(Cross-post from my blog)

  • The SEC is a pseudo-meta regulator of the world 
  • SEC is proposing climate disclosures 
  • If you believe climate disclosures are good you should be writing to the SEC to tell them so

The US SEC (company and financial regulator, securities exchange commission) is proposing to require companies to include climate-related disclosures in annual and regular reports. The SEC commissioners (and politicians) are not unanimous in supporting these proposals. There is a reasonable argument that the SEC is a global meta-regulator. There is an argument that these disclosures will allow easier innovation and assessment of carbon impacts. Thus this is an important step in assisting climate solutions. If you believe this, you should send supporting statements to the SEC while comments are open to 22 May (or contra) as a low cost way of helping potentially a high impact policy. The idea is tractable and impactful. While not very under-researched, most people outside finance seem unaware of this proposal nor of the meta-regulator role of the SEC. This makes the SEC have a uniquely global role.  

BACKGROUND

On 21 March 2022 - “The Securities and Exchange Commission today proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.”….

“The proposed rules also would require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. These proposals for GHG emissions disclosures would provide investors with decision-useful information to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks. The proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.”

In brief detail:

  • Board and management oversight and governance of climate-related risks
  • How any climate-related risks have had or are likely to have a material impact on its business and financial statements over the short-, medium-, or long-term
  • How any identified climate-related risks have affected or are likely to affect strategy, business model, and outlook
  • Processes for identifying, assessing, and managing climate-related risks and whether such processes are integrated into the overall risk management system or processes
  • The impact of climate-related events
  • Scopes 1 and 2 GHG emissions metrics, separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute and intensity terms
  • Scope 3 GHG emissions and intensity, if material, or there is a GHG emissions reduction target or goal that includes its Scope 3 emissions; and
  • Any climate-related targets or goals, or transition plan…

 

WHY IS THE SEC A META-REGULATOR?

This ideas has been discussed in financial and policy circles, but in a public popular way by Bloomberg writer, Matt Levine.

The idea (which he has floated from time to time over the years ) is that the SEC is a form of global “meta-regulator” because US business touches the whole world (and so many “stakeholders”, customers, employees, supplies etc.) in so many ways then the way you regulate US business will regulate the world.

In that sense by demanding climate data, the SEC is suggesting climate is relevant for US business and thus the world.

Levine writes:

“I sometimes say that, in the U.S., the SEC is the all-purpose meta-regulator, and here you can see why. Public companies exist in society, so everything that matters to society is probably material to public companies, and what public companies do about any issue probably matters to society. And regulating what public companies have to say about that issue will affect how they act on it. The title of Commissioner Peirce’s dissenting statement is: “We are Not the Securities and Environment Commission - At Least Not Yet.” But they are! They’re the Securities and Everything Commission.”


WHAT IS THE THEORY OF CHANGE MECHANISM? 

The idea is that is it hard to manage what you do not measure and therefore measurement and disclosure are the first steps in solving a problem.

Market advocates argue that once sufficient transparency is produced that investors / market forces will then (most efficiently or more efficiently than central planning) produce the desired outcome under acceptable trade offs.  

The strong-form argues for limited policy intervention.  The weak-form argues that market forces work alongside policy will be most effective. 

There is evidence that transparency can lower the cost of capital and that it’s helpful at IPO and in overall making stock/debt markets more efficient. 

Mechanisms could be (drawing on Levine): 

The disclosure regime effectively deputizes public companies to be climate enforcers: If their suppliers don’t start measuring and reducing their emissions, the companies won’t be able to do the required disclosure.


If your disclosure under this item says “Our board is not informed about climate-related risks in any systematic way, and never really considers them,” that will look bad. Investors will complain, the SEC will look at you with suspicion, it will be unpleasant. To check this box, you will have to start providing the board with regular reports about climate risk, and devoting time to it in board meetings. (This is true even if you are, like, a software company with a modest environmental footprint.) Perhaps this will all be surly and pro forma and your behavior won’t change, but the (reasonable) theory seems to be that if you force boards to talk about climate change they will end up doing something about it too.

LARGE FUNDS AS UNIVERSAL OWNERS

Matt Levine also highlights a somewhat new piece of thinking on the idea of “Universal Ownership” and how this is different (recall certain passive investors may own 3 - 5 % of all American companies in their tracking mandates).

Several large institutional investors and financial institutions, which collectively have trillions of dollars in assets under management, have formed initiatives and made commitments to achieve a net-zero economy by 2050, with interim targets set for 2030. These initiatives further support the notion that investors currently need and use GHG emissions data to make informed investment decisions. These investors and financial institutions are working to reduce the GHG emissions of companies in their portfolios or of their counterparties and need GHG emissions data to evaluate the progress made regarding their net-zero commitments and to assess any associated potential asset devaluation or loan default risks. [SEC]

Then Matt:

Notice that this is weird. This is not “investors need this information to understand the company providing the information,” but rather “look, investors these days are diversified, and many of them care about the systemic risks to their portfolios, not about how any one company runs its business.” If it’s material to an institutional investor that its portfolio be carbon-neutral, then it needs to know the carbon emissions of each portfolio company, even if those emissions are not actually material to that company.

This strikes me as very new! And basically correct, I mean: Investors are often diversified and systemic these days, so the SEC’s rules might as well reflect how investing actually works. Still it is a novel and surprising concession, asking a company to disclose stuff because it is useful to its shareholders as universal shareholders, not (just) because it is relevant to the company’s own business.

What is the cost? Risk?

There will be increased reporting and staffing costs for companies.  This may cause lower allocation of capital to more impactful items. Second order costs harder to know but might make more intense companies suffer from a higher investment cost of capital.  (Which advocates would argue is a feature not a bug). Major risks seem limited but see counter arguments below.

