The SEC and Climate Risk.

• Author: Benjamin, Lisa

TABLE OF CONTENTS INTRODUCTION I. SHIFTING POLITICAL, INVESTOR, BUSINESS AND JUDICIAL LANDSCAPES A. Shifting Political Landscapes B. Rising Investor Concern C. Business Resistance D. Judicial Hostility II. SEC INERTIA ON SPECIALIZED DISCLOSURES A. The 2010 SEC Guidance on Climate Change B. The Dodd-Frank Conflict Minerals Rule C. The SEC "Disclosure Effectiveness Initiative, " Petitions for ESG and Climate Rulemaking, and 2019-2020 Regulatory Reforms III. THE SEC AND CLIMATE RISK A. Physical and Transition Risks of Climate Change B. Climate Change as Systemic Risk C. The SEC's Role in Regulating Climate Risk D. The 2021 SEC Call for Comments on Climate-Related Financial Disclosures IV. THE RISKS AND BENEFITS OF RULEMAKING ON CLIMATE DISCLOSURES A. The Risks and Benefits of Rulemaking B. Cost-Benefit Analysis C. Constitutional Issues D. Flexible But Firm Rules CONCLUSION INTRODUCTION

Historically, the Securities and Exchange Commission (SEC) has been unsuccessful at regulating climate-related financial disclosures. A 2017 report by the Sustainability Accounting Standards Board (SASB) found that despite the wide-spread adoption of sustainability disclosures by companies, almost half of these disclosures contained boilerplate and vague statements, and less than one-third of disclosures contained any performance metrics. (1) A 2020 report by the U.S. Government Accountability Office (GAO) found that while most companies disclosed sustainability information, the metrics used differed, and so the disclosures were not comparable, clear, or useful for investors. (2) For example, most public companies' disclosures reviewed by GAO differed in their reporting of carbon dioxide, disclosing direct (Scope 1), indirect (Scope 2), value chain (Scope 3) and/or reductions in emissions. (3)

The SEC's hesitancy to effectively manage climate disclosures stems from three interrelated factors. The first is lack of political feasibility. Climate change is one of the most politically sensitive issues in the United States, and, until recently, mandating climate disclosures by public corporations has never been a high political priority. While the SEC is an independent agency, its regulatory reluctance on this issue has persisted through both Republican and Democratic administrations. The second factor is a clash of voices between public companies resisting calls for more climate-related disclosure, and investors, many of whom want increased disclosure from the public companies they invest in. While investors have repeatedly expressed a strong desire for clearer and better disclosures, the SEC has not catered to those concerns. Instead, the SEC focused on the entities it directly regulates--public companies. The agency has acceded to businesses, and industry's general resistance to mandated disclosures. Businesses have generally resisted agency initiatives to impose mandatory environmental, social, and governance (ESG) disclosures, especially climate disclosures. This resistance is particularly strong in public corporations that issue securities and are subject to the SEC's regulatory regime ("issuers"). Many issuers do not want to disclose the risks that climate change poses to their business as this may make investors more reluctant to invest in them and therefore decrease their share price. Issuers at greater risk of climate impacts have an inherent incentive to hide or obscure climate-related risks, making regulation requiring uniform disclosures all the more important. The third and final factor is rising judicial hostility to the expanded remit of the SEC, and recently to independent agencies more broadly. These three factors have contributed to past agency inertia on climate disclosures.

This article explores existing barriers to the SEC in creating a mandatory climate change disclosure regime. It also identifies opportunities for effective rulemaking on the issue. It recommends that the SEC issue flexible but firm rules mandating climate-related disclosures from issuers, which are industry specific and that also include a robust cost-benefit analysis. While many barriers have shifted and investor enthusiasm has increased recently, it is likely that any rule that mandates disclosures will be challenged in the courts. This article provides recommendations as to how these remaining barriers can be overcome or mitigated, particularly regarding judicial review. While a number of authors have addressed SEC action on ESG disclosures, (4) this article focuses exclusively on climate-related disclosures and assesses the policy feasibility of mandatory rules on climate-related financial disclosures, as this is the first element of ESG disclosures that the SEC appears willing to tackle. The costs and benefits of climate-related financial disclosures are also easier to identify and articulate, making them a reasonable starting point for the SEC to address. Even if the SEC does not choose this regulatory option, this article adds to the policy process literature specifically on climate disclosures, suggesting ways to frame cost-benefit analysis on climate disclosures.

