US SEC’s Approach to Regulating Sustainable Finance

1. Summary

The Securities and Exchange Commission, as a US federal agency with mandate to protect investors and maintain market fairness, approaches sustainability investing by requiring listed companies publicly disclose important information related to ESG factors that may affect investor decisions. The SEC has issued a proposed disclosure requirement requiring that companies disclose in registration documents and regular reports (such as Form 10-K) the following types of information:

This requirement was first published as a draft in 2022 March, but is undergoing political and legal challenges, where members of Congress have challenged that the SEC does not have the authority to ask companies to disclose climate related information – visual here, and that it would cost companies billions of dollars. To date, the disclosure requirement has not been passed. As of SEC announcement made in December 2023, the agency will consider finalizing the disclosure requirement in the spring of 2024.

The SEC also establishes reviews and enforcement task forces to ensure that funds promoting ESG investing to investors are accurate and consistent in their claims with regards to the ESG investment they market.

2. Background and development

According to the SEC, there has been significant investor demand for information on how climate change may impact their investments, and this demand has increased in recent years. Everal major institutional investors that collectively manage trillions of dollars in assets, have demanded climate-related disclosure from the companies they invest in because they assess that climate risk is a risk to their portfolio, and to satisfy investor interest in investments that are deemed “sustainable”. These institutional investors have formed initiatives such as the UNPRI, the Net Zero Asset Managers Initiative, and the Glasgow Financial Alliance for Net Zero.

Outside the US, climate and ESG disclosure has become international practice. Since 2015, the Group of 20 Finance Ministers directed the Financial Stability Board, which then established the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD has since developed a comprehensive disclosure framework that is widely adopted by regulators around the world, endorsed by Finance Ministers and Central Bank Governors of the G7. The SEC climate disclosure requirements has also largely referenced the TCFD framework.

The SEC has first addressed disclosure of significant environmental issues since the 1970s. in 2010 the SEC published guidance on how existing disclosure may require disclosure of the impacts of climate change as a result of further investor demand. However, the SEC notes that because of the lack of a standard requirement and guidelines in place, listed companies tend to report voluntarily, in different formats, and without standardized definition such that it provides meaningful information to investors. In March 2021, the SEC requested public input on climate disclosure from investors, registrants, and other market participants, where it solicited input on topics such as how the SEC could best regulate disclosure concerning climate change in order to provide consistent, comparable, and reliable information for investors, whether the SEC should require disclosure of certain climate metrics, etc.

Since March 2022, the SEC has published proposed rule “The Enhancement and Standardization of Climate-Related Disclosures for Investors”, which, when finalized, would become the US securities market’s regulation on climate information disclosure and a first move towards regulation of sustainable finance in the exchange markets.

Currently, after the SEC has collected feedback from the public on its proposed rule, it has announced delays in its finalization, and is facing political and legal backlashes that challenge the requirements within the rule as burdensome to comply with, and that the SEC lacks the legal authority to demand climate related information from companies. As of its latest estimation, the SEC expects to move on with all processes and finalize the rule by Spring of 2024.

Timeline of major events:

3. Climate Disclosure Requirements

3.1 Financial Statement Disclosure

The proposed SEC rule would require registrants to disclose, in a footnote to the financial statements, the financial statement impacts of (1) climate-related events, including severe weather impact such as flooding, drought, wildfires, extreme temperatures, and sea level rise, and (2) transition activities, which are change in business operations and costs incurred in the transition to reduce GHG emissions or other exposures in transitioning to a carbon neutral economy. For both climate-related events and transition activities, the disclosures would include financial impact metrics, expenditure metrics, and a discussion of the impact on financials.

Examples of financial impact disclosures:

Climate-Related Events

Transition Activities

“Changes to revenue or costs from disruptions to business operations or supply chains”
“Impairment charges . . . of assets (such as inventory, intangibles, and property, plant and equipment)”
“Changes to loss contingencies or reserves (such as environmental reserves or loan loss allowances)”
“Changes to total expected insured losses due to flooding or wildfire patterns”

“Changes to revenue or cost due to new emissions pricing or regulations resulting in the loss of a sales contract”
“Changes to . . . cash flow[s] from changes in upstream costs, such as transportation of raw materials”
“Changes to the carrying amount of assets . . . due to a reduction of the asset’s useful life or a change in the asset’s salvage value”
“Changes to interest expense driven by financing instruments such as climate-linked bonds issued”

3.2 GHG Emissions

Registrants would be required to disclose Scope 1 and Scope 2 GHG emissions; Scope 3 GHG emission disclosures would be required if material or a registrant has established a reduction target or goal that includes such emissions.

