Climate change poses serious risks to almost every aspect of the economy, and its impacts will have long-term disruptive effects on financial markets around the world. Currently, these risks are not adequately addressed by financial regulators in the United States. As a result, climate-related information is not accurately incorporated into financial markets, leaving firms, investors, and stakeholders ill-equipped to weather the inevitable effects of climate change.
Recognizing that “investor demand for, and company disclosure of information about, climate change risks, impacts, and opportunities has grown dramatically,” former Securities and Exchange Commission (SEC or Commission) Acting Chair Allison Herren Lee, released 15 questions for consideration on March 15, 2021 “with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change.”
Last week, the Climate Risk Disclosure Lab submitted a detailed comment letter that provides answers to each of the Commission’s 15 questions. Founded in 2020, the Lab seeks to support those in government, the private sector, and civil society who are working to address climate change and the risks it poses to the global financial system, through effective implementation of climate risk disclosure rules. The Lab is an education and policy development initiative created and led by Duke Law’s Global Financial Markets Center, the National Whistleblower Center, and the Nicholas Institute for Environmental Policy Solutions at Duke University.
Over the course of several weeks, the Lab’s leadership held a series of workshops to discuss the issues raised in the SEC’s request. The Lab felt it was important to weigh in on each question, given the time and effort SEC leadership and staff clearly put into asking them in the first place. Recognizing the necessity of immediate action, the Letter discusses actions the SEC can take now, under its existing authority, to develop a mandatory climate risk disclosure regime. However, we also recognize that policymaking is a continuous process, so our letter contains recommendations for the SEC to purse in the long-term, once an initial climate disclosure rule is in place.
What follows is a summary of our most significant recommendations for providing investors and the public with high quality, comparable, and reliable information on climate risks.
The SEC Must Develop Climate Risk Institutional Capacity
To fulfill its task of regulating, monitoring, reviewing, and guiding climate change disclosure, the SEC will have to develop the institutional expertise to fulfill this function. The SEC may also want to consider a commission-wide task force made up of staff from each relevant division and office to coordinate climate risk disclosures and other relevant climate related matters. This group could be permanent or could sunset once climate disclosure rules have been in effect for some time and public company registrants, investors, and other relevant stakeholder are comfortable with the process and information being disclosed.
The SEC should also establish a new advisory committee with representatives from the private sector, the investing community, academia, and civil society to provide continuous guidance on the effectiveness of climate disclosure rules and the compliance burden for disclosing firms. This advisory committee can make recommendations for changes to the climate disclosure framework.
Finally, the Public Company Accounting Oversight Board (PCAOB) has responsibility to establish audit, quality control, ethics, independence, and other standards relating to public company audits. The PCAOB should therefore review and modify, as appropriate, its standards to ensure effective application to any new climate risk disclosures mandated by the SEC in the financial statements of public companies.
Task Force on Climate-related Financial Disclosures (“TCFD”) Recommendations Should be the Starting Point
The Lab does not consider third parties to be appropriate standard setters of climate risk disclosures and the SEC should not delegate rulemaking regarding climate risk disclosures to a third party. Nevertheless, the standards created by third parties, e.g., Task Force on Climate-related Financial Disclosures (the “TCFD”), can and should be utilized as a starting point for a new standard promulgated and enforced by the SEC.
The SEC should leverage the TCFD recommendations, which are a widely used and accepted by registrants, investors, and international policy makers. The TCFD recommendations were developed through the Financial Stability Board (FSB), whose membership is comprised of ministers of finance, central bank governors, and supervisory and regulatory authorities from member jurisdictions. Because the FSB is primarily made up of political appointees, it provides a degree of democratic accountability to their proposals and recommendations, including the TCFD. The TCFD’s recommendations are also flexible enough to apply to all public companies, and, with slight modifications, can be put into a two-tier framework for application to financial companies and non-financial corporates, which the Lab recommends.
