The SEC Sample Climate Change Comment Letter Is a Warning
On September 22, the SEC’s Division of Corporation Finance issued a sample comment letter (the “Comment Letter”) regarding climate change disclosures.1 While the SEC has yet to issue its promised climate change disclosure regulations, the Commission continues to move beyond its 2010 guidance in its consideration of climate change-related matters. The Comment Letter is further evidence that the SEC’s thinking on the topic has significantly evolved, and the eyes of the Commission are already turning towards enforcement. Given this, below are several takeaways public companies should immediately consider.
1. The SEC is checking out that sustainability report of yours.
The first item discussed in the Comment Letter addresses a situation in which the company in question has provided less detail in their 10-K than in the company’s corporate voluntary ESG disclosure. While we have previously warned about the importance of making sure your ESG story is consistent with your other disclosures and corporate behaviors, the Comment Letter shows that the SEC is thinking about exactly the same thing. Additionally, the Comment Letter’s language suggests that the Commission may be considering requiring companies to incorporate climate and perhaps related sustainability information into their annual filings, or at a minimum, explain why they have chosen not to do so.
2. The SEC is so over boilerplate climate risk disclosure.
We have previously discussed the importance of TCFD, chiefly for its role in shaping how businesses (and, particularly, financial institutions) conceptualize climate risk.2 The Comment Letter is similarly focused on the degree to which companies are merely addressing climate risk in a generic and abstract sense or are adequately considering and disclosing both transition (regulation, litigation, credit, etc.) and physical (extreme weather, decreased production capacity associated with chronic physical trends, etc.) climate change-related risks. And the Comment Letter further peels back the onion by noting the need to consider the indirect consequences of climate-related trends as well, including how climate change may have impacts on a company’s supply chain.
3. The SEC is staying up-to-date on ESG news (and wants you to, too).
ESG is moving quickly. The Comment Letter acknowledges that ESG litigation, legislation, and regulation (both in the U.S. and in other jurisdictions), may have material impacts on a company’s business, financial condition and results of operations, and suggests that companies should be more proactive and sophisticated in considering how these developments may affect them. With respect to climate-related litigation, companies should consider not only the history of litigation alleging that a company’s operations have contributed to climate change resulting in property damage, but also should consider the wider array of litigation risks arising out of ESG reporting, including greenwashing claims, and other claims relating to a company’s operations, such as challenges to permits necessary for the operations on the grounds that the project would unnecessarily increase greenhouse gas emissions. When it comes to policies and regulations, companies should assess state and federal developments that could impact their customers and suppliers in addition to their own business and operations. Altogether, this means companies will need to make sure more than ever that they are staying up-to-date on ESG trends in litigation as well as changes in policy and regulation.
4. The SEC wants to know what climate risks and strategies are costing you.
Addressing climate change risks and opportunities can be a pricey endeavor. The Comment Letter specifically calls for disclosures to identify material capital expenditures for climate-related projects, as well as any material compliance costs related to climate change. For the Management Discussion and Analysis section of companies’ periodic filings, the Comment Letter specifically speaks to the need to disclose information on the purchase or sale of carbon credits or offsets to the extent they are material. This takes on special importance for companies that have announced any emissions reduction commitments, especially net zero commitments. If offsets or other capital expenditures are a significant part of a company’s climate strategy, then the company should prepare to more thoroughly discuss that spending and related expectations. Finally, we note that companies should be prepared to address costs associated with navigating both transition and physical climate risks.
5. To the SEC, honesty is the only policy.
When it comes to corporate disclosure, honesty should be a given. However, even when disclosures are not intentionally misleading or inaccurate, there remains a risk of biases about potential demand and market outlook and how those biases may shape assessments of potential climate risks and decision making.3 It is easy to look at climate risks or your company’s position in global climate dynamics and think “yes, but we are special.” This means that while the Commission may respect a company’s ultimate conclusion that they are “special” notwithstanding regulatory and business trends, the rationale behind such a conclusion will likely be subject to substantial scrutiny. For example, if demand is projected to go down in a particular industry, but every company in that industry is saying “this won’t materially affect us,” those companies should not be surprised if the SEC comes and asks to see their homework. So if you are going to claim to be special, be prepared to prove why in future annual filings. This also means that companies should avoid only disclosing the positive, glossy version of their climate-related risks and strategies – it is time to be honest about the downside, the risks, the costs and the uncertainties.
6. The SEC needs you to remember that physical climate risk is more than just “heatwaves and stronger storms.”
While data availability and quality are both continued concerns, the Comment Letter lays out multiple examples of the types of physical effects of climate change that may have an impact on a company’s operations and performance. Beyond the standard consideration of acute and chronic physical climate risks at a company’s own location, these include the availability of insurance and indirect impacts, such as impacts to major customers or suppliers. While many physical climate projections do not have the refinement to predict sub-regional impacts, companies still should be considering the full range of potential climate risks and providing detail where it is relevant and available. As with the entire realm of climate disclosures, these expectations will evolve along with the data and modeling capabilities.
So What Comes Next?
The Comment Letter undoubtedly expands the Commission’s approach to climate change-related disclosures, and also highlights what the SEC believes to be the existing scope of its authority. While we wait for the SEC’s proposed rulemaking, the Comment Letter provides further insight into where the SEC is in thinking about what climate change disclosures should likely cover. Perhaps of more immediate importance, it reiterates the SEC’s focus on climate change, and that focus is likely to result in changes in disclosure requirements and, even before that, practices. We expect that many companies will begin to receive comment letters tailored to their own disclosures soon, and companies should also expect their investors to respond to each new floor the SEC establishes. Companies should prepare to spend more time discussing climate in their SEC filings, and while this does not have to mean longer disclosures, it undoubtedly means more robust data collection efforts and more time articulating how the company is thinking about climate change in a sophisticated and tailored manner.
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2 For a discussion of climate-risk taxonomy, see the 2017 report on the Task Force on Climate-related Financial Disclosures, available here.
3 See, e.g., Toby Macdonald, How Do We Really Make Decisions, BBC News (Feb. 24, 2014), https://www.bbc.com/news/science-environment-26258662.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.