For each emission scope, a registrant would be required to disclose gross emissions (before consideration of any purchased or generated offsets) (1) disaggregated by each GHG (carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride) and (2) on an aggregated basis by using carbon dioxide equivalents (“CO2e”).

A registrant would also be required to disclose GHG intensity in terms of tons of CO2e per unit of revenue and per unit produced for the total of Scope 1 and Scope 2 GHG emissions and separately for Scope 3 GHG emissions.

Under the proposed rule, GHG emissions are categorized and defined as follows:

*Scope 1 GHG emissions*	*Scope 2 GHG emissions*	*Scope 3 GHG emissions*
“[D]irect GHG emissions from operations that are owned or controlled by a registrant”	“[I]ndirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant”	“[A]ll indirect GHG emissions not otherwise included in a registrant’s Scope 2 emissions, which occur in the upstream and downstream activities of a registrant’s value chain”

The proposed rule also identifies certain upstream and downstream activities (Scope 3):

*Upstream Activities*	*Downstream Activities*
Purchased goods and services Capital goods Fuel and energy related activities not included within Scope 1 or Scope 2 Transportation and distribution of purchased goods, raw materials, or other inputs Waste generated Business travel by employees Commuting by employees Leased assets related to purchased or acquired goods or services	Transportation and distribution of a sold product, good, or other output Third party activities related to Processing products sold Using products sold End-of-life treatment of products sold Leased assets related to sale or disposition of goods or services Franchises Investments

3.3 Governance

The proposed rule would require a registrant to disclose the following information about how its board of directors oversees climate-related risks:

The specific board member(s) or board committee(s) responsible for overseeing climate-related risks
Whether any board member has expertise in climate-related risks and, if so, the nature of such expertise
The processes undertaken by the board of directors or board committee(s) to discuss climate-related risks, how those groups are informed of such risks, and how frequently such discussions occur
How climate-related risks are considered by the board of directors or board committee(s) “as part of its business strategy, risk management, and financial oversight”
How the board of directors establishes climate-related targets or goals or oversees the registrant’s progress toward such targets or goals

3.5 Climate Risk Management

A registrant would be required to disclose its processes for “identifying, assessing, and managing” climate-related risks, namely how the registrant (1) assesses the significance of climate-related risks; (2) considers actual or potential regulations (e.g., GHG emission limits) as well as shifts in customer demand, technology, or market prices in assessing transition risks; and (3) prioritizes and mitigates climate-related risks. Further, a registrant would disclose whether those processes are integrated into its broader risk management program.

If a registrant has adopted a climate transition plan, the proposed rule would require a description of such plan, including how the registrant intends to mitigate or adapt to climate-related risks as well as the relevant targets and metrics used in identifying and managing physical and transition risks. A registrant would be required to update its disclosure annually to specify its progress toward completing the transition plan.

The proposed rule would also permit, but not require, a registrant to disclose its process of identifying, assessing, and managing climate-related opportunities.

3.6 Climate Target and Goals

If a registrant has set any climate-related targets or goals related to, for example, a reduction in GHG emissions, energy usage, or water usage, it would be required to disclose information such as:

The scope of activities encompassed in the target (e.g., Scope 1 and Scope 2 only, domestic operations only)
The time horizon envisioned for achieving the target (e.g., a 50 percent reduction in GHG emission by 2030)
Any interim targets established
How the target is measured (e.g., reduction of CO2e emitted, reduction of CO2e emitted per unit of revenue)
How the registrant plans to achieve its targets or goals
An update each year of the registrant’s progress relative to its targets or goals and how (or whether) such progress has been achieved
If carbon offsets or renewable energy certificates (RECs) have been used as part of the plan to achieve climate-related targets or goals, information about the carbon offsets or RECs, including how much of the progress made is attributable to offsets or RECs

4. Additional SEC Policies

In addition to rule making, the SEC also undertakes examination and enforcement efforts. The SEC has launched the Climate and ESG Task Force to develop initiatives to proactively identify ESG-related misconduct in the following areas:

Portfolio management, proper due diligence, fir policies and practice related to ESG and use of ESG terminology
Performance advertising and marketing, review firm’s regulatory filings, website etc. to the extent that it has clearly communicated to clients its commitment to follow ESG framework.
Compliance. Review fir’s written policies and procedures of ESG investing practice and disclosure.
On matters such as naming rules and conventions on ESG funds