SEC climate-change disclosure letter is prediction of regulation to come

The US’ Securities and Exchange Commission (SEC) has published a sample letter highlighting some of the mistakes that firms are making – or expected to make – with regard to their climate-related disclosures. Reading between the lines, the letter serves as a forewarning of impending regulatory change.

Existing climate-related disclosure requirements

Drawing on comments made by Commissioner Allison Herren Lee in June 2021, the SEC notes that a number of its existing disclosure rules and regulations may in fact require disclosures that are related to climate change. This includes, but is not limited to, information about a company’s description of business, legal proceedings, risk factors, management discussions and financial analysis – depending on the individual facts in hand.

In particular, the SEC notes that prescriptive ESG disclosure matters arise within the current 2010 Climate Change Guidance including:

• The effect of pending or existing climate-change related legislation, regulations and international accords;
• The indirect consequences of regulation of business trends; and
• The physical impacts of climate change.

Moreover, on a far broader scale, under Rule 408 of the Securities Act 1933, companies must also disclose “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”.

Sample letter highlights disclosure failings for climate change

With that in mind, the SEC has published an illustrative letter, which contains examples of messages and comments that the SEC’s Division of Corporation Finance may issue to companies regarding climate-related disclosures (or the absence of such disclosures).

The letter highlights a number of points where it has seen failures arise in current disclosure practices. It has asked firms, as an example, to do the following:

• Explain why they may have provided more expansive disclosure information in their corporate social responsibility (CSR) report than provided in their SEC filing.
  
  
• Disclose the effects of transition risk related to climate change that may affect their business, financial condition, and operation results. This includes policy and regulation changes or market trends that could impose operational and compliance burdens or alter business opportunities.
  
  
• Disclose the risk of litigation associated with climate change, and the effect that could have on their business.
  
  
• Quantify any significantly increased compliance costs related to climate change.
  
  
• Discuss the indirect consequences of climate-related regulation or business trends (if material).
  
  
• Disclose information regarding the sale or purchase of carbon credits.
  
  
• Disclose material past or future capital expenditure for climate-related projects.
  
  
• Revise their disclosure to identify material pending or existing climate-related legislation regulations – and describe the effect it has had on business (if material).
  
  
• Discuss the physical effects of climate change on their operations and results.

CUBE comment

The SEC’s demonstrative points, as the regulator has attested, are not exhaustive. However, of the nine key points highlighted at least four pertain to the challenges of climate-related regulation and the costs of complying with such regulations. As such, this letter carries more as a prediction of things to come, rather than a “sample letter”.

In particular, point 4 of the SEC’s hypothetical letter highlights a scenario in which “there have been significant developments in federal and state legislation and regulation and international accords regarding climate change that [a firm has] not discussed in [their] filing”.

With that in mind, this letter is interesting for many reasons, not least because it shows that US regulators (who up until now have been slow to grapple ESG) are very seriously gearing up to implement climate-related regulation and disclosure rules.

It is also interesting because, reading between the lines the SEC seems to be saying ‘new regulation is imminent, this regulation will be challenging to implement, and we will not be soft on firms who fail to meet our expectations’. The letter appears to be an informative flavour of potential areas in which firms are falling short with regard to climate-related disclosures. The cynic in me sees the letter more as a warning – an indication of the approach the SEC will take to poorly executed disclosures.

On a more positive note, while new regulations and disclosure rules may be onerous and potentially have “indirect consequences” to begin with, it is these new rules that may eventually serve to iron out the less administrative and harder to anticipate challenges of climate change, such as damaging physical effects, the devaluing of assets and knock-on effects for insurers and brokers alike.

If we regulate now, the initial effect of managing emerging regulation may be challenging (we’ve got a product that can help). But if we fail to regulate, the overwhelming burden of climate-related risk will surely pose far more of a challenge in the long run?