Shelter from the Storm: Helping Investors Navigate Climate Change Risk<a href="#_ftn1" name="_ftnref1" title="">[1]</a>

This is a watershed moment for investors and financial markets as the Commission today addresses disclosure of climate change risk – one of the most momentous risks to face capital markets since the inception of this agency. The science is clear and alarming,[2] and the links to capital markets are direct and evident.[3]

Thus, I’m very pleased to support today’s proposal and I want to extend my sincere thanks to staff across the agency for their hard work in crafting the proposing release.[4] I also want to thank Chair Gensler for his focus and commitment to this issue, and his counsel, Mika Morse, whose talents have been integral to finalizing this proposal. Today’s proposal is extremely well done, skillfully leverages widely-accepted market-driven solutions including those created by the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas (GHG) Protocol, and responds to longstanding demand for Commission action to enhance climate-related disclosures for investors and markets.

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Maintaining an effective disclosure regime for public companies is among the most important and foundational roles of the Commission. We have broad authority to prescribe disclosure requirements as necessary or appropriate in the public interest or for the protection of investors.[5] Importantly, with that authority comes responsibility. We have a responsibility to help ensure that investors have the information they need to accurately price risk and allocate capital as they see fit. We have a responsibility to millions of families with retirement savings and college funds whose economic well-being is linked to our financial markets. And we have a responsibility to stay firmly focused on facts and science and their implications for financial markets.  

The pandemic provided a timely reminder that a crisis with roots outside financial markets can, and often will, send shock waves directly through our markets. When the pandemic hit two years ago, the Commission sprang into action, issuing guidance, providing targeted relief, and advancing numerous other initiatives designed to alleviate many of the market stresses this public health crisis created, and to get decision-useful information about these financial stresses into the markets.[6] Those initiatives were largely implemented on an emergency basis. However, if we had had more concrete warning of the coming disaster, we could have taken steps in advance to increase transparency around company preparedness for some of the most foreseeable risks in order to get investors the information they needed in a timely manner. 

With climate change, we have ample, well-documented warning of potentially vast and complex impacts to financial markets. Physical and transition risks from climate change can materialize in financial markets in the form of credit risk, market risk, insurance or hedging risk, operational risk, supply chain risk, reputational risk, and liquidity risk, among others.[7] Indeed, we have more than just warning as many of those risks have already materialized.[8]

Climate change thus poses a pressing and urgent risk – for investors, companies, capital markets, and the economy. It is no surprise then that investors representing tens of trillions of dollars – more than the combined GDP of the top five ranked countries in the world – have been clear that they need more and better climate-related disclosure.[9]

We see this in shareholder proposals, we see this in public campaigns and initiatives, we see it in direct demands on companies, and we see it in demands that the Commission take action to require climate-related disclosure. And, while investors are the principal drivers of demand and the principal users of disclosure, the support for enhanced disclosure requirements is far broader.[10] The overwhelming majority of comments received in response to last year’s request for public input favored enhanced climate disclosure. Comments from investors, issuers, academics, accounting firms, third party standard setters, lawmakers, our own advisory committees[11] – a broad and diverse coalition of market participants and commentators agree on the need for the Commission to propose climate-related disclosure requirements.[12]  

This proposal is responsive to that feedback, as well as to those who raise valid concerns about the challenges of these disclosures. It takes a measured and balanced approach to climate disclosure, building upon current market practices, including proposed accommodations for smaller companies, balancing principles-based requirements with the need for climate-related metrics, phasing in certain requirements over time, and even providing a safe harbor for the disclosure of Scope 3 emissions.  

The proposal broadly contains the following provisions:

• It would create new requirements for the disclosure of climate-related risks and impacts based on the TCFD disclosure framework, including information about material impacts of climate risk on a company’s business, and information about a company’s governance, risk management, and strategy related to climate risk.
• It would include a requirement to disclose in a company’s financial statements disaggregated metrics on climate-related impacts, expenditures, and estimates and assumptions.
• It would require the disclosure of a company’s greenhouse gas emissions, drawing on the GHG Protocol, and including Scopes 1, 2, and, for all but the smallest companies, Scope 3 emissions.[13]

The proposal would require these disclosures to be filed with the Commission, phase reporting requirements in over time based on a company’s size, and importantly, includes a phased-in requirement for verification or “reasonable assurance” of GHG Scopes 1 and 2 for larger filers to help ensure the reliability of these disclosures.[14]

