For this final article in our series about the proposed climate disclosure rule from the US Securities and Exchange Commission, experts answer: How does the proposed rule compare to approaches in other jurisdictions, and can we expect to see an international climate disclosure standard?
Special Series: The SEC Climate Disclosure Rule
In light of a recently proposed climate disclosure rule from the US Securities and Exchange Commission (SEC), we ask experts to weigh in on what the rule entails and its implications. Browse the blog series by clicking through these articles:
- Introduction to the Series: Why Do Investors Need or Want the SEC Climate Disclosure Rule?
- Indirect Emissions Disclosures Are Important but Tricky
- Even with Moves toward Transparency, Corporate Climate Pledges and Carbon Offsets Will Be Complicated
- Will the SEC’s Proposed Climate Disclosure Rule Come Up against Legal and Economic Challenges?
- International Context of the Proposed Climate Disclosure Rule from the US Securities and Exchange Commission
In the past decade, regulatory authorities around the globe have introduced voluntary and mandatory climate-related disclosures. As the US Securities and Exchange Commission (SEC) works on finalizing its proposed climate disclosure rule, the agency can note insights from how other jurisdictions have approached this issue.
Has the SEC followed similar methods as in the examples set by the United Kingdom, the European Union, and others? Or is the SEC’s proposed approach fundamentally different in any key aspects? Will investors have enough information to accurately assess the climate risks disclosed by firms in different countries? Would a global standard be better than a mix of approaches across the globe?
For this final installment in our special blog series about the SEC climate disclosure rule, experts address the question: How does the proposed rule compare to approaches in other jurisdictions, and can we expect to see an international climate disclosure standard?
Virginia Harper Ho, City University of Hong Kong
The SEC’s landmark proposal to introduce mandatory climate disclosures comes over a decade after its 2010 guidance first encouraged companies to disclose climate-related financial risks under the current federal reporting rules. Although the 2010 guidance had limited impact on how US companies report climate risk, it got international attention. Since then, a vast array of voluntary—and increasingly mandatory—reporting requirements for greenhouse gas emissions, climate risk disclosure, and other sustainability-related information has been introduced or endorsed by international organizations (including the G20’s Financial Stability Board, the World Economic Forum, and the International Organization of Securities Commissions), stock exchanges (including those in London, Singapore, and Hong Kong), and over 70 governments worldwide (including the European Union, the United Kingdom, and China). As I’ve written previously, all these efforts take somewhat different approaches to reporting climate risks, due to their different goals and audiences.
There’s good reason to be optimistic that the SEC’s proposed rules will support the current momentum toward an international climate disclosure standard.Virginia Harper Ho, City University of Hong Kong
But there’s good reason to be optimistic that the SEC’s proposed rules will support the current momentum toward an international climate disclosure standard. Indeed, the SEC’s proposal notes that international reporting standards for climate-related disclosures are under development by the International Sustainability Standards Board (ISSB) of the International Financial Reporting Standards Foundation. The SEC’s proposal also closely follows the terminology and core elements of the same leading reporting frameworks that the ISSB’s drafted standards rely on, and that most public companies worldwide already use for climate-related disclosures—that is, the reporting framework developed by the G20 Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol. The SEC’s proposed rules may influence the final form of the new international standards, but the ISSB’s goal is to provide a common baseline for each country to build on—not to displace the role of the SEC and other regulators. And the SEC, the ISSB, and governments, along with standard-setters worldwide, all recognize the need to standardize how companies report on climate-related risks to their investors across capital markets.
One of the main issues that any standard has to address is the question of what is “material,” or significant enough to be reported. On this point, both the SEC and the ISSB draft rules have taken the same position. The TCFD framework, which both the SEC and ISSB proposals follow, differs from many international voluntary standards (e.g., the Global Reporting Initiative) and various sustainability reporting frameworks in the European Union. The TCFD framework uses a financial materiality standard that focuses on how climate risks impact the reporting company, rather than using a “double materiality” standard that would require reporting on the company’s external environmental impacts or climate impacts.
The SEC also has to tailor its rules to account for the higher litigation risk that US companies face when they disclose information to the market. For now, the SEC’s rules actually are tougher and more specific in many places than the guidelines they are based on, and the rules may be softened in the final regulatory framework. Still, the fact that both the SEC and the ISSB are working toward the same goals, using the same starting points and approaches, makes the prospect of compatible reporting standards more likely.
Marcin Kacperczyk, Imperial College London
The US Securities and Exchange Commission (SEC) recently issued a proposal to amend rules concerning the disclosure of climate-related information by domestic and foreign registrants. The new proposal is comprehensive and covers several areas of interest. Its main idea is to promote disclosures of issues that could pose material risks to a broad stakeholder base. While some critics argue that such rules already exist, the risks associated specifically with climate-related events are complex and require detailed, firm-specific information that typically is missing in standard corporate reports.