Initial Disclosure Rule Should be Tiered by Financial/Non-Financial Status. Industry Specific Standards Should be Developed Over Time
The initial disclosure framework should be limited to disclosures for financial companies and non-financial corporates. This recommendation stems from the characteristic features of financial actors. Financial institutions are uniquely exposed to the risks of climate change through their counterparties and the securities they trade and hold. In addition, unlike most sectors, they can amplify detrimental carbon emissions through their financing activity. Therefore, the SEC should adopt a simple standard that accounts for the difference between financial and non-financial corporates.
Once the initial rule is in place, the SEC should work with third-party standard setters to develop sector specific disclosures. The primary advantage of developing multiple standards is that industry-specific standards result in the disclosure of information that is most relevant and predicative of a firm’s climate risks and opportunities. In many ways, this mirrors Generally Accepted Accounting Principles (GAAP), which has both general principles and industry specific guidance when the general principles are not sufficient. For investors who want to precisely manage their climate risk exposure, industry-specific standards are more beneficial than generic standards. Industry-specific standards also delineate the differential impacts that climate change will have on various sectors. For example, an oil and gas company will have different risk exposures than a software company.
In March 2021, the International Financial Reporting Standards (IFRS) Foundation announced the formation of a working group to accelerate convergence in global sustainability reporting standards. The goal is to establish an International Sustainability Standards Board (ISSB) under the IFRS Foundation structure. The SEC should work with the ISSB to develop sector specific standards. This recommendation is in line with the June 5, 2021 communiqué issued by G7 Finance Ministers and Central Bank Governors.
Disclosure Must Include a Detailed Mixture of Quantitative and Qualitative Information
First and foremost, per TCFD’s Metrics and Targets recommendation, all companies should disclose scope 1, scope 2, and downstream and upstream scope 3 emissions, and the related risks. In addition, companies should disclose “the metrics used by the organization to assess climate-related risks and opportunities in line with its strategy and risk management process.” Companies should also disclose internal prices of carbon and climate-related opportunity metrics (e.g., revenue from products and services designed for a lower-carbon economy).
To render the disclosures more meaningful, all companies should be required to disclose data on issues such as: their use of carbon offsets, total amount of fossil-fuel related assets owned or managed by the company, annual capital expenditures to reduce emissions, cost of compliance with environmental laws, or Key Performance Indicators (KPIs) used to assess progress against climate-related targets. The SEC should also mandate disclosures of material physical risks (e.g., physical climate risks company will be subjected to due to its geographical location and financial impacts of risks identified as material), metrics for material physical impacts (e.g., annual average losses from projected climate impacts, impact from recent extreme weather events, or increase in capital expenditure). Mandatory disclosures for financial institutions with material physical risks should include location data for mortgage collateral, geospatial location of counterparties, and transition risk (counterparties’ climate footprint or financed emissions).
The SEC should adopt a model set out in TCFD recommendations on Governance and Risk Management. Pursuant to TCFD, registrants should “disclose the organization’s governance around climate-related risks and opportunities.” This includes (1) describing the board’s oversight of climate-related risks and opportunities and (2) describing management’s role in assessing and managing climate-related risks and opportunities.
Registrants should also “disclose how the organization identifies, assesses, and manages climate-related risks.” This includes describing (1) the organization’s processes for identifying and assessing climate-related risks, (2) the organization’s processes for managing climate-related risks, and (3) how processes for identifying, assessing, and managing climate-related risks are integrated into the organization’s overall risk management.
Even if some consider these disclosures to be “immaterial” and therefore not subject to mandatory disclosure, the SEC still has the statutory authority under Section 7 of the Securities Act of 1933 to disclose them.Section 7 gives the SEC full rulemaking authority to require disclosures in the public interest and for the protection of investors. It is clearly in the public’s interest to know how public companies are managing climate-related risks and opportunities.
Tying executive/employee compensation to quantifiable metrics incentivizes meeting those metrics. Therefore, registrants should disclose how the compensation of named corporate executives is influenced by climate risks.
Climate Disclosure Should be in 10Ks and 10Qs
Climate risk disclosures should be included in companies’ 10Ks and 10Qs. This will require making amendments to Regulation S-X and S-K.
