The SEC tries its hand at climate policy

The Securities and Exchange Commission’s (SEC) remit includes ensuring candor, honesty and transparency in what public companies tell investors. Yet it will spend the next few weeks and months trying to fool us into believing that its new 510-page proposal on mandatory climate disclosure is solely about protecting investors and has nothing to do with climate policy or achieving net zero emissions by 2050.

No one should be fooled.

Materiality is the governing principle of corporate disclosure requirements. In 2010, the SEC issued 29 pages of guidance on climate-change disclosures. With respect to what is now called climate-transition risk, the guidance requires that companies “should consider specific risks they may face as a result of climate change legislation or regulations and avoid generic risk factor disclosure that could apply to any company.”

This common-sense approach is now being superseded by an SEC-specified climate-risk reporting and accounting framework that will run in parallel with traditional financial reporting requirements, with its own verification and attestation regime necessitating the employment of legions of climate consultants.  

At the heart of the SEC’s new climate-disclosure regime is quantification of a company’s greenhouse gas emissions, at three levels: those emitted directly as a result of its own operations (Scope 1); those emitted from generating the electricity it consumes (Scope 2); and those emitted by its suppliers and customers (Scope 3). “Greenhouse gas emissions in many respects resemble financial statement disclosures,” writes Commissioner Allison Herren Lee, who, as the SEC’s acting chair in March 2021, initiated the process that led to the current proposal. Such disclosures, she claims, provide “critically important insights into a company’s operations.”

This statement takes us to the crux of the matter. The quantity of greenhouse gases that a company emits is material to its future financial performance if there is a probability that such emissions will be taxed or subject to regulation — in which case, current SEC guidance requires companies to disclose their likely impact. On the other hand, tabulations of corporate greenhouse gas emissions are of great interest to climate activists.

SEC Chairman Gary Gensler claims that forcing companies to make such disclosures is rooted in the concept of materiality. If investors say they need the information, he argues, it must be material. However, as Hester Peirce, the sole Republican SEC commissioner, points out in a 6,000-word statement of dissent, Gensler’s justification omits a clear link between materiality of information and its relevance to the financial return of an investment. The “reasonable investor,” as described by Justice Thurgood Marshall in TSC Industries v. Northway (1976), is “someone whose interest is in a financial return on an investment in the company making the disclosure,” Peirce writes. “Many calls for enhanced climate disclosure are motivated not by an interest in financial returns from an investment in a particular company, but by deep concerns about the climate or, sometimes, superficial concerns expressed to garner goodwill.”

Investors can have any number of nonfinancial motives for wanting climate data. Some want to know how “green” their portfolio is. Morgan Stanley Capital International has developed Paris-aligned indices to help investors make net zero part of their decisionmaking. State Street, the third-largest index tracker provider, has begun marketing four Paris-aligned exchange-traded funds (ETFs) tracking American, European, Japanese and world indices.

The SEC justifies the proposed mandate in part because some investors told the commission they want comparable climate data across their portfolios. Acceding to this would imply, Peirce argues, that the SEC thinks it appropriate for shareholders of the disclosing company to subsidize other investors’ portfolio analysis.

But these are subsidiary considerations. “Let us be honest about what this proposal is really trying to do,” Peirce writes. “Although styled as a disclosure rule, the goal of this proposal … is to direct capital to favored businesses and to advance favored political and social goals.”

Climate disclosure is not, as the SEC claims, about giving investors information about climate risk. Rather, its main purpose is to force companies to provide information on their greenhouse gas emissions and those of their suppliers and customers so that shareholders, interest groups and others can enforce net-zero targets on them through proxy votes and other forms of engagement.

The SEC justifies use of greenhouse gas emissions as indicators of climate-related risk on the grounds that they are a commonly used metric to assess a company’s exposure to such risks. This won’t wash, and it is a travesty that the SEC has adopted such reasoning. Corporate emissions disclosures systematically mislead investors on the degree of climate regulatory risk a corporation is exposed to because such disclosures assume the world is a homogenous regulatory space.

