Is Now the Right Time to Mandate Costly Climate Disclosure?

In August 2021, the United Nations Intergovernmental Panel on Climate Change (“IPCC”) found that “unless there are immediate, rapid and large-scale reductions in greenhouse gas emissions, limiting warming to close to [the Paris Agreement’s goal of] 1.5°C or even 2°C [by 2050] will be beyond reach.”[1]  The IPCC’s conclusions, among others, prompted President Biden’s government-wide mandate to advance climate policy, as articulated in a series of executive orders.[2]

The Securities and Exchange Commission (“SEC”) responded with gusto, hiring its first-ever Senior Policy Advisor for Climate and ESG,[3] directing the SEC’s Division of Corporation Finance to enhance its focus on climate-related disclosures in public company filings,[4] creating a Climate and ESG Task Force in the SEC’s Division of Enforcement,[5] soliciting public input on climate change disclosures,[6] and significantly increasing the number of SEC staff comments on climate change disclosures in public filings.[7]  And, last week, the SEC unveiled a proposal for new climate disclosure rules (the “Climate Rules”) under which public companies will be required to provide specific climate-related disclosure in periodic reports and registration statements.[8]

Current technologies are not enough for us to reach “net zero” – the point at which new global greenhouse gas (“GHG”) emissions are offset by removing an equivalent amount of emissions from the atmosphere.  To achieve this, we need to develop a range of less-mature, low-carbon technologies – some of which have not yet been invented, are in their infancy, or are not yet economical – at a total estimated cost of $21 trillion in new investment over the next 10 years.[9]  No doubt, large public companies will play an important role in creating and developing these new technologies.  Much of that innovation, however, will come from tech startups and other new businesses.  Most of those companies have not yet accessed the public capital markets.  Some have not yet been born.  Consequently, of the money that needs to be invested, at least 10 percent – or a minimum of $2.1 trillion – must come from venture capital, private equity, corporate, and other investors in early-stage companies.[10]  Many of those investors are public themselves, including the venture capital arms of commercial banks[11] and, more recently, non-traditional corporate investors that are also making significant venture capital investments in early-stage technologies.[12]

All of which prompts a question: Will the additional costs imposed by the Climate Rules on clean-tech startups and other new businesses that would normally look to raise capital in the public markets, as well as on the investors who must finance them privately, help or hurt the mammoth redirection of capital that is needed to meet the Paris Agreement goals?

Consider, for example, the requirement under the Climate Rules that public companies disclose their Scope 1 and Scope 2 GHG emissions, in absolute terms (not including offsets) and in terms of intensity per unit of economic value or production.  Scope 1 covers direct GHG emissions from owned or controlled sources, and Scope 2 covers indirect GHG emissions from the generation of purchased electricity, steam, heating, and cooling consumed by the reporting company.  In a new note to the audited financial statements, companies are required to quantify and describe the effects of climate-related events and transition activities on individual line items and disclose the impact of climate-related events and transition activities on estimates and assumptions used in preparing the financial statements.  Public companies must also describe the methodology, significant inputs, and significant assumptions they use to calculate their GHG emissions.

As proposed, these requirements apply to all companies, including emerging growth companies, that access the U.S. public capital markets for the first time.  Tech startups, however, will not be subject to the full set of requirements.  They are not required to have their GHG emissions disclosures independently attested nor are they required to disclose other (not Scope 1 or 2) indirect GHG emissions that occur in a company’s value chain (known as Scope 3 emissions).  Also, smaller reporting companies (which most startups are likely to be) will have a delayed compliance date.  Yet, this relaxation, while a nod in the right direction, still imposes substantial new costs on new tech businesses.

For example, although the Climate Rules do not mandate specific climate governance practices, they do identify items that must be disclosed regarding those practices.  Those include which directors have expertise in managing climate-related risks, which board committees have responsibility for climate over­sight, the processes by which the board or board committees discuss climate risk and the frequency of those discussions, how the board or board committees integrate climate risk into the company’s business strategy, risk management, and financial oversight, and how the board sets and oversees climate goals.  No doubt, particularly for startups pursuing climate-related busi­nesses, the presence (or absence) of these practices will influence investor (and, perhaps, regulator) expectations.  Implementing them will be costly.  A startup considering an IPO will need to take these new costs into account.

In addition, the new reporting requirements will require public companies to implement compre­hensive procedures to manage the new disclosures.  These controls and procedures include a management team to oversee data collection and disclosure processes, new reporting systems, and checks-and-balances to verify data.  The new disclosures, included in the company’s annual reports and financial statements, will be subject to the officer certifications required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as well as the corresponding liability.  The result will be an increase in each company’s need for talent and resources (including among its outside lawyers and auditors) to bolster its climate-related expertise, which if even possible (there are significant talent shortages today[13]), is likely to be quite costly – new costs a startup must consider as part of its “going public” calculus.