What is the benefit?

The first order benefit is that it allows investors (and the public) to know and therefore assess the carbon footprints of large corporates and their climate strategies. This information is difficult to ascertain outside the company. 

It allows more accurate allocation of capital for those investors interested and allows easier comparison of strategies between companies. 

It allows market forces to act better. 

It may allow more efficient litigation if required on if companies follow relevant laws as regards risks (eg carbon risks). 

Why is this a long term benefit ?

If you believe carbon impact is a significant risk then this regulation has plausible probability (I estimate 72%) that it will allow better innovation and risk management. 

In particular, if you give some weight (say 40%) to the SEC as meta-regulator idea then this has a plausible chance  of positive  global systemic benefit. 

The cost of the regulations seem acceptable and the risks of unintended consequences low and of acceptable outcome. 

What are the counter arguments?

These are best articulated by one of the SEC commissioners Hester Pearce.  She argues the regulations are unnecessary and costly. And by extension creep the SECs mission into environmental regulation.  (see link end)

John Cochrane has adjacent arguments although these apple more to the Fed and climate, but worth considering. For the Fed it is overstepping remit and also the wrong area of government to be tackling the challenge as he views limited risk to financial stability.  (see link end)


Is this tractable? Under researched ? impactful ? Should people support it ?

The policy is possible but faces opposition. On principle right leaning politicians dislike the costs and unintended consequences of regulation. The policy could be very impactful. The debate is not well known outside finance circles. Given this if you are minded, it’s a policy worth giving supporting comment to. Cost to support is low.  Especially under an EA minded framework. Do feel free to comment your support (or not) here: https://www.sec.gov/rules/submitcomments.htm

Press release with links to full report here. 

 

Interested in comments and critiques. (This is my first full EA post). Is this EA forum worthy? 


Further thinking and reading:

On climate policy overall, Chris Stark CEO of Climate Change Commitee (UK statutory body), podcast: https://www.thendobetter.com/investing/2022/2/7/chris-stark-ceo-climate-change-committee-netzero-policy-adaptation-cop-fairness-behaviour-change-podcast

 

On climate science: Zeke Hausfather on the state of the science

https://www.thendobetter.com/investing/2021/11/22/zeke-hausfather-state-of-climate-science-energy-systems-post-cop26-tipping-points-tail-risks-podcast


On a simple but comprehensive mental model on solving climate, from the head of Stripe, Climate, Nan Ransohoff https://nanransohoff.com/A-mental-model-for-combating-climate-change-846be1769d374fa1b5b855407c93da66

 

Counter arguments:
Peirce (SEC): https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321

Cochrane: https://johnhcochrane.blogspot.com/2021/07/climate-risk-to-financial-system.html

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Thanks for the post. I think it's worth your time and our attention. I tend to agree with you... do you think a similar reasoning (i e., that you can leverage your impact by pressing "meta"-regulators) would apply to EEUU (eg., the European banking authority), too? And /or to TCFD? On the other hand, it seems that you think individual contributions could have an impact, right? This conflicts with my anecdotal experience with public consultations - where usually interest groups and personal connections tend to be prioritized by policy-markets (who can't really pay attention to all the messages they receive). But if you're right, would it be convenient to draft some guidelines or even a token for messages to be addressed to SEC?

Re: influence of public

Typically, you are correct that individual comments have a low weight. But, I believe the general counts positive/negative are taken into account. Also i) even if there is only a small chance, say 9%, of any one comment have weight - given the cost of a comment is low, it’s still a good return and ii) I do think number of comments does have weight (say, a 79% chance this is true).

 

Re: TCFD

TCFD does not have legal weight (except where governments/regulators decide to use it as such) and is not as globally influential as the SEC.. So the meta-regulator effect of TCFDs is much lower than the SEC, I’d say close to zero maybe 2% or 3%, if SEC is at least 40% and possibly I’d lean higher.


 

Re: EU

While EU has more weight than TCFD, it also does not have the same meta-regulator impact as SEC, as US business and economy is more influential and SEC has more global influence on international companies. I’d estimate 5 or 6% at best.  There is actually already some EU (and UK) regulation in this respect. 


Other meta-regulators...

In this sense the IFRS / ISSB work is more influential globally (but has limited weight of law and is technocratic), but still the SEC has the weight of law and is arguably the strongest (for good or bad) of the possible meta-regulators in this area (also the downstream nd upstream effects eg then asking suppliers to audit carbon). The SEC proposals also have (while contested and technocratic ) a partial political legitimacy if they make it though.


I will consider writing up a short template for people this week. So they can consider.  Thanks so much for feedback and comments.


 

For anyone trying to get updated on the debate over SEC Climate-related disclosures proposal, this is a good summary: https://sites.duke.edu/thefinregblog/2021/07/09/summary-of-comment-letters-for-the-secs-climate-risk-disclosure-rfi/

Thanks for the link. It is a good summary.

I follow a conservative economist who likes to rant about how this is a terrible, terrible idea. See here and here.

I link to John in the orginal post (tho on his Fed counter though similar).  You can probably mitigate some of John's and Hester's (who I also link to) concerns, while still allowing for the data and disclosure part.

 

If you take the steel man version of those arguments the problem is that investors are not doing enough litigation. as

 

"

I. Existing rules already cover material climate risks.

Existing rules require companies to disclose material risks regardless of the source or cause of the risk.

"

They both argue that these disclosures are covered by existing regulation. I have some sympathy for this point, as it is meant to be covered. But often - in reality -  it is not.  Currently we rely on audit/maanager's judgement that this is a material risk.

The only way to then get the disclosure would be to litigate and claim these are material risks. 

The costs part of their argument seem to me to be overstated, but are a true trade-off.