There is no factual basis to justify this assumption, and the SEC offers none. Climate regulation varies widely by jurisdiction. According to economist William Nordhaus, in 2019, 80 percent of global carbon dioxide emissions had an effective price of $0. Unlike prior attempts at global climate treaties, the Paris agreement is based on Nationally Determined Contributions.

Moreover, “net zero by 2050” has no legal standing in the United States. The Senate was not invited to give its advice and consent to the Paris agreement, with its aspiration of achieving net zero sometime in the second half of this century. Yes, net zero by 2050 is the policy of the Biden administration — but Congress has passed no law to put it into effect.  

Once it is admitted that the purpose of requiring American public companies to tabulate greenhouse gas emissions is to provide tools to enforce net-zero emissions targets on them, it all makes sense. The SEC’s proposal imports virtually wholesale the climate financial-risk disclosure regime of Michael Bloomberg’s Task Force on Climate-Related Financial Disclosures (TCFD). Incorporating climate-related risk into corporate decision-making, the TCFD website says, will empower “the markets to channel investment to sustainable and resilient solutions, opportunities, and business models.”  

Similarly, the G-20’s Financial Stability Board, in its “Roadmap for Addressing Climate-Related Financial Risks,” published last year, declares that “progress in identifying and addressing climate-related financial risks will support a shift towards sustainable finance” and create a positive feedback loop for the “mobilization of sustainable finance.” Jean Rogers, founder of the Sustainability Accounting Standards Board, foresees the need for the SEC to ask the Environmental Protection Agency to develop transition pathways for each sector in order to “evaluate the adequacy and materiality of the climate disclosures companies make.”

Nonetheless, the SEC must maintain the pretense that such disclosures are being made to protect investors and therefore fall within the SEC’s narrow congressional mandate; the commission cannot openly admit that mandated climate disclosures are tools to facilitate investors enforcing climate policies on corporate America. There are costs to the SEC’s conduct.

The commission tasked with upholding the probity of financial disclosures is working to mislead financial markets as to the intent of its proposed climate-disclosure regime. Though touted as an indicator of climate-transition risk, consolidated greenhouse gas disclosures cannot serve this purpose unless there is a global greenhouse gas regulator – which, of course, there is not. Rather, such data are an indicator of a company’s vulnerability to climate activists — a different matter altogether, and one that, it’s reasonable to conclude, is the SEC’s intent.

In addition to harming investors, foisting a structurally misleading disclosure regime onto financial markets by labelling it an indicator of climate transition risk runs contrary to the SEC’s mandate to maintain fair, efficient markets and to facilitate capital formation. The effort will push oil and gas investment from public to private markets and from Wall Street-listed companies to overseas ones — especially non-Western companies immune from climate activism.

The greatest cost, though, will be to America’s national interest and to the SEC’s place in constitutional governance. The SEC’s proposal could hardly have been more ill-timed. It was immediately denounced by Sen. Pat Toomey (R-Pa.), ranking member of the Senate Banking Committee, for hijacking the democratic process and disdaining the limited authority that Congress gave the SEC. “With inflation at a 40-year high, gas prices skyrocketing, and Russia waging an energy-funded war, the last thing the American people need are unelected regulators advancing policies by partisan vote that will cause energy costs to further rise,” Toomey said.

Writing in the Wall Street Journal, former SEC chair Jay Clayton and Rep. Patrick McHenry (R-N.C.), ranking member of the House Financial Services Committee, note that the Constitution assigns Congress the task of weighing and resolving the trade-offs inherent in climate and energy policy. “Because the SEC has decided to move forward unilaterally, the debate will shift not to Congress, where it belongs, but to the courts,” they observe.

So it will be in the courts that the SEC will be forced to defend not just its constitutional overreach but also its misrepresenting of its climate-risk disclosure regime as being about investor protection, as opposed to what it’s really about — the SEC trying its hand at climate policy.

Rupert Darwall is a senior fellow of the RealClear Foundation and author of “Climate-Risk Disclosure: A Flimsy Pretext for a Green Power Grab.”