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A Comparative Analysis of the SEC’s Climate Disclosure Proposal

  • Charlie Cibrario and Cynthia Hanawalt

    • In the global effort to protect the earth’s climate, the pace of regulation is rivaled only by the speed of technological innovation.

    What seemed improbable just a few years ago – requiring large companies to measure and report annual greenhouse gas emissions generated by their operations and “value chains”– is becoming reality in several countries.

    While the SEC’s climate disclosure rules are pending, and will probably face litigation when final, regulations from other agencies and jurisdictions are likely to affect U.S. companies soon:

    All these regulations will require companies to make disclosures similar to those at the heart of the SEC’s March 2022 proposal “on The Enhancement and Standardization of Climate Risk Disclosure:”

    1. the risks and higher costs companies expect to face as a result of climate change (so called “climate-related financial risks”), and
    2. their greenhouse gas emissions data (including Scope 1, Scope 2, and Scope 3[1]).

    A Simplified Comparison

    Key Differences

    The materiality qualifier is consistent with the SEC’s definition of financial materiality and the relevant U.S. Supreme Court precedents and so should be tied to the “substantial likelihood” that a reasonable investor would consider the data important when making an investment or voting decision. The SEC notes that disclosure of Scope 3 emissions may be necessary to give a complete picture of a registrant’s climate-related risks.

    It is important to note that the different materiality assessments of these disclosure regimes could yield varying results.

    Some companies (for example, those in heavy industry, depending on their particular customer pool) may only deem Scope 1 and 2 emissions material to their activities, while for others (such as transportation companies) material emissions will all be under Scope 3. The failure to disclose one or more categories will of course hinder comparisons between companies and may result in an incomplete picture of a firm’s emissions and transition risk.

    The Pull Effects of Vanguard Regimes

    Given the fragmented, rapidly evolving policies, multinational corporations subject to multiple emission-disclosure regimes may have to comply with separate frameworks at once.

    Hypothetically, a conglomerate may have to calculate emissions and report them once at the level of its EU entities or EU sub-group (and separately, in the case of distinct EU sub-groups), another time always in the EU, at the level of its non-EU ultimate parent company (where different, or where a different consolidation perimeter applies), and (possibly, several) other times at the level of its U.S. entities (perhaps on consolidated group activities, perhaps not, perhaps both), each time under different national or state reporting rules.

    Take Sony. The group would likely be caught (i) once by EU CSRD rules, at the level of Sony Europe B.V. (disclosing for itself and its subsidiaries), (ii) once more by CSRD rules (although this time under presumably simplified Article 40a reporting standards), at the level of its Japanese parent, Sony Group Corporation (disclosing on the behalf of the entire group), and (iii) potentially several more times  for any entities that are either (a) registered as securities issuers with the SEC (according to available EDGAR data, these are Sony Group Corporation, Sony Corp. of America, Sony Financial Holdings Inc., and Sony Music Entertainment Inc.), (b) active in California or New York, or (c) U.S. federal government contractors.

    Some frameworks make allowances for this anticipated overlap. The California laws will allow covered entities to submit reports generated to comply with substantially similar federal rules (such as the FAR Council or the SEC climate disclosure rules, if they are passed). The EU Commission is responsible for developing an international equivalence framework that would allow companies to submit climate reports prepared under competing frameworks like the SEC rules – although these would likely need to be supplemented to cover the many other ESG-related disclosure requirements that are built into the EU Directive.

    Best practices for climate disclosure will likely converge. We reference Brussels’s and California’s well-known “pull” effect, which drives a general shift of corporate behaviour toward jurisdictions with the most stringent regulatory standards. These effects could be particularly strong here, given the significant overlap among the companies covered by each framework.

    Data substantiates a large potential overlap. Over 6,000 companies are registered with the SEC (most of them U.S.-headquartered). The EU Commission had originally estimated that 4,000 foreign securities issuers would be covered by the CSRD. Article 40a brought the estimated number of foreign in-scope companies to 10,000 – about one-third of them U.S.-headquartered. The California statute should cover 5,000 U.S. companies for emissions disclosures ($1 billion threshold), and 10,000 U.S. companies for climate-risk reports ($500,000 threshold). An October report by Public Citizen estimated that 75 percent of Fortune 1000 listed companies fall within the scope of the California rules. Similar considerations apply to New York. The FAR Council anticipates that over 5,700 significant and major contractors will be affected by its proposed rules. Most companies caught by these different-sized pools will likely be the same entities.

    An Opportunity for SEC Leadership

    The SEC’s rulemaking authority rests on the powers granted to it under sections 7, 10, 19(a), and 28 of the Securities Act, and sections 3(b), 12, 13, 15, 23(a), and 36 of the Exchange Act. These federal regulations allow the SEC to require that U.S. securities issuers make all disclosures that are “necessary or appropriate in the public interest or for the protection of investors.”

    The commission first found that environmental disclosure could promote investor protection in 1973. Given today’s heightened climate emergency, and the markets’ clear perception of climate risk as a source of financial vulnerability and volatility, this mandate should be apparent from a simple reading of the commission’s statutory authority.

    There is a compelling case for the SEC to take responsibility for harmonizing climate disclosure regimes in the interest of investor protection. As Prof. Joseph Grundfest observed in his recent comments to the SEC proposal, the SEC’s rulemaking could serve as a standardized “clearing house” for the various climate disclosures issued by registrants, whether voluntarily or mandatory. Well over 30 countries have adopted or will soon adopt climate disclosure rules. Mandating disclosure in the presence of private ordering is a common occurrence, consistent with the SEC’s historical approach to developing disclosure rules. Indeed, this is what the commission did with respect to international financial reporting immediately after its inception, starting in the 1930s and leading to GAAP.

    Any rules the SEC proposes must facilitate efficiency, competition, and capital formation – which is why the SEC must also conduct a cost-benefit analysis. Compliance with the SEC climate disclosure rules should not, for most registrants, require significant additional costs, as a large percentage of U.S. registrants, and most groups with foreign operations, will soon be publicly disclosing more emissions data than the SEC proposes to require, even if the commission’s rules never take effect. This is without considering that, in the 20 months since the SEC proposal was released (and the SEC’s first cost-benefit analysis conducted), the percentage of companies that are voluntarily disclosing their emissions and climate risks has risen substantially. In parallel, the cost of acquiring climate and emissions data has declined and will continue to decline. The SEC is poised to lead globally in protecting investors from climate-related financial risk and ensuring a harmonized approach to climate disclosures – which are only destined to become more relevant and widespread.

    Beyond Investor Protection

    It is difficult to say whether leadership on climate will come from the SEC. The fact that FAR will likely end up being the more incisive – and more durable – disclosure regime at the U.S. federal level merits consideration. Beyond investor protection, the adaptation and mitigation of climate change is an urgent matter of environmental and industrial policy. Citizens and future generations need courageous and incisive climate policy, regardless of whether and how they may be affected by financial investment strategies and returns. The CSRD is a tool built with that ambition. The U.S. should take stock.

    ENDNOTE

    [1]     The GHG Protocol categorizes corporate greenhouse emissions into three broad scopes, which are the most widely used reference framework for carbon emissions accounting:

    This post comes to us from Clara (Charlie) Cibrario Assereto, a practicing lawyer in the EU, a founder of the global sustainability practice at Cleary Gottlieb Steen & Hamilton LLP, and an adjunct professor at Columbia Law School, and from Cynthia Hanawalt, the director of climate finance and regulation at Columbia University’s Sabin Center for Climate Change Law and former chief of the Investor Protection Bureau for the New York State Office of the Attorney General. 

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