While the SEC proposal is an ambitious step toward improving the corporate information environment, the document currently constitutes a set of ideas, rather than a final regulatory framework. Crucially, this set of ideas is likely to get revised, and it’s not entirely clear which parts will make it into the final rule. In its action, the SEC follows the steps of its global counterparts that have made similar efforts or are in the process of changing their regulatory frameworks. My remarks here do not aim to discuss all the details behind each country’s individual proposal; instead, my goal is to provide some perspective on the substantive details and implementation.
While significant progress has been made in terms of country-specific regulations, this progress has been uneven internationally; crucially, the efforts of individual countries must not be distorted by regulatory loopholes, and disclosures need to be coordinated as much as possible.Marcin Kacperczyk, Imperial College London
Broadly, the SEC is not the first to embark on this regulatory mission. Some countries already have enacted climate-related rules into formal laws. The leading example is the United Kingdom, which in 2013 implemented a law that mandates publicly listed companies to disclose material emissions information. In the European Union, the Non-Financial Reporting Directive of 2014 and its subsequent amendments aim to regulate disclosures. Similar sets of rules, with different degrees of formalism, exist in Asia, including in Singapore and Japan.
But when it comes to the details, interesting differences are notable among the disclosure mandates across international borders. For example, the UK mandate of 2013 requires firms to report absolute levels of Scope 1 emissions (direct emissions), Scope 2 emissions (indirect emissions from energy inputs), and carbon intensity metrics, leaving the reporting entity with discretion in choosing an appropriate denominator variable, which may be sales, cost of goods sold, or a physical measure of output. Carbon intensity metrics can be informative to outside observers in terms of gauging improvements to carbon footprints, particularly for growing firms. But on the other hand, measuring with a ratio may mask a lack of progress in terms of absolute emissions reductions, i.e., the variable that’s ultimately of interest for the trajectory to net zero. The SEC seems to promote the use of absolute levels in climate disclosures, even though the proposed rule also mentions emissions intensities. In its proposed rule, the SEC emphasizes the importance of Scope 3 emissions (indirect emissions that occur “upstream” or “downstream” of the manufacturing process) and forward-looking information, including climate commitments and updates about broader changes in governance structure. This set of ideas moves the SEC disclosure paradigm ahead of other jurisdictions and largely reflects recent changes in best practices related to decarbonization efforts.
Further, the legislation in the United Kingdom and the SEC proposal in the United States largely concentrate on disclosures from large companies, leaving smaller companies less regulated. Because small companies in the aggregate make up large proportions of individual economies, one concern is that leaving these small companies aside would omit significant amounts of emissions from disclosures. This concern recently has been voiced in discussions of regulations in the European Union, where smaller companies likewise would be overlooked in the regulatory framework.
Another area of interest concerns the granularity of emissions reporting. In the European Union, manufacturing plants in carbon-intensive sectors that are covered by the EU Emissions Trading System must report their annual greenhouse gas emissions to the European Union Transaction Log. This element of the European Union’s monitoring, reporting, and verification framework is an enforcement mechanism that prevents the underreporting of carbon emissions. Likewise, in 2010, the US Environmental Protection Agency mandated carbon-intensive production facilities to report direct emissions to a publicly accessible registry. A similar reporting requirement applies to carbon-intensive production facilities in California, as part of the state’s cap-and-trade program. However, one of the overarching problems with this type of disclosure is that these facility-level emission reports are not readily aggregated to firm-level emissions (at least to date). Hence, the SEC needs to require information at the level of individual firms.
Another key aspect of the SEC’s proposed climate disclosure rule relates to global comparability. Because some of the information is difficult to measure (e.g., Scope 3 emissions), a risk looms that the disclosures will not be comparable across firms or across international markets. And, given that some regulations target different sets of companies than others, any differences across firms in their disclosure requirements may distort basic competitive forces and lead to carbon leakage, which is the transfer of emissions into unregulated zones. Hence, standardizing the rules of the game for all players involved will be important to emphasize in the final rule.
While devising an entirely uniform set of global rules is wishful thinking, reconciling the differences among institutional frameworks will be vital. One of the initiatives that goes in this direction is the International Sustainability Standards Board (ISSB), which was announced at COP26 in Glasgow and follows the protocol of the International Financial Reporting Standards Foundation. The aim of the ISSB is to establish standards that produce a high-quality, comprehensive, global baseline of sustainability disclosures that focus on the needs of investors and financial markets. The ISSB will develop the standards such that they can be mandated and combined with jurisdiction-specific requirements or requirements that meet the information needs of broader stakeholder groups. Consistent with the approach taken by the International Accounting Standards Board, jurisdictional authorities will decide whether to mandate use of the ISSB’s standards. The intention is for the ISSB’s standards to cover important sustainability topics about which investors want information—starting with climate, due to the urgent need for information on climate-related matters.
In sum, the reality of climate-related risks is no longer controversial. Climate risks can endanger the welfare, and even the existence, of the human species and need to be addressed promptly and carefully. Access to credible information is an important component in the process of implementing solutions. While significant progress has been made in terms of country-specific regulations, this progress has been uneven internationally; crucially, the efforts of individual countries must not be distorted by regulatory loopholes, and disclosures need to be coordinated as much as possible.