I look forward to what I know will be detailed, data-driven, and robust comments on all aspects of the proposal. I’m especially interested to hear from commenters in a few specific areas:

Reliability of GHG Emissions Disclosures

A company’s internal controls. Greenhouse gas emissions in many respects resemble financial statement disclosures, involving as they do significant estimates and assumptions and providing critically important insight into a company’s operations. As proposed, these disclosures are required under Regulation S-K rather than under Regulation S-X with financial statement disclosures. If emissions disclosures were required under Reg S-X and located in the financial statements, they would generally be subject to a company’s internal control over financial reporting (ICFR).[15] In Reg S-K, there is no such requirement. Would GHG emissions be better placed within Reg S-X and subject to the rigors of ICFR? Alternatively, should we leave emissions disclosure in Reg S-K as proposed but add a new requirement to establish ICFR-like internal controls for GHG wherever they reside?

Third-party verification. The location of GHG in Reg S-K would also mean that the required assurance may be provided by third-party verifiers that are not PCAOB-registered audit firms. On the one hand, will this help to improve competition in this space and thus create better outcomes? On the other hand, PCAOB-registered audit firms are subject to oversight and inspection whereas other types of third-party verifiers are not. Will this difference substantially affect the quality of, or confidence in, the verification?

Reasonable vs. limited assurance. I hope commenters will weigh in on whether to keep the proposal’s requirement to subject GHG Scopes 1 and 2 to reasonable assurance attestation after an interim period of limited assurance. Reasonable and limited assurance are terms of art in the auditing world with significant differences. Broadly, limited assurance is a form of negative assurance that the attester is unaware of any material issues.[16] Reasonable assurance, by contrast, is an affirmative attestation that the information is fairly presented in all material respects.[17] Consider, for example, parachuting from a plane. Would you be content to hear that a review shows nothing to indicate a problem with the chute, or would you instead want to know that the chute has been examined and found to be sound in all material respects? Given what many view as the centrality of GHG emissions in analyzing a company’s climate risk,[18] the difference between limited and reasonable assurance may be no trifling distinction, and it will be critically important to hear from commenters on this issue.  

Scope 3 Emissions

Specificity. Scope 3 disclosures are often vitally important to understanding a company’s overall greenhouse gas emissions and therefore overall climate-related risks. As proposed, Scope 3 emissions must be reported if they are material – either quantitatively or qualitatively. Does the release contain sufficient specificity regarding how companies should undertake this analysis? Also, should companies be required to provide the basis for any determination that their Scope 3 emissions are not material in order for investors assess whether they agree with the determination, especially in light of Supreme Court precedent stating that doubts about materiality should be resolved in favor of disclosure?[19]

Assurance Carve-out. The proposal would not require any type of verification or assurance over Scope 3 emissions disclosures. Given the overall significance of such data, would it be more prudent to phase in an assurance requirement over time for Scope 3? Would a phase-in period be consistent with an expectation that Scope 3 disclosures are likely to mature over time with across-the-board disclosure of Scopes 1 and 2 emissions?  

Safe Harbor. The proposal contains a broad safe harbor for Scope 3 emissions disclosures unless they are made without a reasonable basis or not in good faith. Should the safe harbor also or instead be conditioned upon the use of specific methodologies such as the Partnership for Carbon Accounting Financials (PCAF) Standard if the registrant is a financial institution, or the GHG Protocol Scope 3 Accounting and Reporting Standard for other types of registrants? 

On these and the many other important questions raised by the proposal, I hope commenters will weigh in with their views and supporting data.

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Climate change has broader implications than those within the Commission’s remit that we address today. Other regulators or lawmakers may consider or take action based on their own jurisdictions and responsibilities. However, our responsibility to help ensure accurate and complete disclosure of risks for investors and markets is long-standing and central to our mission. Climate risk is not unique in this regard. It is not unlike similarly pressing concerns for investors such as cybersecurity threats, or risks related to supply chains and worker safety brought to the fore by the pandemic. And with climate, we have the benefit of an extensive body of research on this risk and how it will impact financial markets, years of work and analysis by market participants trying to improve disclosure of the risk, and a clear record of quite rational investor demand for better disclosure of climate risk information. Today’s proposal reflects a commitment to remaining focused on these facts and to data-driven policymaking.

One final thanks again to the dozens of staff all across the agency who have worked so hard on this proposal, and a special thanks to my counsel, Katherine Kelly, who has worked tirelessly and with deep commitment on this effort. Thank you.