Material Climate Change Disclosure

The U.S. Securities and Exchange Commission (SEC) is considering enhancing corporate disclosure requirements related to climate change risks.

Last month, the SEC wrapped up a 90-day comment period on its “concept release” effort to gather information needed to potentially modernize business and financial disclosure requirements in Regulation S-K, the prescriptive regulatory framework that governs reporting requirements for public companies.

Regulation S-K was developed by the SEC to harmonize two separate disclosure regimes – mandated by the Securities Act of 1933 and the Securities and Exchange Act of 1934 – into a single, integrated system for corporate disclosure. According to the SEC, corporate disclosure provides investors with information needed to make informed investment and voting decisions by “lowering information asymmetries between managers of companies and investors.”

Among many other things, the concept release touches on information disclosure related to public policy and sustainability matters, such as climate change. The SEC outlined a series of questions for comment, all basically related to how to find the right balance of limiting costly reporting burdens on companies while still requiring disclosure of “material” (the definition of which can be subject to debate) information to investors.

Historically, the SEC believes sustainability and public policy information had not been material to investment decisions. Concerns about compliance costs outweighing benefits and using the SEC to advance societal issues have been raised in opposition to expanding these requirements. However, the SEC notes in its concept release that the role of sustainability and public policy information in voting and investment decisions is evolving.

In 2010, the SEC released guidance for public companies, identifying how existing disclosure requirements in Regulation S-K apply to climate change-related matters, including:

• Item 101 – Description of Business. This line item in the S-K requires a company to describe aspects of its core business.  Included in this is disclosure of costs to comply with environmental laws.
• Item 103 – Legal Proceedings. This items requires companies to describe pending legal proceedings to which it (including subsidiaries and property) is a party to, including disclosure of environmental litigation.
• Item 503(c) – Risk Factors. This requires a company to include a discussion of what factors may make investment in the company more risky or speculative.
• Item 303 – Management’s Discussion and Analysis (MD&A). Among other specific requirements, this section requires company management to contextualize (e.g. identify trends, qualify past performance in future context, etc.) the information provided, to allow investors to understand the company’s vitality through management’s viewpoint.

The guidance document goes on to identify several examples of climate change related issues that may trigger disclosure under the various S-K items identified above.  For example, material impacts (positive or negative) related to: developments in state or federal climate change legislation or regulations, international climate accords, indirect consequences of regulation or business trends (e.g. creating demand for new products and services, increased competition from other businesses), and physical impacts of climate change to company operations and assets.

In spite of the SEC’s efforts, some believe there is more work to be done.  A recent report by ClimateWire, published in Scientific American, found that many public companies tout efforts to combat climate change and environmental initiatives in sustainability reports, but fail to disclose climate risks to the SEC. 

A two-year investigation by the New York Attorney General’s Office into the now bankrupt coal giant, Peabody Energy, found the company privately predicted a downturn in coal demand and prices, but hid that information from investors. 

In January 2016, the GAO issued a report on climate change-relate supply chain risks and the evolution of SEC’s efforts to determine if additional climate change disclosure is needed.  The report noted that SEC periodically reviews company filings for climate change related risks and sends comment letters to companies that should enhance their reporting.  Initially, the SEC issued comment letters to 23 companies, but issuances quickly trailed off and no enforcement actions have been taken. In addition, SEC hasn’t followed up with two other planned activities – hosting a public roundtable on the climate disclosure issue, and putting the issue before the SEC’s Internal Advisory Committee. GAO found that failure to pass federal climate legislation may have reduced SEC’s focus on the issue, maintaining that the S-K reforms could provide a venue to reinvigorate the topic.

Public calls for greater disclosure have been mounting.  A 2015 letter from institutional investors representing over $1.9 trillion in assets raised concerns about oil and gas companies underreporting material climate risks to the SEC. In July 2016, three former U.S. Treasury secretaries sent a letter to the SEC encouraging greater promotion and enforcement of climate disclosure mandates. And just last week, White House advisors called on the SEC to step up climate disclosure in the wake of Louisiana’s historic floods.

Perhaps those cries (and other factors) encouraged the SEC to take action earlier this year to force Exxon Mobil to include a shareholder resolution on its annual proxy, which if passed, would require the company to disclose to investors how climate change and climate legislation could impact profitability. Chevron got a similar letter from the SEC too.

Yet, outcries from opponents of climate disclosure are perhaps equally as loud.  There have been efforts to defund SEC’s climate disclosure enforcement in Congress, accusations from Republican Attorney Generals’ offices that SEC is trying to advance a political agenda by expanding disclosure requirements, and that additional disclosures would yield non-material information that appeal to only a subset of investor-activists.

Meanwhile, across the pond, corporate climate disclosure is much more robust.

SEC’s timeline for a proposed rule is unclear, as is the inclusion or exclusion of greater requirements for public policy and sustainability issues.

In the spirit of noble prize winning economist Joseph Stiglitz, “…the reason that the invisible hand often seems invisible is that it is often not there.” Whenever there are “externalities” present – whenever there is imperfect information and imperfect risk markets – markets will not work well. In such instances, government plays an important role in making markets work.

SEC’s efforts to provide better information and more accurately identify risks may just make the markets work better for investors.

Christina Simeone

Kleinman Center Senior Fellow

Christina Simeone is a senior fellow at the Kleinman Center for Energy Policy and a doctoral student in advanced energy systems at the Colorado School of Mines and the National Renewable Energy Laboratory, a joint program.