The Climate Rules also require public companies to disclose climate-related risks reasonably likely to have a material impact on their businesses or financial statements, including regulatory, technological, and market changes, such as higher costs due to changes in law or policy.  Even for companies that already provide climate-related disclo­sures, these new requirements will add significant costs as they build out new climate risk assessment processes.  Those assessments must include the impact on the reporting company of GHG emissions by others with whom they do business.  In effect, even though the Climate Rules do not require smaller reporting companies to disclose Scope 3 emissions, they must still assess the nature of those emissions by business counterparties and the risks those emissions pose for them.  Doing so will be difficult, most likely requiring companies to hire outside consultants to assist them in assessing on an ongoing basis the climate-related vulnerabilities to which they may be exposed.  The costs, however, are largely unknown since, as the SEC acknowledges in the Climate Rules release, reliably calculating Scope 3 data will be difficult to do.[14]

Take, for example, the use of cobalt, which is a component of rechargeable batteries and electric automobiles.  Cobalt, itself, has long been known to create its own environmental problems, in addition to cobalt mining being harmful to miners and people who live near the mines.[15]  As a result, reliance on cobalt has dropped,[16] and there are promises of new batteries that bypass cobalt altogether.[17]  There are, nevertheless, significant Scope 3 supply chain risks as the market for electric vehicles continues to grow.[18]  Although Congo is the world’s largest supplier of cobalt, both Russia and Ukraine are also major exporters.[19]  Russia’s aggression in Ukraine, and the Western sanctions imposed on Russia, will require a shift from that region to other suppliers of cobalt, like those in Congo.  In Congo, downstream refining of mined cobalt often occurs elsewhere, predominantly Asia, since China controls a substantial portion of the Congolese mines.  Producers must ship large volumes of cobalt ore long distances to be refined, which substantially inflates GHG emissions.[20]  Although China’s control of Congolese mines is uncertain,[21] the lack of domestic refineries in Congo significantly increases the carbon footprint of cobalt mined in that part of the world.  As a result, shifting from Ukraine or Russia to Congo is likely to increase GHG emissions – and that increase may result in regulatory, cost, or other issues that a reporting company that relies on supplies of cobalt must consider disclosing.

What this means is that newly-public companies must assess the potential business and financial risks resulting from Scope 3 emissions, even if they are not required to disclose the emissions themselves.  How easy will it be for a company to assess the impact of the change in GHG emissions between Russia and Congo?  A significant increase in GHG emissions, as a company switches from Russia to Congo, may raise substantial investor concerns for a company whose mission is to promote new carbon technologies.

Perhaps most significantly, private companies will be affected by the new Climate Rules.  Startup founders, even if not directly subject to the Climate Rules, must still respond to the disclosure concerns of investors who themselves are public companies.  Among them, public investors (that are not smaller reporting companies) will be required to disclose Scope 3 emissions, if material, or if the investor set a GHG emissions target or goal that includes Scope 3 emissions.  For investors, Scope 3 emissions data will require that they evaluate the GHG emissions of companies they invest in or lend to.  This will significantly affect private portfolio companies that are not directly subject to the Climate Rules.  To what extent, for example, would changes in GHG emissions, as a result of changes in cobalt supplies, be reflected in the Scope 3 emissions data of a venture capital investor with a portfolio of rechargeable battery companies?  And will those changes affect what technologies the investor chooses to fund?  Should potential changes in an investor’s GHG emissions disclosures influence which promising technologies it should fund or not fund? [22]

The Climate Rules include a safe harbor from securities law liability for Scope 3 emissions data unless it is shown that the disclosure was made without a reasonable basis or other than in good faith.  To qualify for the safe harbor, lenders and investors in private companies – including those early-stage companies pursuing low-carbon technology solutions – will require the calculation and disclosure of Scope 3 emissions data.  Expect that regular GHG disclosures, and the ability to confirm their accuracy, will become a common requirement of startups by lenders and private equity investors.  In effect, even though the Climate Rules do not directly require early-stage companies to disclose Scope 3 data, they will still be required to collect that data even before they go public for their investors to be able to assess the materiality of their Scope 3 emissions and what needs to be disclosed.  Rule 144A offerings may also incorporate GHG and other climate-related disclosures, since they tend to follow the disclosure rules applicable to public offerings.

