U.S. securities and exchange commission issues guidance - when companies must report climate change risks

The U.S. Securities and Exchange Commission (SEC) finally put years of public outcry and speculation to rest with the release of an interpretive guidance document explaining how publicly traded companies are expected to assess and disclose business risks associated with climate change. The Commission voted 3-2 in favor of the guidance document that formally explains when, and to what extent, publicly traded companies must disclose environmental risks and liabilities associated with climate change to the SEC and shareholders. The SEC's decision marks a noticeable difference in the Commission's receptiveness to climate-related investment requirements from the previous administration, which has been criticized for taking a hands-off regulatory approach before the current financial crisis.

SEC regulations require publicly traded companies to disclose material risks to their businesses in certain SEC filings, which are intended to inform investors of a company's financial condition. Specifically, companies must disclose material changes to the business, material legal proceedings, and analysis of known trends, uncertainties, and financial conditions that could materially affect operations. The law has not changed, but the SEC’s interpretation of the law has.

While the SEC's decision is significant, it was not unexpected and is in line with the global trend in favor of requiring companies to disclose environmental and climate change risks. Prior to this decision, many contended that it was unclear whether environmental and climate change factors constituted “material risks” that had to be disclosed in SEC filings.

However, one can trace back the steps leading up to this decision over the past three years and realise that this decision was inevitable. CERES, a network of institutional investors, environmental organizations and public interest groups, issued a report in June 2009 finding that 'about 76 percent of Standard & Poor's 500 companies failed to mention climate change in their annual reports to the commission last year.' Less than 10 percent of companies discussed climate change in 2008 Form 10-K, the report said. The report analyzed more than 6,000 Form 10-K filings by Standard & Poor's 500 companies between 1995 and 2009 and found what it termed 'an alarming pattern of non-disclosure by corporations regarding climate change.'

Shortly after the CERES report, a collection of investor advocacy groups, state treasury departments and environmental groups wrote a letter calling for the SEC to address a corporation’s duty to disclose climate change and other environmental, social and governance risks in securities filings. The SEC had refused to take such steps after receiving a similar letter in 2007. However, with a new administration in the White House, this time the SEC issued a response saying it would take a “hard look” at whether climate change risks should be addressed in SEC filings. The SEC has taken a hard look and has now formally explained what it expects from companies in terms of disclosing climate change risks.

For European companies, this is nothing new. The Modernisation Directive (2003/51/EC) imposes a duty on European-listed companies to include environmental and other non-financial performance indicators in their annual reports. While many countries have provided exceptions to this general rule based on revenue or number of employees, other counties such as France and the United Kingdom extend reporting duties beyond purely environmental risks and require publicly listed companies to address social and community issues in their annual reports. One notable characteristic of France’s reporting law (arguably the strictest in the world) is that all companies listed on the French Stock Exchange must address environmental risks for all countries where the company operates, not just in France.

Other countries around the world are in the process of developing or expanding corporate reporting laws to address environmental and climate change risks. For example, the Costa Rican government is considering a law that would require companies to annually report the measures it takes to protect the environment and to improve the quality of life for its workers and the surrounding community. As proposed, the Draft Law on Corporate Social Responsibility (Propuesta de Ley Marco de la Responsabilidad Social Empresarial) would require all companies operating in Costa Rica with 200 or more employees to undergo an external audit to determine a company’s social balance, which would be publicly reported along with a company’s annual economic accounts. Japanese companies can also expect to see corporate environmental reporting requirements in the near future. Under the Law on the Promotion of Environmental Reporting for Specific Industries only public entities are required to submit annual environmental reports at this time. However, as the duty to disclose environmental risks becomes
the rule rather than the exception, Japanese companies can reasonably expect to see environmental reporting requirements extend to the private sector sometime soon.

Considering the data from the CERES report mentioned above, the SEC’s ruling means that over 75 percent of U.S. publicly traded companies must now begin considering and disclosing climate change risks as they pertain to corporate profitability. This may require companies to adopt procedures and methods for assessing risks and liabilities from climate change in addition to the environmental risks they currently consider, and may lead to further competitiveness between companies to present a more environmentally secure business structure in terms of attracting investment. For those companies who have not considered climate change risks in SEC filings yet, they must begin taking their own “hard look” from a corporate profitability perspective at how climate change will impact them.

For those who would like to know more about the SEC’s new stance on corporate environmental reporting requirements and other environmental and sustainability reporting programs from around the world, Enhesa will be presenting a full discussion of the topic at an upcoming webinar – “Sustainability Reporting - It's the Law.” The webinar will take place 6 May 2010 (9:00 AM EST) and 11 May 2010 (11:00 AM EST). To register or to receive more information, e-mail or call Maria Panteris at webinars@enhesa.com or +1 202.552.1090.

Enhesa also has consulting services available to help assess how well your liability management system is prepared for this new financial reporting requirement and how it might impact issues such as SOX reporting, contaminated properties reserves reporting, and FIN 47 liabilities. To discuss how Enhesa can help you evaluate your preparedness to assess and report climate change related liabilities, contact Gaye van der Eerden at gv@enhesa.com or +1 202.552.1090.

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