What is the Securities and Exchange Commission?
Formed in 1934, the Securities and Exchange Commission (SEC) is a U.S. government oversight agency with a responsibility to regulate the securities markets and protect investors by maintaining fair and orderly functioning of the securities markets, and facilitating capital formation. The SEC mainly regulates the major securities market participants, including broker-dealers, transfer agents, and self-regulatory organisations, such as stock exchanges, FINRA, and clearing agencies.
As an independent government agency tasked with maintaining a fair and orderly market, and facilitating capital formation, one of the main focuses of the Commission is to protect investors. To do so, the SEC places a requirement on public companies, fund and asset managers, investment professionals, and other market participants to regularly disclose significant financial and other information. This is so investors have the timely, accurate, and complete information they need to make confident and informed decisions about when or where to invest.
Enhancing and standardising climate-related disclosures for US public companies
In March 2022, the SEC proposed rule amendments to enhance and standardise climate-related disclosures, requiring that US public companies must include certain climate-related information in regular financial filings namely Form 10-K and Form 20-F. These amendments are proposed to Regulation S-K and Regulation S-X, which would mandate significant climate-related disclosures for public companies. The SEC builds on the well-established recommendations from the Taskforce for Climate-related Financial Disclosures (TCFD), introduced in 2017 to improve public disclosure of climate-related financial information and help companies better structure their internal approach to assessing climate risks and opportunities.
The proposed rule amendments bring urgency to environmental, social, and governance (ESG) data strategy planning. It is driven by the needs of investors and issuers to have access to information that provides an awareness of how climate risks can pose significant financial risks to companies. It also provides investors with consistent, comparable, and useful information for making their investment and risk decisions, while providing consistent and clear reporting obligations for issuers. The proposed rules will require that public companies make significant additional disclosures regarding climate-related risks. They will have to include their processes for identifying, assessing, and managing those risks as well as their climate-related targets and goals. Furthermore, companies must make known how climate-related risks have, or will, impact their business and consolidated financial statements, as well as their strategy, business model and outlook. Companies will be required to disclose their greenhouse gas emissions and provide an attestation report to provide reasonable assurance, after a phase-in period, covering certain disclosed emissions.
How do the proposed changes affect SEC Filings?
Filings place requirements on public companies, certain company insiders, and broker-dealers to file periodic financial statements and other disclosures. The information provided is reviewed by the SEC to enhance and monitor compliance. The fillings are then studied by investors and financial professionals to provide an overview of company performance and activities to assist them in making informed decisions when evaluating whether to invest in a company.
The proposed rules indicate that the registrants shall include the following in their fillings in relation to environmental, social & governance (ESG):
Prospective risks and material impact on the business, strategy and outlook caused by climate change, generally consistent with the TCFD disclosures (such as asset risks at a zip code level).
Scope 1 and 2 greenhouse gas (GHG) emissions.
Scope 3 emissions, if the material or if the registrant has set a GHG emissions reduction target that includes Scope 3 emissions.
Additional qualitative and quantitative climate risk disclosures, including the financial impacts of severe weather events and other natural conditions and transition activities on line items of the financial statements.
Governance of climate-related risks and risk-management processes.
The proposal has been set to support plans to comply with a company’s advertised environmental claims (such as net-zero commitments) as well as assurance on a phased-in period for accelerated filers and large accelerated filers. The proposed rules will require disclosures on Form 10-K and Form 20-F about a company’s governance, risk management, and strategy with respect to climate-related risks.
1. SEC Form 10-K
This is an annual report that provides a comprehensive analysis of the company's financial condition. The form provides a depth of business summary, including a description of the company's operations, such as its products and services, business segments, market, subsidiaries, markets, research and development, and regulatory issues. It also highlights the management discussion and analysis to explain the company’s operations and financial results for the preceding fiscal year. Financial statements with an income statement, cash flow statements and balance sheets are also provided. Furthermore, the filling also comprises an additional section that discusses the company’s management team and legal proceedings. The proposed rule will require US-based companies to provide climate-related disclosures in this annual or transition report.