This process will be costly for all investors: for large public investors (who presumably will have a sizeable investment portfolio over which to spread the costs); for mid-tier public investors, including banks (like Silicon Valley Bank and First Republic Bank) that are more likely to provide banking support for technology startups but without the economies-of-scale of larger lenders;[23] and even for non-public investors who will share in a portion of the incremental cost that early-stage companies must bear for public investors to assess their Scope 3 disclosure requirements.[24]  Will this rise in costs alter the landscape of investors, as some argued occurred after passage of the Sarbanes-Oxley Act?  Will it limit a startup’s access to capital?  Will the relatively greater cost lower the financial support that mid-tier banks provide today?  In addition, will the potential delay in accessing the public capital markets (either through an IPO or acquisition by a public company, including a SPAC), in light of the greater disclosure require­ments, affect and make less attractive the anticipated returns of early-stage investors?

The upshot is that the new Climate Rules will impose higher costs on private and public companies that are pursuing early-stage low-carbon technologies precisely at a time when we need to be able to efficiently fund and grow those and future businesses.[25]  New technologies are what will drive lower carbon emissions.  To discover, pursue, and implement them will require the redirection of substantially more capital than has been invested to date.  Some may argue that the potential returns from investing in green technology will outweigh the likely costs, even with passage of the new Climate Rules.  That is difficult to say, particularly if (as is likely) the new Climate Rules disclosures affect an investor’s ability to raise capital from others.  What is clear is that the Climate Rules threaten to make the investment process more costly and less efficient for early-stage businesses.  As well-intentioned as the Climate Rules may be, this is not the time to add cost to a process that is fundamental to achieving the goals of the Paris Agreement.

ENDNOTES

[1] United Nations Intergovernmental Panel on Climate Change, Climate change widespread, rapid, and intensifying (Aug. 9, 2021), https://www.ipcc.ch/2021/08/09/ar6-wg1-20210809-pr/.

[2] See, e.g., Executive Order on Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis (Jan. 20, 2021), Executive Order on Tackling the Climate Crisis at Home and Abroad (Jan. 27, 2021), and Executive Order on Climate-Related Financial Risk (May 20, 2021).

[3] SEC, Satyam Khanna Named Senior Policy Advisor for Climate and ESG (Feb. 1, 2021), https://www.sec.gov/news/ press-release/2021-20.

[4] SEC, Acting Chair Allison Herren Lee, Statement on the Review of Climate-Related Disclosure (Feb. 24, 2021), https://www.sec.gov/news/public-statement/lee-statement-review-climate-related-disclosure.

[5] SEC, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021), https://www.sec.gov/news/press-release/2021-42.

[6] SEC, Acting Chair Allison Herren Lee, Public Input Welcomed on Climate Change Disclosures (Mar. 15, 2021), https://www.sec.gov/news/public-statement/lee-climate-change-disclosures.

[7] See Paul Kiernan, SEC Asks Dozens of Companies for More Climate Disclosures, Wall Street J. (Sept. 22, 2021), available at https://www.wsj.com/articles/regulators-ask-dozens-of-companies-for-more-climate-disclosures-11632341672.

[8] SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors, Rel. No. 33-11042 (Mar. 21, 2022) [“Climate Rules Release”].

[9] Wendi Backler et al., Boston Consulting Group, Private Investors Must Commit as Much as Eight Times More to the Low-Carbon Economy (Oct. 28,2021), https://www.bcg.com/publications/2021/private-investment-in-low-carbon-technologies.

[10] Id.

[11] See, for example, JP Morgan’s commercial banking division focused on early-stage tech startups, which is described at https://www.jpmorgan.com/commercial-banking/startups.  BlackRock and Temasek recently announced a joint effort to raise one of the largest venture-capital funds dedicated to carbon-cutting technologies.  The firms announced a commitment of $600 million, including $300 million of seed capital for a $1 billion fund, with the remainder raised from outside investors.  See Erik Schatzker, BlackRock, Temasek to Raise Billions for Carbon-Cutting Startups (Apr. 12, 2021), Bloomberg.com, https://www.bloomberg.com/news/articles/2021-04-12/blackrock-and-temasek-are-raising-billions-to-invest-in-carbon-cutting-startups#:~:text=BlackRock%20and%20Temasek%20Are%20Raising,in%20 Carbon%2DCutting %20Startups%20%2D%20Bloomberg.

[12] See Pitchbook Data & National Venture Capital Association, Venture Monitor Q4 2021 25 (Jan. 14, 2022), available at https://files.pitchbook.com/website/files/pdf/Q4_2021_PitchBook_NVCA_Venture_Monitor.pdf (“Nontradi­tional institutions participated in an estimated 6,483 deals, which produced $253.5 billion in deal value [during 2021].  Noting that nontraditional venture investors have driven trends seems almost an understatement . . . .  Barring a major financial event or market crash, we expect this activity level to increase in the coming year, especially from corporate VCs (CVCs), which have continued to enter the market at an astonishing pace.”)

