US Securities and Exchange Commission — Climate risk disclosure proposal
US regulators have been slow but doing catchup with their counterpart in Europe and APAC.
Regulatory requirements are evolving from voluntary disclosure of climate related financial risks towards more prescriptive rule based. For instance, SEC sent out its proposal for consultation asking industry on specifics that might become rule based in near future.
Brief overview of US based regulations: Securities Exchange Commission (SEC)
SEC: proposed rules — The enhancement and standardization of climate related disclosures for investors. to require various companies to provide information of climate related risks that may impact business and operations in their registration statements and annual reports. These requirements were in part modeled on TCFD and GHG emission protocols. This information should include, governance and oversight, business strategy, risk management (identification, measurement and monitoring) and emission metrics. This rule is primarily intending to address investor’s demand for more consistent and comparable information about climate related risks. These rules are going to take into effect potentially in 2024 onwards.
Key topics for disclosure to include:
· Climate related Risks: Describe the impact (material) of the climate related risks (Physical and transition) to business and financial statements. Provide an assessment of opportunities along with clear definition of short, medium and long horizons over which these risks will manifest [Section B]
· Climate related impacts on Strategy, business model and outlook: Perform meaningful analysis of potential impact of climate risks on business strategy, financial planning and capital allocation with description of both current and forward-looking metrics. [Section C]. This information will be akin to transition plan for company’s emission reduction strategy. If any carbon offsets are utilized as part of the emission reduction they should be identified and disclosed. Another area for disclosure is around use of internal carbon price and use of scenario analysis tools to evaluate risks and opportunities and resiliency of the operations.
· Governance: Board and senior management have clear oversight on the climate related risks. This include having committees with process to assess and manage climate related risks embedded in their business. [ Section D]
· Risk Management: framework for identification, measurement, monitoring and managing of climate related risks should be established and disclosed. This includes development of policies, procedures and analytical capabilities to embed the climate risk framework in the organization. [Section E] Transition plan as part of emission reductions to align with Paris agreement to be disclosed, including compliance to restrict usage of high carbon foot print products.
· Financial statement metrics: Financial impact, Expenditure metrics and uncertainty in estimates with along with assumptions considered should be disclosed [Section F]
· GHG emission metrics: Emission metrics are starting point for transition risk analysis to understand degree of alignment with the emission reduction programs. Scope1 (emissions owned or controlled by the company), and Scope 2 (emissions due purchased or acquired electricity) should be disclosed. Material scope 3 (emissions that are outside the company boundary) need to be disclosed separately. These emissions need to be expressed in accordance with GHG protocol in terms of Co2 equivalent. Disclose the materiality determination for the scope 3 emissions.
· Attestation of emissions: Reported Scope 1 and 2 emissions should be attested by a qualified external provider to ensure, consistency, comparability and reliability.
· Targets and Goals: Disclose scope of activities and emissions included in the target; unit of measurement including absolute or intensity based; time horizon consistent with treaty, regulation or by organization; any interim targets and others.
Looking at these components of disclosure requirements one can clearly see SEC has set an ambitious target for companies to comply when this proposal becomes law.
One simple question is whether this regulation will become a cumbersome compliance journey or can companies derive business opportunity here and benefit themselves and society as a whole? People who think climate change is not a settled event consider this act as regulatory overreach. On the other hand whether climate change believers consider, nature resources should be harnessed in a sustainable way hence this regulation is much needed.
I think, over the course of last 150 years in the wake of industrial revolution innovations have been constantly evolving on how we interact with nature and use the resources to support our economic activities. Components of this proposed regulation such as climate related risks and their impacts to business strategy are required so that firms are taking mitigation and adaptation measures. Using tools such as scenario analysis (IEA, NGFS and bespoke) and internal carbon pricing to evaluate business opportunities will become a new area in itself. WSJ study confirmed that carbon trading has weathered multiple hiccups and becoming a model to emulate globally.
Additionally, this will open new go to markets and opportunities to reduce emission footprint. Another topic is around the metrics for carbon emission foot print (a.k.a — scope 1, 2 and 3) measurement and reporting through attestation and setting targets. This information is much needed for investors to conduct their transition risk analysis and understand whether an organization is meeting its pledged goals.
Despite, climate goal pledges across the industry from fossil fuel companies we are still witnessing consistently inconsistent information being reported concluded in a Columbia study.
US oil and gas companies despite producing reports in accordance with TCFD, due to lack of clear guidance on the methodologies, the information is not comparable and not useful to meet investor demand to understand whether we are on track to meet climate specific goals or not. SEC guidance is requiring to report Scope 1 and 2 emissions and report only material scope 3 emissions. However, bulk of carbon footprint comes from Scope 3 emissions and that should not be excluded although further innovation is required to achieve reliability in the metrics produced today.
Overall, I think this proposal when it becomes law will definitely create formidable challenges around compliance and reporting. On upside it will result in more reliable, consistent information to the markets which is bedrock on which financial markets operate.