Introducing climate risk disclosures to financial statements required by Regulation S-X is preferable as this will make the disclosures subject to audit. Such an amendment to Regulation S-X could mandate that climate disclosures are included in the footnotes to the financial statement. The narrative footnote disclosures could discuss a company’s emissions associated with the assets and cash flows itemized in the financial statement. Other issues that could be included in footnotes are, e.g., price of carbon assumptions made by the registrant, emissions embedded in the fossil fuel reserves of fossil fuel companies, annual emissions that are offset via purchase of carbon offsets, the names of the offset projects, and CAPEX considerations to determine the transition costs.
Any disclosures not appropriate for Regulation S-X should be mandated by amendment to Regulation S-K, which generally focuses on narrative disclosures. This is in line with SEC’s 2010 interpretive guidance that identified existing provisions of Regulation S-K that relate to disclosure of climate change risk. Climate risk disclosures should also be reported in the “Risk Factors” section of 10Ks and 10Qs. Some aspects of climate risk could also be included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Another option is to mandate a new section entitled “Climate Risks.” If the SEC decides not to mandate a new section, TCFD recommendations should be utilized and included within the appropriate items in the annual report on Form 10-K. Under TCFD recommendations, “Governance” can be included in Item 10 “Directors, Executive Officers, and Corporate Governance,” and “Risk Management” can be included under Item 1A “Risk Factors.” “Strategy” can be included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” “Metrics and Targets” can be included in Item 15, “Exhibits, Financial Statement Schedules.”
Furthermore, registrants should file climate risk disclosures in their financial statements (10Ks and 10Qs). Including the climate risk disclosures in the financial statements filed with the SEC creates an implied private right of action for material omissions and misrepresentations in the filed report, whereas furnishing a report to the SEC does not. Therefore, filing is critical because it allows investors to enforce effective climate risk disclosures and will lead to great consistency and reliability of disclosed information.
Climate Disclosures Should be Enforced by Multiple Parties
The SEC should ensure that the climate risk disclosure framework is safeguarded by appropriate enforcement mechanisms. The Lab recommends that disclosures be assessed within the reporting firm and by an independent third party. The SEC should also support whistleblower activity. Ultimate enforcement authority must rest with the SEC and private litigants through the private rights of action for material omissions or misrepresentations in filings made with the SEC.
For medium to large issuers, the SEC should require that CEOs and a board member who has been given responsibility for climate issues both assess and certify the accuracy and completeness of climate and ESG related disclosures—including for subsidiaries. Such a certification would mirror section 302 of the Sarbanes-Oxley Act, which requires the CEO and the CFO of publicly traded companies to certify the appropriateness of their financial statements and disclosures, and to certify that they fairly present, in all material respects, the operations and financial condition of the company. Many believe that this requirement was one of the most important in Sarbanes-Oxley at ensuring the accuracy of financial reporting. Requiring CEO and CFO certifications focuses the mind of those executives. It also encourages CEOs and CFOs to invest in control systems to ensure the accuracy of their certifications.
The Lab believes that the experience with Sarbanes-Oxley merits CEO and CFO attestation of climate disclosures. While many companies are already disclosing climate-related information, it is still a new practice that may not be ingrained throughout a company’s governance and risk management processes. There is no surer, or faster, way to obtain such integration than by requiring CEO and CFO certification.
Audit assurance gives investors greater confidence that climate disclosures were developed and reported according to the appropriate standard. This independent third-party review helps provide this confidence. Auditors also provide the benefit of reviewing multiple standards and can thus provide reporting firms with a necessary horizontal/peer perspective that will drive greater consistency and comparability across firms. Auditors, through their ability to flag issues, can also alert investors to any issues within the firm’s climate reporting framework.
Furthermore, wherever appropriate, disclosures should be integrated into the issuer’s financial statements, which brings the benefit of requiring this information be audited. This would also trigger Section 404(b) of Sarbanes-Oxley, which requires a publicly held company’s auditor to attest to, and report on, management’s assessment of its internal controls.
To the extent that climate change disclosures are not incorporated into the financial statements via Regulation S-X, they too should still be validated, ideally by independent professionals providing assurance as to their material accuracy. Also, because section 404(b) of Sarbanes-Oxley only requires management to attest to the internal control environment around financial reporting, the SEC may want to consider expanding management’s attestation requirements for other aspects of the control environment.
