• The SEC on Monday unveiled a proposal to expand the climate-related disclosures that companies make. Officials think it will help investors make more informed decisions.
• Commissioner Allison Herren Lee called climate risk "one of the most momentous risks to face capital markets since the inception of this agency."
• If adopted, the rule could directly impact individuals who buy company stock and corporate bonds. It may indirectly affect investors in mutual funds and ETFs, pensioners and society more broadly.

The Securities and Exchange Commission on Monday unveiled a sweeping proposal to expand investors' insight into the threat that climate change poses to public companies and how they contribute to a warming planet.

If adopted, the proposal would have a far-reaching impact across the spectrum of investors, according to legal and financial experts.

Here's what investors need to know about the 510-page rule.

What is it?

The SEC proposal concerns disclosures that all publicly traded companies make to investors on a regular basis.

The agency is trying to require a minimum level of climate-related reporting as part of this disclosure framework.

The title of the proposed rule — "The Enhancement and Standardization of Climate-Related Disclosures for Investors" — outlines its broad goal.

Why is the SEC doing this?

The SEC requires publicly traded companies to be transparent about risks and other information they deem "material" to the firm. That can encompass a broad range of items, from cybersecurity risk to geopolitical risk, for example.

Such disclosures are the backbone of the agency's regulatory regime, according to Erin Martin, partner at the law firm Morgan Lewis and a former attorney at the SEC.

Investors use the reports to assess a company's financial health and governance, for example, which in turn impact decisions to buy, hold or sell a company's stock or bonds.

SEC officials say they're responding to investor demand for transparency around climate-change risk — which Commissioner Allison Herren Lee on Monday called "one of the most momentous risks to face capital markets since the inception of this agency."

Human-caused climate change has fueled hotter temperatures and drier conditions across the world, and scientists widely believe it's contributing to worsening disasters like hurricanes, wildfires and heatwaves. The last seven years have been the hottest on record.

That can affect companies in the form of credit risk, market risk, insurance or hedging risk, operational risk, supply-chain risk, reputational risk and liquidity risk, among others, Lee said.  

Not all officials agree, though. Commissioner Hester Peirce, who voted against the proposal, thinks it oversteps the SEC's authority and places the interests of environmental activists ahead of other shareholders, among other criticisms.

"[The proposal] forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company's climate reputation is of equal or greater importance than a company's financial performance," Peirce said.

The SEC approved the proposed rule in a 3-1 vote.

What types of disclosures?

The proposal would require many tranches of disclosure.

For example, companies would have to detail the impact of "physical" risks (such as a severe ice storm or hurricane) on their bottom line, and which properties and operations are subject to those risks, SEC commissioner Caroline Crenshaw said.

They'd also answer questions like: How might future hurricane seasons impact the company's business in the short, medium and long term? she said.

Companies would also need to disclose "transition" risks. For example, how easily might a company adapt to a less-carbon-intensive economy, or insulate its business from physical risks?

Companies that made climate targets or commitments would have to disclose those, and their plans to achieve them.

They'd also disclose their greenhouse-gas emissions, both direct (from sources owned or controlled by the company) and indirect (from electricity and energy used by the company).

Some (but not all) would report a third tier of emissions further down the supply chain (in the production and transportation of goods from third parties, or employee commuting or business travel, for example).

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Emissions data, which would be reviewed by a third party, helps investors understand how revenues and expenses may be impacted as the U.S. transitions to a lower-emissions economy, and offer insight into how companies are meeting climate pledges, SEC officials said.  

"Climate risk is not unlike any other risk that can affect a company's performance," said Dylan Bruce, financial services counsel for the Consumer Federation of America, an advocacy group.

OK, great. But is this a big deal?

Yes. Currently, companies tell investors about climate risk if they think it's material.

About a third made some type of disclosure in 2019 and 2020, according to SEC chair Gary Gensler. Others may do so outside the SEC's jurisdiction, perhaps in sustainability reports, experts said.

But the proposed rule asks all public companies to provide this type of disclosure.

"It's not a company-by-company determination," Martin said. "The SEC is saying it believes all this information is material information companies should be providing to the general public."

Companies also don't necessarily know what information to report now — meaning its scope, specificity and reliability varies, and investors don't get uniform data, Crenshaw said.

What does this all mean for investors?

The rule's impact goes beyond individuals who buy a company's stock, experts said.

For example, asset managers who pick stocks and bonds for mutual funds and exchange-traded funds, and institutions that oversee pensions and endowments, may opt to limit holdings in a company that appears overexposed to climate risk. These sorts of decisions may indirectly impact millions of investors.

"It's not just climate-aware funds — it's all funds," said Jon Hale, the global head of sustainability research at Morningstar. "I can't talk to an asset manager today who says they're not concerned about climate at all. No one says that."

Even index-fund managers who don't actively pick stocks and bonds will have more ammunition to influence change at companies, he said.

Index-fund providers like Vanguard Group and BlackRock are big shareholders in public companies, and can leverage that power to sway managerial decisions during shareholder meetings if they feel companies aren't doing enough to address climate risks, for example, Hale said.

Might there be an impact beyond investing?

There could be a bigger knock-on environmental and societal effect, experts said.

The SEC's purview is the realm of investing. But there could be an inadvertent public-relations aspect to the disclosure requirements, for example. Might a big greenhouse-gas emitter redouble efforts to rein in their carbon footprint, fearing public blowback for its emissions disclosures?

It's too soon to tell, but this is just one of the potential cascading effects of the rule, experts said.

When does it take effect?

Not for a while.

The proposal kick-started a 60-day period of public comment. The SEC will then assess feedback and incorporate it into a final version of the rule. If a final rule takes effect in December this year, the largest public companies would start reporting in 2024, and the smallest in 2026, according to the SEC.

But even that timeframe may be delayed by a lawsuit, which is a near certainty, experts said.