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Sustainability Matters

2 Takeaways About the SEC’s Proposed Climate Disclosure Rule

U.S. asset managers’ comments reveal broad support but also deep concerns in some key areas.

Public policy advocacy is an important part of an asset manager’s active ownership strategy. Asset managers recently had a key opportunity to influence U.S. climate policy as the SEC invited comments on its proposed rule for corporate disclosures of climate-related information.

Climate-related risks have increasingly become important for companies within many industries. As such, disclosures in this area are financially material and a key aspect of investor decision-making—a point emphasized in Morningstar’s own response to the SEC.

U.S. sustainable fund assets have grown rapidly in recent years—an average 30% per year from the end of 2018 through the end of June 2022, even accounting for the fall in total assets in a turbulent year to date.

It stands to reason, then, that asset managers with growing amounts of assets in strategies committed to addressing the climate crisis should be keen to engage with regulators like the SEC in setting guidelines for corporate disclosures on climate change. Our latest research bears this out.

With the SEC’s comment period now closed, we analyzed the responses of the 10 largest U.S. fund asset managers: Vanguard, BlackRock, Fidelity Investments, Capital Group, State Street Global Advisors, T. Rowe Price, Invesco, J.P. Morgan, Franklin Templeton, and Dimensional.

Table of the top 10 U.S. asset managers by fund assets, showing levels of involvement in climate policy and engagement.The top 10 U.S. asset managers, ranked by fund assets sourced from Morningstar Direct, show varying levels of involvement in climate policy and engagement. - source: Morningstar Analysts

Eight of the 10 managers have engaged directly with the SEC on the proposed climate disclosure rule. All these respondents agree with the SEC that consistent, comparable, and reliable information on climate-related financial risks and financial metrics is important to allow investors to make informed investment decisions.

However, respondents also have significant concerns in some important areas. Here, we take a closer look at two of the key themes.

1) What Is the Definition of Materiality?

The SEC’s proposed climate disclosure rule would require companies to disclose “whether any climate-related risk is reasonably likely to have a material impact on a registrant, including its business or consolidated financial statements, which may manifest over the short, medium, and long term.”

The top 10 asset managers expressed broad concern over what the exact definition of “material” would be for these purposes.

Materiality is a central point of discussion in international consultations on the future of climate and sustainability reporting standards, so it is not surprising to see it emerge as a key issue here.

A majority of the top 10 asset managers—and the Investment Company Institute, an association of investment managers representing over USD 30 trillion in assets—note that the proposed rule appears to deviate from the materiality definition long-established by the U.S. Supreme Court.

Under the Supreme Court’s definition, a fact is material “if there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision or if it “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” to the shareholder.

The Investment Company Institute summarizes its objection this way:

“By requiring companies to disclose in SEC filings information that the SEC believes to be ‘decision-useful’ without regard to whether the information is material to the company, the commission would undermine the important protections provided by the traditional materiality standard. … A departure from this standard will expose companies to unnecessary litigation risk.”

Much of this concern relates to proposals to require some companies to disclose indirect greenhouse gas emissions known as scope 3 emissions (discussed below).

But there are also broader concerns that the proposed rule requires companies to make certain climate-related disclosures regardless of their materiality. Some respondents are concerned that this would be detrimental to investors, as it could make it harder to find useful, decision-relevant information amid the wealth of data presented.

2) Scope 1, 2, and 3 Emissions: What Should Be Disclosed?

The proposed rule would require all public companies to provide mandatory disclosures of direct greenhouse gas emissions (scope 1) and indirect greenhouse gas emissions from purchased electricity (scope 2).

Disclosures of all other indirect greenhouse gas emissions in a company’s value chain (scope 3) would also be required if those emissions are material, or if the company has set an emissions reduction target that includes scope 3 emissions.

Definitions of Scope 1, 2 and 3 greenhouse gases.Greenhouse gas emissions are defined according to three different scopes, according to the SEC's proposed climate rule and the Greenhouse Gas Protocol. - source: Morningstar Analysts

All the respondents in the top 10 agree that disclosures of scope 1 and scope 2 emissions are necessary. Most also believe that such disclosures should be mandatory for all public companies.

Dimensional is a noteworthy dissenter: It believes that scope 1 and scope 2 disclosures should be mandatory only for public companies exposed to material climate risk, on the grounds that “the costs of requiring companies to disclose specific climate-related information will be high and may not necessarily benefit investors.”

It’s the proposal to mandate disclosure of scope 3 greenhouse gas emissions that receives the strongest opposition from the top 10 asset managers. Such disclosures are widely seen as premature because reliable measurement methodologies for scope 3 emissions (which necessarily overlap with the scope 1 and scope 2 emissions of other reporters, raising the risk of double counting) are still being developed.

The Investment Company Institute’s comment letter reflects the views of most of the top 10 asset managers when it states:

“A large majority of our members believe that the commission should not require companies to report scope 3 emissions at this time, because of significant data gaps and the absence of agreed-upon methodologies to measure scope 3 emissions. These deficiencies seriously undermine the ability of most companies to report consistent, comparable, and verifiably reliable data.”

Capital Group is an exception here. It favors mandatory scope 3 emissions disclosures for larger companies, viewing these as “a necessary supplement to scope 1 and scope 2 [greenhouse gas] emissions data.”

What Comes Next for the Climate Rule?

Asset managers’ concerns over materiality and scope 3 disclosures—as well as on climate-related board expertise, which we cover in greater depth in the report—will no doubt give the SEC much to think about as it finalizes its proposed rule.

Notably, the SEC’s consultation on climate disclosures comes alongside similar consultations from European and international standard setters which will close for comment within the next few weeks. Given that asset managers and asset owners are keen to realize a “global baseline” of harmonized climate and sustainability standards, the SEC’s next move will be important in determining whether they get their wish.