- The US securities regulator’s newly proposed climate risk disclosure framework is notable for its focus on governance, including the need for auditor oversight.
- This considerably broadens the pool of those liable for reporting climate risks and will not come cheap.
- The final rule is set to face litigation but is expected to look broadly how the proposal stands today.
The world’s most influential financial regulator late last month published its keenly awaited take on a trend sweeping the world: mandatory corporate reporting on climate risk – a topic that has taken on even greater significance following the latest, and direst, warnings from the Intergovernmental Panel on Climate Change in the past month.
The 510-page proposal from the US’s Securities and Exchange Commission (SEC), issued on 21 March, is seen to mark a major step on the path towards better quality non-financial markets information. And it contains a number of ground-breaking aspects: its approach to human capital, its warning on voluntary carbon offset markets, and the likelihood of the final rule – and the jurisdiction of the regulator itself – being challenged in court.
But the governance aspects – particularly surrounding auditing and assurance – of the plans have real potential to shake things up, yet are attracting less attention than most parts of the document.
The SEC proposes that, before filing their climate reports, both company management teams and an independent third party sign off carbon emissions data, with a phased-in approach according to the level of attestation required and the size of the company.
There is very little assurance and management oversight of ESG reports in governance terms now (see chart below). Hence the SEC’s move is a “game changer”, says Coco Zhang, head of ESG research at Dutch bank ING in New York.
“Corporate law is littered with requirements for boards to be fully informed and for shareholders to have access to board credentials,” she explains. “The SEC proposals home in on this as an important underpinning, so that corporates steer [through] the ESG waters on an informed basis.”
The third-party assurance requirement could mean the SEC goes further than other capital market regulators on climate risk disclosure, argues Wes Bricker, co-leader of US trust solutions at consultancy PwC in Washington, DC.
“An independent auditor gives a truly outside-in look, which matters because it’s so important that we raise confidence in this kind of information,” he tells Capital Monitor. “This information is at least as important as financial information to investment decisions, so it should have the same level of safeguards.”
Others support this view.
"Auditing of [climate] data is where we need to end up, so the SEC’s stance is interesting and, in a way, more advanced than the EU, UK or ISSB [International Sustainability Standards Board]. While they [the latter jurisdictions] are asking for more information overall, the SEC is asking for audits,” says Michael Hugman, director of climate finance at the Children's Investment Fund Foundation, a London-based independent philanthropic organisation affiliated with hedge fund the Children's Investment Fund.
“I think the thing people have missed is [the SEC] said if you have a target then you must disclose annually your plan to hit that target and how you’re doing," he adds. "And that’s pretty powerful."
Setting a precedent
Ultimately, though, the assurance aspect seems likely to make an appearance in other climate reporting frameworks.
The Taskforce on Climate-related Financial Disclosures (TCFD) – the framework broadly followed by regulators in the EU, UK, US and dozens of other jurisdictions – does not provide specifically for audit oversight. But Tim Mohin, chief sustainability officer at carbon accounting firm Persefoni, says that “given the reference to ‘financial disclosures’, the [TCFD] framework was designed to be assured”.
Just days after the SEC published its proposals, the ISSB published its first draft of a global baseline for sustainability disclosures – which is, again, broadly based on the TCFD.
These steps towards global harmonisation on climate disclosure are huge, says Bob Eccles, visiting professor at Oxford University’s Saïd Business School and a leading authority on integrated reporting. “I’m reasonably optimistic that we will eventually end up on consensus on this, and that's not an easy thing [to achieve]."
Such sentiment is widespread among investors, with large and influential asset owners – from German insurer Allianz to California State Teachers' Retirement System to Ontario Teachers’ Pension Plan – having publicly stressed how key they see mandatory climate reporting to be.
Liability burden to grow
The SEC’s proposed audit requirement could see independent auditors looking over not only past climate information but also net-zero pledges published in the future, says Bricker. They would be considering whether any commitments made fully represent a firm’s business, which standards they align with and whether they convey an accurate and complete understanding of a company’s strategy.
The SEC plans as they stand will increase and broaden the liability burden for climate information, where it has long been difficult to pinpoint an individual responsible for inaccurate or misleading reporting. Both directors and audit companies will be exposed to this liability, just as they would be for traditional financial statements.
As of November 2021, around 3,000 companies globally – mostly in the US – had set some form of net-zero commitment. But a near total lack of standardisation or oversight and a strong incentive for pledges to sound impressive has made numerous commitments difficult to trust. And while some companies use third-party verifiers for their climate disclosures, their role would typically be to provide a report to management, rather than assure investors that information is accurate and complete.
The SEC proposal expresses concern over corporate emissions reduction targets and the US watchdog is not alone in doing so. The UN’s new dedicated task force for corporate climate targets was launched on 31 March and will soon be drawing up guidelines for measuring, analysing and reporting net-zero emissions pledges.
But while many agree that independent attestation is important, it does not come cheap. This is likely to be a key sticking point for those, including Republican senators and state attorneys general, gearing up to challenge the rule in court.
“This proposal, if adopted, will face massive challenges in the courts,” says Justin Cooke, a securities partner at law firm Allen & Overy in New York. “The fact the SEC has specified that those outside parties need to qualify as experts will prove enormously costly. It's absolutely certain that the fees currently charged by third party advisors for analysing GHG emissions will be even higher for attestation in SEC filings, because the potential liability is that much higher.
“I can imagine smaller companies may find courts with a sympathetic ear when it comes to the challenges of complying with this rule,” he adds.
Fear of liability and ultimately litigation could discourage some companies from setting Scope 3 emissions targets if they have not already, Cooke adds. “Registrants know that litigation is likely, so there could be some perverse effects that ultimately end up giving asset managers less information in the end.”
The SEC has sought to manage this risk by proposing a phased-in approach. No company will need independent attestation in the first year of reporting, then only the biggest companies will require it, then smaller ones. The very smallest will be exempt.
Work to do
“There’s a big difference between where most companies are at right now with their voluntary disclosures, and what will be required – everything from digital tagging to assurance will be different,” says Mohin.
Tech company Intel and software firm Salesforce are two of the closest to compliance with the SEC’s proposal, he adds, particularly as they already integrate carbon disclosures into their financials. But even they will have some work to do.
That said, many believe any litigation is unlikely to have much success.
“Any large-cap company is not going to sit around and wait to see if some extremists challenge the SEC on it, and if that case survives all the way to the Supreme Court,” says Eccles. “Investors everywhere are pushing for this so they’re going to have to just get on with it.
“The overall narrative has changed so much,’ he adds. “The ship has really already sailed on corporate climate disclosure.”
Campaigners and investors will be hoping Eccles is right. Certain corporates and politicians, perhaps less so.
Additional reporting by Joe Marsh.