SEC March 2022 Climate Change Disclosure Rule Proposal

Mitigation | Drought | Heat | Fire | Storm | Flood | Governance

The SEC proposed new and expansive rules in March, 2022 for climate disclosure that will likely require publicly traded companies to document select metrics related to climate change, information on climate-related risks that are likely to have a material impact, and greenhouse gas emissions disclosures.The financial impacts of the drastic and accelerating effects of climate change have become increasingly prevalent in recent years. SEC guidelines have been slowly changing to respond to this threat by including suggestions for the disclosure of economic exposure to environmental factors.

The Security and Exchange Commission (SEC) rules guide how corporate and financial interests regulate climate change and increased severe weather events. The SEC regulates many factors that could have a significant impact on how a company performs financially, even environmental, social and governance “ESG” factors which go beyond the traditional economic metrics used to identify risks and rewards in investing.

The SEC and public companies have a responsibility to ensure that climate risk is documented in a way that is consistent, accurate, and accessible to investors making financial decisions. ClimateCheck and other climate data companies offer public companies the tools needed to comply with precise reporting requirements. The proposed 2022 climate risk regulations will promote the spread of credible data on ESG financial risk throughout the whole U.S. real estate and financial market. Previously, a patchwork of voluntary documentation through ESG reporting frameworks had led to a system of small-scale and sometimes inconsistent disclosures.

SEC Climate Disclosure History

Back in 2010, the SEC released a guidance document for climate disclosure rules. These rules mostly focused on specific industries and companies that had a direct connection to climate risk. That year, the Environmental Protection Agency began to require large emitters to collect and report data on their greenhouse gas impact.

The March 2022 rules would update SEC climate disclosures to include all publicly traded companies. Companies would be required to report select metrics related to climate change, information on their likely material impact on the company, and greenhouse gas emissions numbers in registration statements and annual reports. These disclosures are subject to internal control over financial reporting (ICFR) and external auditing.

Other International regulatory bodies have also taken up the challenge to provide standards for climate disclosure. The Sustainable Finance Disclosure Regulation (SFDR) is a set of rules in the EU that aim to improve the reliability and accuracy of disclosures.The rules were proposed in 2019 and came into effect in March of 2021 as part of a new wave of climate regulation in Europe. These rules and policies are intended to support the European Green Deal, a set of European Commission policy initiatives intended to achieve carbon neutrality in the EU by 2050.

Impact of SEC Climate Risk Rules

Approximately 12,000 public companies are registered with the SEC, including 1,150 non-U.S. companies. The proposal would give investors across the U.S. more consistent and reliable information on climate risk. Previous rules did not require companies to disclose the full amount of information needed to understand the scope or precise location-specific risks that severe weather events can cause.

Definitions

Required disclosure includes both physical risks as well as the dangers of transition risks. Transition risk, or regulatory risk, is the disruption to an asset or sector due to policy, technology, and market changes caused by climate change. Changes in land and water use policies and developing low-carbon energy alternatives are some examples of this type of risk. Physical risks apply to property damage caused by severe weather. They are categorized as both the “acute” and “chronic” risks that affect a business and its direct partners:

  • Acute: Event-driven risks caused by short-term extreme weather events such as hurricanes, tornadoes, floods, and storm surge.
  • Chronic: Risks based on longer-term weather patterns such as extreme heat, drought, and sea level rise. This category also includes factors that may be related to these effects such as decreased land habitability or access to fresh water and electricity.

SEC disclosure rules also apply to emissions which are categorized into scope 1, scope 2, and scope 3. Below is a general outline of what each level encompases:

  • Scope 1: Direct
  • Scope 2: Indirect
  • Scope 3: “Upstream” and “downstream” supply chain (only required by SEC guidelines if these emissions are considered material or included within a stated company greenhouse gas emissions goal)

Required Location and Severe Weather Disclosure

SEC guidance in the new rules requires registrants to supply the location of identified physical risks to properties, processes and operations that are likely to have a material impact on its business. Physical risks can be concentrated within particular geographic areas, such as beachfront properties or fire-prone areas. Companies with fixed assets may be at risk of increased exposure to climate risks, information important for potential investors.

Water Risks

  • Flood: In the case of flooding risk, the proposed rules require companies to disclose the percentage of their buildings and properties that are present in flood hazard areas. Buildings within flood risk zones are at risk of water damage, losing value, losing insurance.
  • Drought: Additional disclosure may also be needed for properties within areas of high water stress or frequent drought. Lack of water access can disrupt business operations, supply lines, and business expenses.
  • Sea Level Rise: Rising sea levels pose a dangerous risk to coastal properties, especially in the real estate sector.

Fire Risks

  • Wildfire: Business operations in wildfire-prone areas face a significant probability of business disruptions and destruction of property. Farms, wineries, and outdoor spaces have been heavily affected in California by long fire seasons with disruptive smoke.

Climate Disclosure within Business Strategy

1. Material Impact Disclosure

The new rules indicate that companies must comply with providing all information that could have a “material impact” on business operations. When companies and bodies in the regulatory world discuss what makes a “material impact”, they are referring to things that have a “substantial likelihood that a reasonable investor would consider important” when making investment decisions. This includes: loss in revenue, supply chain disruptions, changes in assets, or exposure of assets to extreme weather risk. For each type of company the source of most risk will vary, from the effect of extreme heat on a construction workforce to the dangers of sea level rise to tourism.

The determination of materiality can change over the short, medium, and long term; SEC requirements therefore require risk projections for each of these time frames. This helps take into account a company’s preparedness for risks to its assets over a long time span.

2. Disclosure of Expertise

Public companies are required by the new rules of the SEC to disclose metrics intended to ensure that the company has the necessary competence within its employees to accomplish climate disclosures. This includes acknowledging whether any member of the board of directors has expertise and responsibility in climate matters and the type and frequency of board discussions on climate-related factors. In the case where expertise is lacking, the company can hire outside consultants.

Conclusion

The full disclosure of climate-related information will not only affect the public companies that the SEC guides. Acknowledgement of the importance of climate change in the operations and management of companies is an important step that will likely spread through the U.S. and world economy. The average investor will soon see climate risks accounted for within their investment decisions.