The Securities and Exchange Commission under the Biden administration has made no secret of the fact that climate change is high on its agenda. On March 21, the agency’s commissioners voted 3-to-1 to advance a hotly anticipated proposal on mandatory climate risk disclosures. This rule, if enacted, would require public companies to disclose their greenhouse gas emissions and exposure to climate-related risks.
The proposed rule spans an eye-watering 506 pages, so here we’ve sought to highlight its major provisions, legal basis and what comes next.
What Is the SEC Proposing?
The rule would require foreign and domestic public companies to disclose within their financial reports an array of climate-related information. Specifically, the SEC wants companies to detail how the various risks associated with a warming climate—such as those arising from extreme weather events, regulatory actions or changing customer expectations—stand to materially impact their operations, strategy and outlook. In addition, management would be expected to outline their formal processes for identifying, assessing and managing these risks.
To comply with the rule, publicly traded companies would also have to disclose the greenhouse gas emissions generated by their direct operations and by the energy they use. These emissions numbers would need to be verified by an independent attestation provider. Moreover, the SEC also wants larger companies to disclose emissions generated throughout their value chain—including from suppliers or consumers—if they might be considered financially material, or if companies have referenced these emissions in their public climate pledges.
This last caveat is consistent with the SEC’s prior remarks on corporate climate commitments: Chair Gary Gensler and Commissioner Caroline A. Crenshaw have both previously expressed misgivings about companies’ efforts to monitor progress toward, and meet, their emissions goals. Accordingly, the SEC’s proposed rule would require a company that has publicly announced a climate-related target to “disclose information about the target along with the unit of measurements, the defined time horizon, the baseline the target would be tracked against, and relevant data to indicate whether the registrant is making progress.” As part of this, companies would need to disclose the degree to which their net-zero ambitions rely on carbon offsets. This will likely come as welcome news to environmental groups, many of which have cautioned that these accounting mechanisms may allow corporate polluters to delay more meaningful decarbonization efforts.
Taking a Step Back: How Did We Get Here?
In recent years, we’ve seen heightened public awareness of climate change and its negative effects on communities worldwide. Consumers are realizing the limitations of individual action and instead calling on the primary culprits behind global warming—major corporations—to reassess their impacts on the natural world.
Facing pressure to address their environmental footprints, many of the world’s most powerful businesses have unveiled ambitious plans to reach net-zero emissions within a given time frame. At the same time, financial institutions have responded to growing investor demand for values-aligned solutions by creating funds with attractive descriptors such as “green” or “sustainable.” The only trouble? Many of these pledges and products don’t hold up to scrutiny, and their issuers have subsequently been accused of making misleading claims regarding their sustainability credentials (a practice known as “greenwashing”).
As it turns out, the SEC has been paying close attention to all of this and last year announced the formation of a Climate and ESG Task Force aimed at protecting investors from such deceptive practices. Among the first orders of business for this task force: dusting off the existing framework for voluntary climate-risk disclosures that had been in place for more than a decade. In doing so, the commission sought public input on how best to regulate climate disclosures and subsequently attracted hundreds of comments (including from Ethic). According to Gensler, the vast majority of respondents expressed broad support for such measures.
What’s the Rationale Behind the Rule?
SEC officials have indicated that their latest proposal comes, in large part, as a response to investor demand. Indeed, there’s a growing understanding that climate change presents credible threats to the global economy—and one survey indicated that more than 90% of institutional investors believe markets have yet to adequately price in these risks. Still, public companies have been slow to respond to the demand for greater transparency, and many continue to disclose limited information about their impacts on the environment or their resilience to climate-related crises.
We’ve often referred to environmental, social and governance investing as “full-information investing.” We believe access to a wider array of reliable data concerning a company’s impacts on people and the planet can facilitate more informed decision-making, enabling investors to better assess a company’s vulnerabilities to hazards like weather-related supply chain disruptions, consumer boycotts, climate litigation and more. The SEC’s rationale is seemingly a quite similar one: Better information can lead to more educated decisions. This is the premise behind a regulatory device known as mandated (or mandatory) disclosure, something the SEC has long touted as central to advancing its mission.
Gensler has previously intimated that companies’ current voluntary disclosures on climate risks yield a patchwork of discordant and incomplete information that may be of limited use to investors. By introducing its own framework for reporting climate risks, the SEC hopes to empower investors with “consistent, comparable, and decision-useful information for making their investment decisions” while also providing “consistent and clear reporting obligations for issuers."
What Happens Now?
It remains to be seen whether the rule as it currently stands will be adopted. The SEC is giving the public up to 60 days to submit comments on the plan, and a final rule could take effect by the end of the year. If this transpires, the largest companies would need to start reporting in 2024, while smaller entities would have until 2026.
It’s worth noting that the rule is almost certain to face legal challenges—some have posited that the SEC is overstepping its statutory authority and any measures to mandate climate disclosures could violate First Amendment limitations on compelled speech. Among the agency’s most vociferous critics on this issue is its lone Republican commissioner, Hester Peirce, who presented a lengthy statement outlining her various objections to the proposal.
What Does This Mean for Advisors?
This landmark regulatory development comes at a time when investors are seeking out companies that embrace positive environmental, social and governance practices—and not only for ethical reasons. Increasingly, investors are also recognizing the long-term financial ramifications of poor stewardship and inaction on challenges such as climate change. We believe they deserve access to reliable information about how companies in their portfolios are poised to adapt or endure amid a fast-changing natural environment, quickly evolving regulatory landscape, and rapidly shifting technologies and consumer behavior.
This latest rule-making activity is likely just the beginning for Gensler’s SEC—the chairman has hinted that the agency will also be turning its attention to the products offered by asset managers and advisors under the guise of “sustainable investing.” In prepared remarks last year, he asserted his belief that “investors should be able to drill down to see what’s under the hood of these funds” and that, absent standardized definitions for sustainability-related terms, his staff is considering whether fund managers should be required to disclose their criteria and underlying data.
To date, many advisors have held back from ESG adoption—a trend that might, in part at least, be attributed to a lack of robust information and reporting standards. However, the SEC’s efforts to standardize climate risk disclosures represent a critical first step in helping advisors cut through the noise and effectively evaluate companies’ risks and opportunities across various sectors. As it becomes ever clearer that conversations around climate risk should form part of an advisor’s fiduciary duty to their clients, and as evidence suggests those same clients are hoping their advisors will initiate said conversations, the question becomes: What are you waiting for?
Emma Smith is director of communications, and Alex Acosta is chief compliance officer, at Ethic. Ethic is an independent provider of custom direct indexing solutions. Its scalable platform enables financial advisors to deliver passive equity portfolios that meet investors’ growing demand for personalized, values-aligned solutions.