Public disclosures related to climate must be vigorously enforced by staff within the Division of Enforcement with specific expertise on this issue. The SEC should consider increasing the climate-related expertise at Regional Offices, particularly those offices responsible for areas most affected by climate change. The SEC’s Division of Enforcement must prioritize climate-related cases and quickly respond to tips and complaints received by the SEC.
The Division of Corporation Finance must establish a climate-related disclosure review team to commence the immediate review of climate disclosures and issue clarifying bulletins designed to answer frequently asked questions or correct for any common deficiencies or omissions in disclosures. Ultimately, all staff members within the Division of Corporate Finance must be trained in climate risk disclosure as these disclosures will apply to all public companies. This will require the SEC to update its internal training programs and processes.
As the SEC itself recognizes by inclusion of the SEC Whistleblower Office in the Climate and ESG Task Force, without access to information from whistleblowers, the SEC’s ability to enforce climate and ESG-related disclosure requirements may be severely handicapped. The SEC should utilize its authorities under the Dodd-Frank Act to ensure that whistleblower allegations related to climate and ESG disclosure rules are prioritized within the Division of Enforcement, and that whistleblowers who disclose climate-related disclosure violations are fully incentivized and protected.
Private Companies Must not be Exempt from Climate Disclosure
It goes without saying that any new disclosure standard introduced by the SEC should bind all public company registrants. However, if the SEC expands its disclosure requirements for public companies, it is likely that many companies will feel the pressure to go or stay private. This pressure will likely be greatest in industries with perhaps the largest climate-related risks, such as fossil fuels, real estate, and financial services.
Climate and ESG-related disclosures are critical for continued robust functioning of the U.S. capital markets. If the U.S. disclosure requirements fall behind the rest of the world, it will put the U.S. public and private funds at a competitive disadvantage. In contrast, if the U.S. takes the lead in this space, it will attract global capital that is seeking to have access to robust ESG information.
In general, given its mission to protect investors, the SEC should reconsider the appropriateness of allowing the movement of capital out of public equity markets through new exemptions (e.g., Rule 144A or Rule 506). Climate financial risk is growing without scrutiny in the private markets, and steps must be taken to reverse this migration. The SEC should revise its rules to push large companies and large offerings of securities into the SEC’s public markets reporting regime. Further, the SEC should consider conditioning any remaining exemptions upon the disclosure of details of the securities, including financial information, and climate and ESG-related information.
The Lab is encouraged by the emphasis and attention given by the SEC to climate risk disclosure. This issue is one that needs to be addressed to protect investors, maintain fair, orderly, and efficient markets, and continue to facilitate long-term capital formation. Clearly, it falls squarely within the SEC’s mandate. In forthcoming reports by the Lab, we seek to further explore these matters by engaging with experts to better understand and answer the questions posed by the SEC, along with others.
The Climate Risk Disclosure Lab seeks to support those in government, the private sector, and civil society who are working to address climate change and the risks it poses to the global financial system, through effective implementation of climate risk disclosure rules.
The Lab is an education and policy development initiative created and led by Duke Law’s Global Financial Markets Center, the Nicholas Institute for Environmental Policy Solutions at Duke University, and the National Whistleblower Center.
 A. Lee, U.S. Securities & Exchange Comm’n, Public Input Welcomed on Climate Change Disclosures (Mar. 15, 2021), available athttps://www.sec.gov/news/public-statement/lee-climate-change-disclosures.
 Public Company Accounting Oversight Board, Standards, available at https://pcaobus.org/oversight/standards.
 U.S. Department of Treasury, G7 Finance Ministers & Central Bank Governors Communiqué (Jun. 5, 2021), available athttps://home.treasury.gov/news/press-releases/jy0215.
 TCFD, Recommendations of the Task Force on Climate-related Financial Disclosures (June 2017), p. 19, available at https://www.fsb-tcfd.org/recommendations/.
 Id., p. 21.
 See 15 U.S.C. § 77g(a)(1) (“Any such registration statement shall contain such other information, and be accompanied by such other documents, as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.”).