SEC Guidance a Boost for Carbon Disclosure

February 10, 2010
This post is by my colleague Lucia Silva Gao, Assistant Professor of Finance, College of Management, University of Massachusetts, Boston. Her research focuses on the relationship between environmental and financial performance.

SEC On January 27, 2010 the SEC voted to issue interpretive guidance on disclosure requirements of climate risks in SEC filings. The SEC stressed that the interpretive releases do not create new legal requirements but are intended to provide clarity and enhance consistency on existing requirements. Nonetheless, the issuance of guidance indicates the growing focus of the SEC on climate change disclosure and the need for companies to expand and improve their environmental disclosure.

Till now the SEC had not called for any specific disclosures regarding climate change nor provided interpretative guidance regarding the application of existing disclosure requirements for “material risks” to climate change-related matters. The SEC sent a signal that it was preparing for future action when in a briefing released July of 2009 it included “Environmental, Climate Change and Sustainability Disclosure” on the list of possible refinements of the disclosure regime for the Investor Advisory Committee.

As the SEC explains in its release, existing regulations require a company to disclose information related to risk factors and call for management discussion and analysis. The new guidance on those rules emphasizes that when assessing potential risks, companies should consider the impact of existing climate change legislation and regulation, international accords or treaties on climate change, indirect consequences of regulation or business trends, for example new risks for the company created by legal, technical, political and scientific developments, and the physical impacts of climate change. This appears to be an impressively comprehensive assessment of investor risk associated with climate change.

Ceres proclaimed this action to be the “the first economy-wide climate risk disclosure requirement in the world”. The guidance follows a petition sent to the SEC in 2007 by a group of investors, state agencies and environmental advocates, led by Ceres, urging the SEC to issue guidance on climate-related impacts. Ceres has long pursued a strategy of exerting leverage on companies by institutionalizing information disclosure of value to investors. Ceres initiated the Global Reporting Initiative and, more recently, the Investor Network on Climate Risk. The Carbon Disclosure Project (CDP) mechanism has become the most prominent mechanism for corporate carbon disclosure, though the value of the information to investors is unclear.    

Moreover, CDP-style data has not been integrated into formal SEC reports. According to two major studies released last year by Ceres, Environmental Defense Fund (EDF) and the Center for Energy and Environmental Security (CEES) climate-related disclosure “continues to be weak or altogether nonexistent in SEC filings of global companies with the most at stake in preparing for a low-carbon global economy.” The SEC initiative responds to repeated investor requests for formal guidance on the climate-related disclosure companies should be providing in securities filings.

SEC Commissioner Elisse Walter commented that the decision “is designed to improve the quality of disclosures filed by U.S. public companies for the benefit of investors.”. She mentioned that she does not consider “that public companies today are doing the best job they possible can do with respect to their current mandated disclosures.” The SEC guidance thus represents an endorsement for more stringent and meaningful carbon disclosure, and moves it beyond a voluntary “social responsibility” type of activity into the regulatory realm.

Some critics have argued that the guidance will not lead to meaningful change in corporate reporting. Zac Bissonnette from DailyFinance writes that “the absolute best thing that will come of this policy is that some public companies will add a few lines of boilerplate that no one reads to the risk factors section of the 10-Ks they file with the SEC.” Others argue that some of the terms used are unclear. As an example, the guidance states that “when assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material.” Jane Wells of CNBC questions “what constitutes material”. Julie Gorte, a senior VP for sustainable investing at mutual fund company Pax World Management LLC, suggested that corporate officers would still have considerable discretion in deciding what constitutes a “material risk” that must be shared with investors.

The guidance is likely, however, to prompt companies to increase climate disclosure or face the threat of legal action for failure to disclose required information in light of the 1933 Act. In his blog, John Shideler makes the case that “the SEC’s action should prompt more companies to collect, analyze and report on climate change information. Companies that do not do so face added risks of litigation or regulatory action if future developments show that management failed to disclose material financial impacts linked to climate change.”

Even though this SEC initiative provides “guidance” rather than create new legal requirements, its impact could be very far reaching. SEC enforcement and legal challenges will gradually clarify the detail and form in which companies have to assess and disclose climate-related risks in their filings and improve their climate related disclosure.

One Response to “SEC Guidance a Boost for Carbon Disclosure”

  1. Jane Wells of CNBC asks “what constitutes material.” In the context of an SEC disclosure, a “material” impact is one that would affect decision making on the part of the user of the financial disclosure. The threshold for materiality in this case presumably is lower than what most greenhouse gas program rules allow (± 5%) for voluntary reporting of greenhouse gas emissions at the organization level. Establishing materiality is an inherently subjective exercise, and the threshold can differ from one organization to another. Mid single digits expressed in percentage terms against financial metrics (revenue, invested capital, etc.) would definitely be material in my view. Fractions of a percent would likely not be. The tougher calls come when the numbers fall somewhere between these ranges.