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U.S. SEC Proposes New Climate Change Disclosure Requirements

Currently, there are no clear regulations regarding climate change disclosures for publicly traded corporations in the United States. Any company that sells stocks and is required to report their financials is able to disclose as much or as little as they want, with no easy way to compare reports across companies. This allows organizations to cherry-pick information for their reports and appear as though they are participating in climate change activism when in reality, the non-disclosures are arguably more important. However, the Securities and Exchange Commission (SEC) is going forward with important new standards for climate change disclosures that will have a wide impact across the accounting industry and affect the Generally Accepted Accounting Principles (GAAP). Moreover, these changes will allow sustainable investing, a strategy that seeks to consider both financial return and social or environmental good to bring about social change, to further develop.

The SEC is considered the front line in terms of identifying emerging issues and areas of accounting that need attention, but they look to the private sector for leadership in establishing and improving upon the accounting methods used to prepare financial statements. Since 2012, there has been an increased demand for climate change information and questions about whether current disclosures adequately inform investors. Now, due to this demand and increased pressure from the Biden administration, the SEC is on the verge of setting hard rules on climate-related disclosures that corporate issuers will have to abide by in order to establish greater consistency, reliability, and transparency for investors, creditors, and the market to better evaluate an entity. These rules are expected to enhance climate data standardization and accelerate sustainable investing. 

As it stands, about 90% of the firms in the S&P 500, a stock market index which tracks the performance of 500 large companies listed on U.S. stock exchanges, voluntarily release reports disclosing statistics on metrics like carbon emissions and the amount of renewable energy they use, but these statistics are often cherry-picked. The SEC chairman Gary Gensler provided more clarity on the proposed rule changes meant to help with this issue. The rules are indicated to be set in tiers, with different sized entities complying with different levels and types of rules on differing timeframes. Small companies will likely be required to comply with less stringent rules due to the cost involved in reporting as well as a likelihood of less relevance for investors, and larger companies will have more rules but a longer timeframe in which to provide data. This is reminiscent of the EU’s proposed Corporate Sustainability Reporting Directive (CSRD) which has been an expansion of regulations dated back to 2011. 

Regulated companies will be expected to consider “double materiality”—the enterprise value creation (financial materiality) plus the “significant impacts on the economy, environment, and people”—when determining whether a piece of information should be disclosed. These disclosures will be in the form of both qualitative and quantitative reporting, such as strategies to address the physical and transitional risks associated with climate change as well as quantitative emissions data. Some things to consider will include potential litigation or the transition away from fossil fuels, capital expenditures for climate-related projects, the potential for lower demand for goods and services that produce significant greenhouse gas emissions, and the effects of severe weather on company operations, among other things. Quantitative disclosure such as emissions data and compliance costs related to climate change will also likely be required.

Some business groups argue that the uncertainty of the extent and effects of climate change makes it difficult to accurately predict potential costs related to climate reporting, but the increased demand from investors, as well as changing requirements from the EU and other jurisdictions, has shown that regardless of potential inaccuracies, the world is moving towards regulation of these reporting standards.

Implementation of these regulations is uncertain given the time it will take to release and finalize the full set of proposed rules and the sequential corporate adaptation. The expected adaptation to GAAP is beyond 2022, but other countries and jurisdictions have allowed for longer timelines; the EU released the CSRD proposal in April 2021 and expects to start implementation in 2024, and the SEC has to ensure a high alignment between GAAP and International Financial Reporting Standards (IFRS) in order to decrease compliance costs for the new standards as much as possible.

Overall, these new requirements will put higher scrutiny on corporations, allow for investors to make informed decisions, and increase confidence in the transparency of disclosures while benefiting the sustainable finance market’s development. The companies who are required to disclose their sustainability measures will be held to a higher level of accountability for their climate-related risks and reporting. Although these changes do not come without challenges, they have been a long time coming and represent a wider interest in sustainability and climate change in society as a whole.

 

Sources

Choi, Jina, and David Lynn. “SEC Staff Highlights Comments on Climate Change Disclosure.” JD Supra, https://www.jdsupra.com/legalnews/sec-staff-highlights-comments-on-2195753/

“Fact Sheet: Biden Administration Roadmap to Build an Economy Resilient to Climate Change Impacts.” The White House, The United States Government, 15 Oct. 2021, https://www.whitehouse.gov/briefing-room/statements-releases/2021/10/15/fact-sheet-biden-administration-roadmap-to-build-an-economy-resilient-to-climate-change-impacts/

Herdman, Robert. “Testimony Concerning the Roles of the SEC and the FASB in Establishing Gaap.” Testimony: Roles of SEC and FASB in Establishing GAAP (R. K. Herdman), https://www.sec.gov/news/testimony/051402tsrkh.htm

Kiernan, Paul. “Sec Asks Dozens of Companies for More Climate Disclosures.” The Wall Street Journal, Dow Jones & Company, 22 Sept. 2021, https://www.wsj.com/articles/regulators-ask-dozens-of-companies-for-more-climate-disclosures-11632341672

Lee, Allison. “Public Statement.” SEC Emblem, 15 Mar. 2021, https://www.sec.gov/news/public-statement/lee-climate-change-disclosures.

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