2. SEC Form 20-F
This is a form submitted to the SEC by all "foreign private issuers" with listed equity shares on exchanges in the U.S. as stated by the Securities Exchange Act of 1934. The form requires issuers to submit an annual report within four months of the end of a company's financial year or if the financial year-end date changes. This standardises foreign-based companies' reporting requirements to help investors evaluate these investments alongside domestic equities. Furthermore, this form is also availed to shareholders of the company as required by the New York Stock Exchange (NYSE) rules. The proposed rules will require companies based outside the US to include climate-related disclosures in these registration statements and annual and transition reports.
What is the Timescale?
Since the proposal of the rules to enhance and standardise Climate-Related Disclosures for Investors for 2022-2046 on March 21, 2022, proposed key dates regarding ESG disclosures for investor compliance have been released. However, the original finalisation date for the rules, December 2022, has now been extended to 2023 so the timeline has shifted significantly. This, in part, was due to debates about aspects of the proposal, including the disclosures of GHG emissions from upstream and downstream activities in value chains (also known as Scope 3). There was also the fall-out from the Supreme Court’s June decision in West Virginia v. EPA that limited federal regulation of power plant emissions.
What are the Requirements for Registrants?
A company registrant must identify their climate change risks and how they had or are likely to, have a material impact on the business and consolidated financial statements, which may manifest over the short, medium, or long-term. Furthermore, companies will have to explain how their strategy, business model, and outlook are affected, or likely to be affected by:
Climate-related events (severe weather events and other natural conditions).
Transition activities on the line items of a registrant’s consolidated financial statement.
The financial estimates and assumptions used in the financial statements.
The rules proposed also require companies to highlight :
Greenhouse Gas (GHG) emissions (Scope 1)
Indirect emissions from purchased electricity or other forms of energy (Scope 2)
GHG emissions from upstream and downstream activities in its value chain (Scope 3), if the material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.
How Does My Company Prepare for the SEC’s Climate-Related Disclosures?
In preparing to adopt the rules, there are relevant steps to assist companies in evaluating their existing disclosures, internal processes, procedures, and quantitative methodologies. This is to align them with the SEC’s proposed requirements:
Steps to prepare for the SEC's proposed Climate-Related Disclosure (Source: Halper J. et.al, 2022).
Companies must disclose information about their boards and managers’ oversight and governance of climate-related risks, such as physical risks and transition risks, in reviewing and implementing related policies and procedures.
Companies must also evaluate their boards and managers’ roles and processes for assessing, managing, and overseeing climate-related risks to ensure that proper expertise oversees climate-related matters. Furthermore, companies must consider engaging outside consultants or counsel to evaluate their climate-related risks and advise them on complying with the SEC’s proposed new requirements. Companies must also measure their Scope 3 supply chain emissions as well as providing attestation reports from independent GHG emissions assurance providers (or auditors) to cover Scope 1 and 2 greenhouse gas emissions metrics for large accelerated filers, and accelerated filers.
What are the Benefits?
These proposals will provide investors with useful information to assess a registrant’s exposure to, and management of, climate-related risks and transition risks. The proposed rules will provide a safe harbour for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. Furthermore, the disclosures will enable investors to understand aspects of the registrants’ climate risk management for those that conduct scenario analysis, have developed transition plans, or publicly set climate-related targets or goals.
By following these disclosure recommendations, businesses can identify, evaluate, and address actual and potential climate change-related risks. This should lead to better investment decisions, protected assets, greater business continuity, improved reputation among stakeholders, and increased profits.
Web Sources:
5. https://corpgov.law.harvard.edu/2022/05/11/how-to-to-prepare-for-the-secs-proposed-climate-disclosures rules/#:~:text=To%20prepare%20for%20the%20new%20proposed%20SEC%20rule%2C%20companies%20should,with%20the%20SEC's%20proposed%20requirements.