[13] See Adrienne Klasa & Brooke Masters, Sustainable investing boom prompts fierce fight for talent (Mar. 21, 2022), The Financial Times, available at https://www.ft.com/content/fe5853a4-ba3e-434a-abe0-1b43c094ae85.

[14] See Climate Rules Release, supra note 8, at 217.

[15] See, e.g., Shahjadi Hisan Farjana et al., Life cycle assessment of cobalt extraction process, 18 J. Sustainable Mining 150, 155 (Nov. 2019).

[16] See, e.g., U.S. Department of Energy, Office of Energy Efficiency & Renewable Energy, Vehicle Technologies Office, Reducing Reliance on Cobalt for Lithium-ion Batteries (Apr. 6, 2021), https://www.energy.gov/eere/vehicles/articles/reducing-reliance-cobalt-lithium-ion-batteries.

[17]  See, e.g., id; Tina Casey, IBM Changes The Energy Storage Game With Cobalt-Free Battery (Dec. 18, 2019), CleanTechnica, https://cleantechnica.com/2019/12/18/ibm-changes-the-energy-storage-game-with-cobalt-free-battery?.

[18] See U.S. Department of Energy, Office of Energy Efficiency & Renewable Energy, Vehicle Technologies Office, Research Plan to Reduce, Recycle, and Recover Critical Materials in Lithium-Ion Batteries 5 (June 2019), available at https://www.energy.gov/sites/prod/files/2019/07/f64/112306-battery-recycling-brochure-June-2019%202-web150.pdf; CO2 emissions from cobalt production expected to soar—report (Apr. 19, 202), Mining.com, https://www.mining.com/co2-emissions-from-cobalt-production-expected-to-soar-report/ (hereinafter, “Mining Report”).

[19] Andrew Woodman, War’s ESG dilemma for investors: Solve short-term needs or confront long-term goals (Mar. 25, 2022), Pitchbook.com, https://pitchbook.com/news/articles/esg-ukraine-europe-russia-energy-dependence-renewables.

[20] See Mining Report, supra note 18.

[21] See Nicholas Bariyo, In Congo, China Hits Roadblock in Global Race for Cobalt (Mar. 12, 2022), Wall Street Journal, available at https://www.wsj.com/articles/in-congo-china-hits-roadblock-in-global-race-forcobalt-11647081180.

[22] As SEC Commissioner Hester M. Peirce noted in her dissent to the Climate Rules, “The climate-change mitigating invention which right now may be rattling around in the head of a young girl in Cleveland, Ohio . . .is something of which we regulators cannot even dream.  Our limited job as securities regulators is to make sure that enterprising young woman can get matched up with the funds necessary to bring her idea to life.”  We are Not the Securities and Environment Commission—At Least Not Yet (Mar. 21, 2022), https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321.

[23] See, e.g., a list of recommended banks for startups at https://kruzeconsulting.com/best-business-banks/.

[24] See, e.g., Evan Weinberger, SEC’s Climate Plan Poses Compliance Hurdles for Mid-Tier Banks (Mar. 23, 2022), Bloomberg Law, https://www.bloomberglaw.com/bloomberglawnews/exp/eyJjdHh0IjoiU0xOVyIsImlkIjoiMDA wMDAxN2YtYjI5Yy1kMjVlLWE1ZmYtYmVkZjA4MzYwMDAxIiwic2lnIjoiNnlBclpYV202SlRIelBTcUFYSnBIMTdiRHE0PSIsInRpbWUiOiIxNjQ4MTIwNDIxIiwidXVpZCI6ImhZeU5vS3JtZ2pFSUdYMGxQN1djUEE9PVRLV1luaXA1K1N4WW1lSGtKMjlWQlE9PSIsInYiOiIxIn0=?bwid=0000017f-b29c-d25e-a5ff-bedf08360001&cti= LSCH&emc=bslnw_nl%3A3&et=NEWSLETTER&isAlert=false&item=document&qid=7266434&region=digest&source=newsletter&uc=1320018197&udvType=Alert&usertype=External.

[25] The Climate Rules Release estimates that, for smaller registered companies, the costs in the first year of compliance would be $490,000 ($140,000 for internal costs and $350,000 for outside professional costs), while annual costs in subsequent years would be $420,000 ($120,000 for internal costs and $300,000 for outside professional costs).  Even if we were to eliminate the internal costs, the estimated costs of outside professionals is quite substantial for a new business.  See Climate Rules Release, supra note 8, at 386.

This post comes to us from Charles K. Whitehead, the Myron C. Taylor Alumni Professor of Business Law at Cornell Law School and Founding Director of the Law, Technology and Entrepreneurship Program at Cornell Tech.

Leave a Reply

Your email address will not be published.