This article moves the debate forward by focusing on the risks and benefits of SEC rulemaking in this area, incorporating a selection of comments (both positive and negative) received by the SEC in the 2021 call for public input around climate-related financial disclosures. It identifies the SEC as the most appropriate agency to regulate climate disclosure, despite its past failures. It explores unsuccessful attempts over the past decade by the SEC to regulate climate and social disclosures, including the SEC 2010 guidance on climate-related disclosures, the SEC 2012 rule requiring disclosure of use of conflict minerals, and the SEC's modernization of general corporate disclosures in 2019-2020. It applies lessons from those past attempts, and proposes recommendations that could mitigate persisting barriers.

Despite past failures in this area, political and financial approaches to the risks of climate change have shifted dramatically in the past few years to varying degrees. Climate change is a major policy priority for the Biden Administration. Many businesses, particularly institutional investors, express a strong desire for uniform climate disclosure regulation. Some issuers (sometimes referred to interchangeably as public corporations in this article) even express enthusiasm for climate disclosures, although some prefer a voluntary disclosure regime, and only a few support a mandatory rule. Generally, however, business resistance to climate-disclosure rulemaking, and judicial hostility, remain important factors for the SEC to consider. Despite the risks of rulemaking, this article argues that the time has never been better for the SEC to use rulemaking to regulate climate change disclosures.

This is particularly so due to the escalating risks of climate change to financial actors and systems. Several authors have advocated over the years for ESG disclosure rules by the SEC. (5) This article adds to these calls but highlights some of the internal failings by the SEC over the years, as well as some of the pitfalls facing the agency as a result of past agency failures and recent judicial decisions, and then provides some recommendations. These recommendations may improve the odds of successful regulatory efforts going forward for climate-related financial disclosures.

This Article proceeds as follows. Part I establishes a taxonomy of shifting political, business, and judicial landscapes on climate risk regulation. Political and investor shifts are due in large part to increased concern about the financial risks of climate change. Part II charts agency inertia of the SEC on specialized disclosures. It fleshes out examples of the hurdles and agency approaches identified in Part I that have contributed to agency inertia. The 2010 SEC guidance on climate change was rarely enforced by the agency. The 2012 conflict minerals rule and the agency's 2020 proposal regarding Regulation S-K disclosures demonstrate persistent business resistance and judicial hostility, including the Supreme Court's recent decision in AFPF v Bonta which demonstrates increasing judicial hostility towards disclosure regimes. (6) Part III advocates for SEC regulatory action despite the risks identified in Part II. This Part focuses on the systemic character of climate risks, and the important role that the SEC plays as a regulatory bulwark against future escalation of climate change to a systemic financial risk. It also analyzes a selection of public responses to the recent SEC call for comments on climate disclosures in 2021, illustrating investor enthusiasm but also continuing business resistance. Part IV weighs the risk and benefits of a rule mandating climate-related disclosures, and it also suggests some strategies and recommendations that may prove useful to navigating these barriers and harnessing rising political and investor enthusiasm for regulating climate-related disclosures while also mitigating countervailing issuer and judicial hostility. It advocates for robust cost-benefit analysis, a flexible yet firm regulatory approach that incorporates industry specific rules, and is in keeping with existing international standards, thereby increasing policy feasibility.

1. SHIFTING POLITICAL, INVESTOR, BUSINESS AND JUDICIAL LANDSCAPES

   Climate-related disclosures by public corporations did not receive much political attention in the U.S. until the Biden Administration. During the previous Democratic and Republican administrations, the issue was never a political priority. This is partly related to investors and financial regulators' lack of focus on the financial-related risks of climate change. The escalating financial risks of climate change have affected political approaches to the issue, with the Biden Administration closely tracking scientific and investor approaches to climate...