The SEC’s Climate Disclosure Line-Drawing and its Limits

In the coming weeks, the US Securities and Exchange Commission (SEC) is expected to introduce its final corporate climate disclosure rules. This effort to standardize climate disclosure has brought to light deep divides among the public, and among US corporate and securities law scholars, about the proper scope and goals of climate disclosure reform. Expectations are that some of the more controversial aspects of the draft rules will, not surprisingly, be pared back.

Much of the current anti-ESG controversy stems from confusion (and fears) about whether the regulatory reach of ‘climate risk’ disclosure will sweep in other undefined ESG factors, and about the rules’ ultimate goals, causing some to question the SEC’s authority to mandate climate disclosure in the first place. This controversy comes at a time when investor demand for ESG investment products is rising exponentially and when the European Union and the International Sustainability Standards Board are moving forward to standardize how climate risk and other ESG information is reported to investors.

My recent paper 'Climate Disclosure Line-Drawing & Securities Regulation' responds to these questions. It analyzes how the SEC has made the various boundary or ‘line-drawing’ choices that are part of any climate risk disclosure regime, and also explains the impact and limits of the SEC’s line-drawing choices. It concludes by outlining steps that could be taken to better ensure that the proposed reform achieves its goals.

The paper first considers how climate risk intersects with broader ESG concepts under the SEC’s draft rules and under the Task Force on Climate-Related Financial Disclosure (TCFD) framework on which they are based. Here, the analysis confirms what many standard-setters recognize—that the dividing line between financial materiality and external corporate impacts (ie single and ‘double’ materiality), on the one hand, and between climate risk and other environmental and social risks on the other, is not so clear. Regardless of how narrowly the SEC tries to draw the lines then, the scope and scale of climate risk means that companies will also need to tell investors more about how they manage certain related ESG risks, too.

At the same time, the SEC’s approach is highly flexible and much narrower than other emerging international reporting mandates. For instance, the SEC has also wisely chosen to lower companies’ compliance costs and promote harmonization internationally by building on the established frameworks developed by the TCFD and the Greenhouse Gas Protocol. Limiting the scope of the rules to climate risk and building on the dominant international frameworks is the most efficient way to achieve the highest benefits for investors at the lowest cost to reporting companies. Yet the SEC’s minimalist approach reflects the high constraints it faces in adopting any form of climate-specific disclosure, even one that is focused on financial materiality like the TCFD. There are, of course, strong arguments that the rules fall squarely within the SEC’s long-standing regulatory authority and should easily pass constitutional muster. However, the SEC’s rules, even in draft form, are designed to hew closely to the core of its statutory authority. The SEC hopes to avoid being seen as reining in corporate climate externalities, attempting to ‘fix’ climate change, driving green capital allocation, or regulating corporate behavior generally, all goals that elsewhere would be assumed to be important potential public benefits of corporate disclosure.

This conservative stance comes at a cost. It is axiomatic that the more flexible disclosure rules are, the less effective they are in achieving standardization, which is the primary goal of these new rules. As with GAAP and IFRS, creating a US-specific approach also makes the kind of global standardization the ISSB had originally hoped to achieve unlikely.

The paper also considers how introducing TCFD-based climate disclosure in the US context will affect companies’ risk of liability for securities fraud. Since the focus of the rules is disclosure about risk, I argue that the standards courts have set for securities fraud claims and the scope of existing safe harbors for projections and other forward-looking statements are likely to make it difficult for such cases to succeed. However, the low chance of success will not discourage securities fraud lawsuits from being brought in the first place. Such claims could also increase, given that the rules will require some companies to produce more prescriptive disclosures, for instance, about corporate climate targets, and to report more often and in greater detail about known material risks. Although current ‘safe harbors’ for forward-looking statements and those proposed for indirect Scope 3 emissions are an important protection, they do not reach broadly enough. Litigation risk is therefore another potential cost of the new rules and could discourage the kind of more precise risk disclosure the new rules are designed to produce. The paper therefore argues that all firms should enjoy a temporary moratorium on private securities litigation while they adjust to the new requirements.

In addition, the SEC should promote international harmonization by encouraging voluntary sustainability reporting by US-listed companies based on the forthcoming ISSB sustainability standards. The SEC should also accept corporate reporting against either the European Union or ISSB standards as fully complying with its own rules.

Virginia Harper Ho is Professor of Law at the City University of Hong Kong School of Law.