International Context of the Proposed Climate Disclosure Rule from the US Securities and Exchange Commission

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?

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

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.

For more information, contact Marc Hafstead, the director of RFF’s Climate Finance and Financial Risk Initiative.

Browse the articles in this blog series about the SEC’s proposed climate disclosure rule.