditures for environmental control facilities for the remainder of a registrant’s current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem material.
Item 103 of Regulation S-K requires a company to briefly describe any material pending legal proceeding to which it or any of its subsidiaries is a party. Item 103 specifically applies to the disclosure of certain environmental litigation including proceedings arising under any federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primary for the purpose of protecting the environment. Disclosure is required for both private civil suits and litigation where a governmental entity is a party. In 2010 the threshold for disclosure where the government is a party was $100,000, but that threshold has since been increased to either $300,000 or a threshold determined by the company as material but in no event greater than the lesser of $1 million or 1% of the current assets of the company.
Where appropriate, climate change risk factors would need to be included, such as existing or pending legislation or regulation.
Management Discussion and Analysis (MD&A)
Item 303 or Regulation S-K – MD&A is intended to satisfy three principal objectives: (i) to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management; (ii) to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and (iii) to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.
The 2010 guidance contains a lengthy discussion on MD&A including management’s necessity to identify and assess known material trends and uncertainties considering all available financial and non-financial information. The SEC indicates that management should address, when material, the difficulties involved in assessing the effect of the amount and timing of uncertain events and provide an indication of the time periods in which resolution of the uncertainties is anticipated.
Item 303 requires companies to assess whether any enacted climate change legislation, regulation or international accords are reasonably likely to have a material effect on the registrant’s financial condition or results of operations. This analysis would include determining the likelihood of the legislation coming to fruition as well as potential impact, both positive and negative. Items to consider include: (i) costs to purchase, or profits from sales of, allowances or credits under a “cap and trade” system; (ii) costs required to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a “cap and trade” regime; and (iii) changes to profit or loss arising from increased or decreased demand for goods and services produced by the company arising directly from legislation or regulation, and indirectly from changes in costs of goods sold.
However, despite the lengthy discussion of MD&A, the SEC guidance lacks in real-world application. I would certainly hope that the SEC’s updated forthcoming updated guidance provides a better framework with tangible information to assist management’s analysis.
Foreign Private Issuers
Foreign private issuers’ (FPI) disclosure obligations are generally delineated in Form 20-F. Although many items are similar to, they differ from those in Regulation S-K. However, an FPI is required to disclose risk factors; effects of governmental regulations; environmental issues; MD&A and legal proceedings, all of which may require climate-related information.