CFA Institute Responds to SEC Proposal on Climate-Related Disclosures: 5 Key Takeaways

CFA Institute has issued a comment letter responding to the US Securities and Exchange Commission’s Proposed Rule The Enhancement and Standardization of Climate-Related Disclosures for Investors (The Proposal). In formulating our response, we take the perspective of long-equity investors seeking to obtain value relevant information for effective investment decision making. Below are five abbreviated takeaways from our letter that highlight specific views in response to the Proposal as well as select ancillary points.

One: Disclosures Outside Financial Statements:  Climate-Related Risks, Risk Management & Governance, Impact on Strategy, Business Model & Outlook

• • We support disclosures in a separate section of documents filed with – as opposed to furnished to – the SEC. 
  • We support disclosure of climate-related risks and opportunities, noting there will be likely more disclosure of risks than opportunities. We believe incorporation of time horizons into materiality assessments is useful and that a requirement to describe materiality conclusions is unique, but welcome. 
  • We support disclosures on risk management, governance, and the impact on strategy, business model & outlook and would like to see similarly detailed requirements for other risks.
  • We support physical risk disclosures and present several suggested improvements to facilitate investors understanding of the risk of loss to the registrant.   
  • We support commitment, target, and goals disclosures, believing they likely will result in more meaningful transition disclosures. Such commitments and targets are important in crystallizing a company’s transition path.
  • We are concerned that many of the climate-related disclosures will be qualitative – including impact disclosures – and, therefore, believe enforcement will be key to ensure company specificity.
  • We are concerned by the lack of disclosure regarding the cost of reducing GHG emissions since such emission metrics will need to be translated from non-financial metrics to financial impacts for investment decision-making – making such disclosures more useful to sophisticated investors.
  • We are disappointed by the lack of a requirement to make sensitivity analysis disclosures.   
  • We believe the SEC must consider longer-term implications of basing disclosures on a current snapshot of the Task Force on Climate-Related Financial Disclosures (TCFD) framework.
  • We believe that the provision of climate-related definitions in the SEC rules for disclosures outside the financial statements will create many interpretive issues because they are also being required to be incorporated into disclosures within the financial statements. This increased scrutiny due to the incorporation within financial statements will, in the end, increase clarity regarding the use of similar terms globally. 

Two: Disclosures Outside Financial Statements:  GHG Emissions

• • We support disclosure of Scope 1 and 2 emissions, and intensity metrics, using definitions of greenhouse gases as CO₂, CH₄, N₂O, NF₃, HFCs, PFCs, and SF₆ as well as using CO₂ equivalent as the accepted standard.
  • Acknowledging the challenges, we support mandatory, not voluntary, disclosure of Scope 3 emissions noting:
    • they are likely the most material emissions; as such, their relevance supersedes perfect reliability;
    • disclosure as a range to reflect estimation uncertainty is preferred, along with safe harbor provisions; and
    • transition by most significant industries and largest registrants first would be reasonable.
  • We support disaggregation of GHG emission disclosures by scope, type of GHG within scope, location, geography, segment, and upstream and downstream category. We support a visual display of disaggregation.
  • We believe comparative period disclosures can be built on a go forward basis.
  • We support a reporting period and deadline consistent with Exchange Act rules and we do not oppose estimations or lags.
  • Although historically we have not supported initial application of disclosure requirements by size of registrant or staggered adoption dates, as it relates to GHG emissions, particularly Scope 3, we see support for transition relief mechanisms.
  • We believe the SEC must consider the implication of effectively endorsing the GHG Protocol as the GHG emissions disclosure standard. It makes the organization a shadow standard setter. We are concerned that many interpretive issues are likely to arise and have questions around the SEC’s role in these interpretations. 
  • We support attestation (i.e., or transition to higher levels of assurance) of Scope 1 and 2 emissions as it will likely result in a more reliable number. However, given there is no disclosure of the cost to the registrant of reducing these audited GHG emissions, their use in assessing the financial impact to the enterprise is reduced by the measurement uncertainty of investors estimating the cost of reducing the emissions.  Said differently, multiplying a perfectly reliable GHG emission by a highly uncertain cost of reducing the GHG emission will produce an uncertain impact on the registrant.   
  • We believe that attestation providers of all types should be held to the same level (e.g., PCAOB level) of professional and attestation standards.

Three: Disclosures Inside Financial Statements: Financial Statement “Metrics”

• • We support anchoring disclosures outside financial statements with disclosures within financial statements; though unique to the US, this requirement would increase quality of disclosures globally.
  • We are concerned that new climate-related terms will create significant interpretative issues given their use to identify, capture, record, and report transactions within financial statements. That said, this very issue will bring attention to and focus on the terms which will eventually result in increased clarity.
  • We believe the financial impact metrics proposed are really elements of financial statement captions rather than metrics per se.
  • We believe the disaggregation level proposed would be supported by investors for many types of disclosures.
  • We do not believe the proposed metrics provide meaningful information as they are accrual not cash-based, backward-looking, and we do not believe they are cohesive with each other. 
  • We prefer cash-based metrics as they are more decision-useful and relatable to climate-related risks disclosed outside financial statements.
  • We seek disclosure of the quantitative impacts of changes in estimates and assumptions as they would provide greater indication of variability of estimates. 
  • We support initial disclosure of cash-based metrics outside the financial statements, transitioning to inclusion within financial statements once reliability is improved.
  • We support comparative period metrics being developed on a go forward basis. 
  • In our opinion, metrics will likely never capture value chain climate-related impacts as they will not be provided by suppliers. 
  • We believe the SEC must recognize the need to balance a complement of financial reporting improvements in addition to climate disclosures.
  • We believe that data inside and outside the financial statements must be tagged for machine readable consumption.

Four: The Needed Link: Industry Based SASB/ISSB Standards

• • We foresee significant challenges with the proposed SEC requirement to discuss the relationship between financial statement metrics, GHG emission metrics, and the description of risks, their management and governance, and their impact on the registrants’ strategy, business model and outlook.  We foresee this as challenging because: a) GHG metrics will be non-financial – with no financial cost to reducing them provided; b) the discussion of risks and their impact will likely be highly qualitative; and c) the financial statement metrics will be accrual based and backward-looking. 
  • We have proposed: a) the development of cash-based financial impact metrics that can be more closely related to climate-related risk disclosures provided outside of financial statements; b) quantitative disclosure of changes in estimates and assumptions that provide an indication of the future variability of cash flows; and c) the inclusion of industry-based SASB (soon to be ISSB standards) which highlight drivers of future performance and would provide a link between disclosures inside and outside of financial statements.   

Five: Proposed Path Forward – In our response, we have suggested a path forward inclusive of the SEC disclosures we support, our preferred cash-based financial statement impact metrics, and the adoption of industry-based SASB (soon to be ISSB) standards. Our proposed path forward also, because of the importance of the disclosures, supports a level of flexibility for registrants – as to the disclosures that need to be made (e.g., Scope 3), transition dates, location of the disclosures, and the need for comparative periods – that we have not traditionally supported. In our full letter we provide a table with our proposed disclosures and transition dates.